When you sell property you inherited, capital gains tax on inherited property is calculated on the difference between your sale price and the property’s fair market value on the date the previous owner died, not what they originally paid for it. That reset is called the step-up in basis, and it usually eliminates most or all of the appreciation that built up during the decedent’s lifetime. Federal law also treats inherited property as long-term no matter how quickly you sell, so the gain qualifies for the lower long-term capital gains rates of 0%, 15%, or 20%.
How the Step-Up in Basis Works
Federal tax law sets the cost basis of inherited property at its fair market value on the date the owner died.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent If your parent bought a house in 1985 for $80,000 and it was worth $400,000 the day they died, your basis is $400,000. The decades of growth from $80,000 to $400,000 simply drops out of the tax calculation. You owe capital gains tax only on appreciation above $400,000.
Fair market value is typically established through a professional appraisal or a comparative market analysis dated as of the day of death. If you sell soon after inheriting for roughly that appraised value, your taxable gain is close to zero. Families holding real estate for generations can often liquidate it with little or no federal tax.
The rule works in reverse when the property has lost value. If a condo was purchased for $350,000 but was worth $280,000 at the date of death, your basis is $280,000. You can’t reach back to the original purchase price.
One boundary worth knowing: the executor of a large estate can elect to value estate assets six months after death instead of on the death date, but only when doing so reduces both the gross estate and the estate tax owed.2Office of the Law Revision Counsel. 26 US Code 2032 – Alternate Valuation If the election is made, your basis shifts to the alternate date, so ask the executor which valuation applies.
Inherited Property Is Always Long-Term
For most assets, the tax rate hinges on how long you owned them. Inherited property is an exception. Federal law treats it as held for more than one year regardless of when you sell.3Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property Sell a week after the funeral and you still get long-term rates. That matters for heirs who need to close quickly to cover estate debts or split proceeds among beneficiaries.
2026 Long-Term Capital Gains Rates
Long-term gains are taxed at 0%, 15%, or 20% federally. The rate depends on your total taxable income for the year, not just the gain itself.4Internal Revenue Service. Topic No. 409, Capital Gains and Losses For 2026:
- 0% applies to taxable income up to $49,450 (single), $98,900 (married filing jointly), or $66,200 (head of household).
- 15% applies above those floors and up to $545,500 (single), $613,700 (married filing jointly), or $579,600 (head of household).
- 20% applies above those upper thresholds.
Most heirs land in the 15% bracket. A large property sale can push your income into a higher bracket for the year even if your wages alone wouldn’t get you there, so run the numbers before you close.
The 3.8% Net Investment Income Tax
A separate 3.8% surtax applies to net investment income when your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly).5Internal Revenue Service. Net Investment Income Tax Those thresholds aren’t indexed for inflation, so they catch more filers each year. Capital gains from a property sale count as investment income here. An heir in the 20% bracket with income above the surtax threshold faces a combined federal rate of 23.8% on the gain.
State Taxes
Many states tax capital gains as ordinary income, adding a meaningful layer to the bill. A handful of states don’t tax income at all. Factor your state’s treatment into any projection of net proceeds before deciding when to sell.
Situations That Change the Math
Community Property Doubles the Step-Up
How the property was titled changes how much of it gets a new basis. When one spouse dies and the couple held the property as community property in a community property state, both halves receive a fresh basis at fair market value.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent This double step-up applies in roughly nine states.
Joint tenancy outside community property states works differently. Only the decedent’s share steps up. If you and your sibling owned a house as joint tenants and your sibling died, your half keeps its original basis and your sibling’s half moves to date-of-death value. Your combined basis is the sum. Married couples in non-community-property states who hold as joint tenants also get a step-up only on the deceased spouse’s half.
Moving Into the Home
If you use the inherited property as your main home, you can eventually qualify for the primary residence exclusion, which shelters up to $250,000 of gain ($500,000 for married couples filing jointly).6Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence You need to own and live in the home as your principal residence for at least two of the five years before the sale. You own the property from the date of death, so the clock starts then.
A surviving spouse gets an added benefit: the deceased spouse’s ownership and use count toward the two-year requirement. For other heirs, only your own occupancy counts. If the property has kept appreciating since the date of death, two years of residence before selling can shelter a large portion of that later gain.
Inherited Rental Property
Rental property normally comes with depreciation recapture, taxed at up to 25% before the regular capital gains rate applies. Inheriting a rental wipes that slate clean. The step-up eliminates the decedent’s depreciation, so you owe no recapture on their deductions.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
If you keep operating the rental, your depreciable basis starts fresh at date-of-death fair market value, minus the land. Residential rental property depreciates over 27.5 years using the straight-line method from the date you place it in service. Any depreciation you personally claim will create recapture exposure when you eventually sell.
Deferring the Gain With a 1031 Exchange
If the inherited property qualifies as investment or business real estate, a like-kind exchange lets you swap it for another investment property and defer the capital gains tax. The property must actually be held for investment. A home you inherited and immediately listed for sale, without renting it or putting it to business use, probably won’t qualify. Renting it for a meaningful stretch first strengthens the case.
The deadlines are strict: identify a replacement property within 45 days of selling, and close within 180 days. Because your stepped-up basis rolls into the replacement, the deferred gain stays modest compared with what the original owner would have carried.
Selling at a Loss
If the market drops after the date of death and you sell for less than your stepped-up basis, you have a capital loss. Losses offset capital gains dollar for dollar, and any leftover net loss offsets up to $3,000 of ordinary income per year ($1,500 if married filing separately). Losses beyond that carry forward.4Internal Revenue Service. Topic No. 409, Capital Gains and Losses
The loss has to come from an arm’s-length sale to an unrelated buyer. You can’t sell to another beneficiary of the same estate, the executor, or a family member and claim it. Using the property personally before the sale also disqualifies the loss.
Reporting the Sale
Report the sale on Form 8949, which feeds into Schedule D of your Form 1040.7Internal Revenue Service. Gifts and Inheritances On Form 8949, describe the property in column (a), write “INHERITED” in the date-acquired column (b), and enter the actual sale date in column (c).8Internal Revenue Service. Instructions for Form 8949 Your stepped-up basis goes in the cost-basis column and the sale price in proceeds. The difference flows to Schedule D and combines with your other capital gains and losses. Report the sale in Part II of Form 8949 (long-term transactions), because inherited property is always long-term.
Most tax software handles the form integration. If you file on paper, include all pages of Form 8949 and Schedule D with your 1040. Any tax owed is due by the April filing deadline.
Estimated Tax Payments
A big gain can trigger an underpayment penalty if you wait until April. You generally need to make estimated payments when you expect to owe $1,000 or more after withholding and credits, and your withholding won’t cover at least 90% of the current year’s tax or 100% of last year’s tax (110% if your prior-year adjusted gross income exceeded $150,000).9Internal Revenue Service. Large Gains, Lump Sum Distributions, Etc.
If the sale closes mid-year, you can annualize your income and make a larger estimated payment for that quarter rather than spreading it evenly. The IRS publishes an Annualized Estimated Tax Worksheet in Publication 505 for this. Missing these payments doesn’t change your total tax bill, but the penalty is an avoidable cost.
Records to Keep
Good documentation protects you if the IRS questions the basis or the gain. Gather these before or right after closing:
- A date-of-death appraisal is the single most important document. A comparative market analysis from a real estate agent can supplement it, but a formal appraisal from a certified appraiser carries more weight.
- The settlement statement from the sale (sometimes called an ALTA or HUD-1) confirms the sale price and transaction costs.
- Receipts for capital improvements you made after inheriting, such as a new roof, an addition, or rewiring, increase your basis and reduce the taxable gain. Routine maintenance and repairs don’t count.10Internal Revenue Service. Publication 551 – Basis of Assets
- Estate documents: the death certificate, the will or trust, and any executor correspondence about the valuation date if the alternate valuation was elected.
Keep these records for at least three years after filing the return that reports the sale. That’s the standard window for the IRS to assess additional tax.11Internal Revenue Service. How Long Should I Keep Records If gross income was underreported by more than 25%, the window extends to six years, so hold on longer when a large sale is involved.