Capital Gains Tax on Inherited Property: What Heirs Owe When They Sell

The rule: you start from the value at death

Your gain on selling inherited property is the sale price, minus selling costs, minus your basis. Under IRC 1014(a), that basis is the property's fair market value on the date of death, not what the decedent paid. Decades of appreciation, and the depreciation a landlord parent claimed, drop out of the calculation for income tax purposes. Two further rules help heirs:

• Long-term automatically. IRC 1223(9) treats inherited property sold within a year of death as held more than a year, so any gain gets long-term rates.
• Gain or loss from the new starting point. If the market drops after death and you sell below the stepped-up value, the result can be a capital loss, provided you did not convert the property to personal use.

In our first example the heir sells four months after death for $60,000 more than the date-of-death value, pays $35,000 in costs, and owes $6,075 on a $25,000 gain. Had the parent sold the same house while alive, even after a $250,000 home sale exclusion, the tax would have been $135,451.

Proving the stepped-up value

The step-up is only as solid as the number behind it. Get a date-of-death appraisal from a qualified appraiser, even when no estate tax return is due; an appraisal ordered years later and backdated is far easier to challenge. For a house sold soon after death, an arm's-length sale price is itself strong evidence of value.

When an estate tax return (Form 706) is required, IRC 1014(f) adds a basis consistency rule: your basis cannot exceed the value finally determined for estate tax. The executor reports those values to the IRS and to each beneficiary on Form 8971 and Schedule A, due 30 days after the Form 706 is due or filed (Form 8971 instructions, 2025). Form 8971 is not required when a return is filed only to elect portability for a surviving spouse. Final regulations under Section 1014(f) were issued as T.D. 9991 in 2024 (IRS Publication 551).

Because the federal basic exclusion is $15,000,000 per person for 2026 (IRC 2010(c)(3) as amended by P.L. 119-21), most estates file no Form 706, and heirs rely on the appraisal alone.

Alternate valuation: the six-month date

The executor can elect under IRC 2032 to value all estate property six months after death instead. Property sold or distributed within those six months is valued on the date of sale or distribution. The election is allowed only if it lowers both the gross estate and the estate tax (IRC 2032(c)), so it is available only to taxable estates, and it lowers the heirs' basis along with the estate tax. For a falling market it trades a lower estate tax at 40% (IRC 2001(c), 2026) for a lower basis and potentially more capital gain later.

Spouses: community property versus joint tenancy

How a married couple holds title decides how much basis the survivor gets. For spouses holding property as joint tenants, only the decedent's half is included in the estate (IRC 2040(b)), so only that half is stepped up. The survivor's own half keeps its original basis.

Community property is treated better. Under IRC 1014(b)(6), the surviving spouse's half also gets a new basis, as long as at least half of the community interest was included in the decedent's estate. IRS Publication 555 lists the nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Alaska, Tennessee and South Dakota allow couples to opt in by agreement or trust; Publication 555 does not address the federal result of those elections.

Our cabin example shows the stakes. Held in joint tenancy, the widow's sale produces a $550,000 gain and $166,007 of tax. Held as community property, the same sale produces a $50,000 gain and $12,150 of tax. A widow selling the couple's home also gets a $500,000 exclusion instead of $250,000 if she sells within two years of the death (IRC 121(b)(4)).

What does not get a step-up

IRC 1014(c) denies a step-up to income in respect of a decedent (IRD), income the decedent earned but had not yet been taxed on. Heirs pay ordinary income tax on it when they collect, with a possible deduction for estate tax attributable to it under IRC 691(c). Common IRD items:

• Traditional IRAs, 401(k)s and other pretax retirement accounts.
• An unpaid installment note from a sale the decedent made: the deferred gain passes to the heirs (IRC 691(a)(4)). See the installment sale analysis.
• Accrued but unpaid wages, bonuses and deferred compensation.

Two other traps: under IRC 1014(e), if you give appreciated property to someone who dies within one year and it comes back to you or your spouse, there is no step-up. And suspended passive losses on an inherited rental are allowed on the decedent's final return only to the extent they exceed the step-up (IRC 469(g)(2)).

Gifts get carryover basis instead

Parents sometimes deed a house or land to children before death to avoid probate. For income tax that is usually costly. Under IRC 1015(a), the recipient of a gift takes the donor's basis, so all the built-in gain comes along. If the property is worth less than the donor's basis at the time of the gift, the basis for figuring a loss is the lower fair market value.

In our third example, the heir who received the house as a lifetime gift and sold it pays $243,702, versus $6,075 if the same house had been inherited. A revocable living trust usually avoids probate and keeps the step-up, because the trust assets are still included in the estate. The step-up at death hold analysis covers the owner's side of that decision, and gifting before a sale covers when a gift still makes sense.

Selling soon, renting it out, or moving in

Most heirs sell within a year or two. The gain is small if the sale price is close to the date-of-death value, and any gain counts as long-term. Keep track of costs that raise basis or reduce the amount realized: commissions, transfer taxes, title fees and repairs made to sell.

Renting the property first changes the math: you depreciate it from the stepped-up value, and that depreciation is taxed at up to 25% as unrecaptured Section 1250 gain when you sell (IRC 1(h), 2026). Moving in can let you use your own home sale exclusion after you have owned and lived in it for two of the five years before the sale (IRC 121). For larger inherited land or rentals, a 1031 exchange or seller financing can defer gain that has built up since death. See also capital gains tax on a land sale and our California capital gains guide. If an inherited property is large or mixed with other estate assets, get the Big Sale Tax Analysis to model each path.

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