You can claim a capital loss on inherited property, but only if you held it as an investment rather than for personal use. The loss is the difference between the property’s fair market value on the date of death (your “stepped-up basis”) and what you sold it for. It’s automatically a long-term capital loss, it first offsets capital gains, and up to $3,000 of any excess ($1,500 if married filing separately) can reduce ordinary income each year, with the rest carrying forward until used up.1Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses
How the Loss Is Measured
Your basis in inherited property is not what the deceased person paid. It resets to fair market value on the date of death, under Section 1014 of the Internal Revenue Code.2Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent Fair market value is what a willing buyer and willing seller would agree on, usually established by a professional appraisal dated near the death.3eCFR. 26 CFR 1.1014-1 – Basis of Property Acquired From a Decedent
If a parent bought a house for $100,000, it was worth $400,000 the day they died, and you sold it for $375,000, your loss is $25,000. Any outstanding mortgage on the property does not reduce your basis.
One wrinkle to check before you calculate anything: the executor may have elected to value the estate as of six months after the date of death instead of the date of death itself. This “alternate valuation date” is available only when it lowers both the estate’s total value and its estate tax, and the choice is irrevocable once made on the estate tax return.4GovInfo. 26 USC 2032 – Alternate Valuation If it was elected, your basis is the value on that later date, which could be lower and shrink your loss. Ask the executor which date was used.
The Personal-Use Rule Decides Everything
This is the single biggest factor. Federal law lets individuals deduct losses only from a trade or business, a transaction entered into for profit, or certain casualty and theft events.5Office of the Law Revision Counsel. 26 USC 165 – Losses A loss on personal-use property is not deductible.
If you move into the inherited house, even briefly, it becomes personal-use property and any later loss is gone. The same result if you let a family member stay there rent-free. To keep the property on the investment side of the line, show intent to profit: list it for sale promptly, market it actively, or rent it to tenants at market rent.6Internal Revenue Service. Publication 544 – Sales and Other Dispositions of Assets
Document what you did. Listing agreements, correspondence with agents, utilities kept in the estate’s name rather than yours, and any lease all help if the IRS questions the deduction.
If You Used It Personally First, Then Rented It Out
You can still deduct a loss after converting personal-use property to rental use, but the deductible amount is limited. Your loss is measured from the lower of two figures: your stepped-up basis, or the property’s fair market value on the date you converted it to rental use.6Internal Revenue Service. Publication 544 – Sales and Other Dispositions of Assets From that starting point, add any improvements made after the conversion, subtract depreciation you claimed or should have claimed, and compare the result to the sale price.
Say you inherited a home with a $300,000 basis, lived there a year, then converted it to a rental when its value had dropped to $270,000. After five years you claimed $35,000 in depreciation and sold for $220,000. You start from $270,000, not $300,000. Subtract $35,000 of depreciation to get $235,000, then subtract the $220,000 sale price. The deductible loss is $15,000, not $45,000.6Internal Revenue Service. Publication 544 – Sales and Other Dispositions of Assets
Selling to a Relative Kills the Deduction
Even if the property is a clean investment, selling it to a related party wipes out the loss. Federal law disallows losses on sales between family members, which for this purpose includes your spouse, siblings (including half-siblings), parents, grandparents, children, and grandchildren.7Office of the Law Revision Counsel. 26 USC 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers It also covers sales between an individual and a corporation or trust they control.
The disallowance applies even at a genuine market price. Sell an inherited property with a $400,000 basis to your daughter for its actual $350,000 value, and the $50,000 loss is gone. To keep the deduction, sell to an unrelated buyer. A sale between an estate’s executor and a beneficiary of that estate counts as a related-party transaction too, with a narrow exception for a sale that satisfies a specific dollar bequest in the will.7Office of the Law Revision Counsel. 26 USC 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers
Always Long-Term, Even If You Sell Right Away
Inherited property is treated as held for more than one year no matter when you sell it, so any loss is a long-term capital loss.8Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property That classification matters for how losses combine on your return. Long-term losses first offset long-term capital gains, then short-term gains, and only the remaining excess goes against ordinary income.
The $3,000 Annual Cap and the Carryover
When your capital losses for the year exceed your capital gains, only $3,000 of the excess can reduce ordinary income (wages, retirement distributions, and the like). The limit is $1,500 for married filing separately.1Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses
Anything left over carries forward to the next year and keeps carrying forward with no expiration date.9Office of the Law Revision Counsel. 26 USC 1212 – Capital Loss Carrybacks and Carryovers A $30,000 loss on inherited property could take a decade to use up at $3,000 a year if you have no capital gains along the way. Track the remaining balance each year on Schedule D so you don’t lose it.
How to Report It
Report the sale on Form 8949. In the “date acquired” column, enter “INHERITED” instead of a specific date, which tells the IRS the stepped-up basis rules apply. Because the property is automatically long-term, use Part II of the form (long-term transactions).10Internal Revenue Service. Instructions for Form 8949 The totals from Form 8949 flow to Schedule D of your Form 1040, where all your capital gains and losses for the year are combined.11Internal Revenue Service. About Form 8949 – Sales and Other Dispositions of Capital Assets
Keep the date-of-death appraisal, the closing statement, and records of any improvements or expenses. Those documents back up both your basis and your sale price if the return is audited.
Unused Losses Don’t Fully Survive Your Death
If you die with a capital loss carryover still on your books, it can only be claimed on your final income tax return. Your estate cannot pick it up and neither can your heirs. The rule runs the other direction for losses generated by an estate itself during administration: if those carryovers are still unused when the estate terminates, the beneficiaries who receive the remaining property can claim them on their own returns.12Internal Revenue Service. Publication 559 – Survivors, Executors, and Administrators
If your inherited-property loss is large enough that $3,000 a year won’t consume it in your lifetime, one option is to realize capital gains from other investments sooner. Those gains absorb the carryover and keep the deduction from going to waste.