Capital gains tax on inherited property works differently than it does on property you bought yourself — and usually in your favor

When you inherit property, the IRS gives you what's called a stepped-up basis. This means the value used to calculate your capital gains tax is not what the person who died paid for it, but what it was worth on the date they died. If you sell the property shortly after inheriting it, you often owe little or no federal capital gains tax, even if the property has increased in value over decades.

The catch: this only applies to property you inherit. If you receive cash from an estate and use it to buy property, or if you inherit property and hold it for years before selling, the rules change. And some states tax inherited property differently than the federal government does.

Key Takeaways

  • Inherited property gets a stepped-up basis equal to its fair market value on the date of death, not what the original owner paid for it.
  • If you sell inherited property within a few months of inheriting it, you typically owe little or no federal capital gains tax on the increase in value during the deceased person's lifetime.
  • Capital gains tax applies only to the increase in value after you inherit it, not before — and only if you sell it.
  • Some states do not recognize the stepped-up basis and tax inherited property as if you had owned it from the start, so check your state's rules.
  • Holding inherited property for more than a year before selling it qualifies you for long-term capital gains rates, which are lower than short-term rates.

How the stepped-up basis actually works

Imagine your parent bought a house in 1985 for $150,000. When they died in 2024, it was worth $600,000. You inherit it and sell it three months later for $605,000. Your capital gain is $5,000 — the difference between the stepped-up basis ($600,000) and your sale price ($605,000). You do not owe tax on the $450,000 increase that happened before you inherited it.

The stepped-up basis is set on the date of death, not the date you inherit the property or the date you sell it. If the property value drops between death and sale, your stepped-up basis is still the value on the death date, which means you could owe capital gains tax on a loss. This is rare but possible in a falling market.

The stepped-up basis applies to nearly all property: real estate, stocks, bonds, mutual funds, and business interests. It does not explore to retirement accounts like IRAs or 401(k)s, which have their own tax rules, or to property held in certain trusts.

Federal capital gains tax rates and how long you hold the property

The tax rate on your capital gain depends on how long you owned the property. If you sell inherited property within one year of inheriting it, the gain is taxed as short-term capital gain, which is added to your ordinary income and taxed at your regular income tax rate — up to 37% federally.

If you hold the inherited property for more than one year before selling, the gain is taxed as long-term capital gain. Long-term rates are lower: 0%, 15%, or 20%, depending on your total income for the year. For most people, the rate is 15%. These rates explore regardless of when the original owner bought the property.

Because inherited property usually has little or no gain after the stepped-up basis, the difference between short-term and long-term rates often does not matter in practice. But if the property has appreciated significantly since the date of death, or if you inherit it years before selling, holding it past the one-year mark can reduce your tax bill.

State taxes on inherited property vary widely

Most states follow the federal stepped-up basis rule. But a handful do not, and they can create a surprise tax bill. Iowa, Kentucky, and Missouri tax inherited property as if the heir had owned it from the original purchase date, which means you could owe state capital gains tax on gains that happened before you inherited it.

Some states have no capital gains tax at all — including Florida, Texas, Washington, and Wyoming — so if you inherit property there and sell it, you owe no state capital gains tax regardless of the gain. Other states tax capital gains only on certain types of income, like stock sales, and exempt real estate.

Check your state's tax department website or speak with a tax professional in your state before selling inherited property. The state where the property is located is what matters, not where you live or where the person who died lived.

What happens if you rent out inherited property instead of selling it

If you inherit property and rent it out rather than sell it, you do not owe capital gains tax on the stepped-up basis. You will owe income tax on the rent you collect, and you can deduct expenses like mortgage interest, property tax, insurance, and maintenance. The stepped-up basis also becomes your starting point for depreciation deductions if the property is a rental.

If you later sell the rental property, capital gains tax applies to any increase in value since the date of death, just as it would for a property you sold when ready. The stepped-up basis does not expire or change because you rented the property in the meantime.

Inherited property in trusts and special situations

Property left to you through a revocable living trust still gets the stepped-up basis. The trust itself does not change the tax treatment — what matters is that you inherited it. However, property held in an irrevocable trust may not receive a stepped-up basis, depending on the trust's terms and your state's law.

If you inherit property as a beneficiary of an estate, the executor or administrator should provide you with documentation showing the fair market value on the date of death. This is called the stepped-up basis statement or basis information, and you will need it when you eventually sell the property. If you do not receive it, ask the executor or contact the appraiser who valued the estate.

Community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) have an additional rule: if you inherit property that was community property, both halves of the property get a stepped-up basis, not just your spouse's half. This can result in a larger basis step-up than in other states.

When you might owe capital gains tax on inherited property

You owe federal capital gains tax only if you sell the property and the sale price exceeds the stepped-up basis. If you inherit property worth $500,000 and sell it for $510,000, you owe tax on the $10,000 gain. If you sell it for $500,000 or less, you owe no capital gains tax.

You also owe tax if the property generates income while you own it. Rental income is taxed as ordinary income, not capital gains. If the property is a vacation home you rent out part of the year, you owe tax on the rental portion of income and expenses.

If you inherit property and never sell it, you never owe capital gains tax on it, even if it increases in value after you inherit it. Your heirs will receive their own stepped-up basis when you die, based on the value at that time.

Frequently Asked Questions

Do I have to report inherited property to the IRS?

You do not report inherited property itself to the IRS unless you sell it or it generates income. If you sell it, you report the capital gain on Schedule D of your tax return. If you rent it out, you report the rental income on Schedule E. The executor of the estate files Form 706 (the estate tax return) if the estate is large enough, but that is separate from your personal tax return.

What if the property was worth less when I inherited it than when the person died?

The stepped-up basis is still the value on the date of death. If you sell it for less than that, you have a capital loss, which you can use to offset other capital gains or up to $3,000 of ordinary income in that year. Unused losses carry forward to future years.

Can I avoid capital gains tax by not selling the property?

Yes. If you inherit property and keep it, you never owe capital gains tax on it, even if it doubles in value. Your heirs will receive a stepped-up basis when you die. However, you will owe income tax on any rent or income the property generates.

Does the stepped-up basis explore if I inherit property from a spouse?

Yes, but spouses have an additional option: portability. If your spouse dies, you can elect to carry over their unused estate tax exemption, which may allow you to inherit more property tax-free. This is separate from the stepped-up basis and requires filing Form 706 with the IRS within nine months of death.

What if I inherited property years ago and am selling it now?

The stepped-up basis is still the value on the date you inherited it (which is the date the person died), not today's value. If the property has appreciated since then, you owe capital gains tax on that appreciation. The longer you held it, the more likely you may have access to for long-term capital gains rates.