Capital gains on a Transfer on Death deed work in the beneficiary’s favor: the transfer itself is not a taxable event, and when the beneficiary sells, the taxable gain is measured from the property’s fair market value on the date the original owner died, not from what the owner originally paid. Appreciation that built up during the owner’s lifetime is wiped off the tax ledger. For beneficiaries who sell soon after inheriting, the reportable gain is often small or zero.
Why the Stepped-Up Basis Matters
The rule that does the heavy lifting is 26 U.S.C. § 1014. Property acquired from someone who has died takes a basis equal to its fair market value at the date of death, not the decedent’s original purchase price.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent Tax professionals call this a stepped-up basis, and it applies to real estate passing through a TOD deed the same way it applies to property passing through a will or trust.
A concrete example makes the mechanics obvious. A parent bought a house decades ago for $120,000. At the parent’s death, it appraises at $450,000. The beneficiary’s basis is not $120,000. It resets to $450,000. The $330,000 that accrued during the parent’s lifetime is gone from the tax calculation. A sale at $450,000 produces a taxable gain of zero.
To lock in that number, get a professional appraisal dated as close to the date of death as practical. That appraisal is the documentation supporting your basis if the IRS ever questions the sale. Residential appraisals typically run a few hundred dollars. Complex or high-value properties cost more. It is a small expense against a potentially large tax exposure.
Calculating Your Gain When You Sell
The math is straightforward. Take the sale price, subtract your selling expenses to get the net sale price, then subtract your stepped-up basis. Whatever is left is your capital gain.
Selling expenses that reduce the taxable gain include:
- Real estate agent commissions, usually the largest item
- Title search and title insurance fees
- State and local transfer taxes
- Attorney and escrow fees
- Recording fees and document preparation costs
Most of these appear on the closing statement your escrow or title company prepares at settlement. Keep that statement with your tax records for the year of the sale.
One rule genuinely helps here. Even if you sell the property a week after inheriting it, the IRS treats your holding period as long-term. Under 26 U.S.C. § 1223(9), anyone whose basis is determined under the stepped-up basis rule is considered to have held the property for more than one year, no matter how brief the actual holding period.2Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property Any gain qualifies for long-term capital gains rates of 0%, 15%, or 20% depending on your income, rather than the higher ordinary income rates.
You report the sale on your federal income tax return for the year the sale closes. If your stepped-up basis plus selling costs equals or exceeds the sale price, there may be no gain to report, or even a deductible loss.
The Alternate Valuation Date
The date-of-death value is the default, but it is not the only option. If the property loses value in the six months after death, the executor can elect to use the value six months after death instead. This election lives in 26 U.S.C. § 2032 and is available only when the estate is large enough to require a federal estate tax return and when using the alternate date reduces both the estate’s total value and its estate tax liability. Once made, the election is irrevocable.3Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation
If the executor makes the election, the beneficiary’s basis follows the lower six-month value. In a falling market, this reduces the estate tax but leaves the beneficiary with a lower basis and a larger potential gain on a later sale. For estates below the federal filing threshold, none of this applies.
Why a TOD Deed Beats a Lifetime Gift on Taxes
The stepped-up basis is the reason a TOD deed is far more tax-efficient than gifting property while the owner is alive. A lifetime gift of real estate carries the donor’s original basis into the recipient’s hands. The tax code calls this a carryover basis.4Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
The dollar difference can be dramatic. If a parent bought a property for $80,000 and it is now worth $500,000, gifting it hands the recipient an $80,000 basis. Selling for $500,000 produces a $420,000 taxable gain. Transferring the same property by TOD deed resets the basis to $500,000, and an immediate sale produces no gain. At the 15% long-term rate, that is roughly $63,000 in federal tax versus nothing.
Lifetime gifts also carry reporting duties. For 2026, the annual gift tax exclusion is $19,000 per recipient.5Internal Revenue Service. What’s New – Estate and Gift Tax Gifting real estate worth more than that requires the donor to file Form 709, even when no gift tax is actually owed because of the lifetime exemption. A TOD deed avoids this altogether: no gift occurs until death, and transfers at death are not gifts for tax purposes.
The only situation where a lifetime gift competes on tax grounds is when the property has lost value or barely appreciated. In that narrow case, the carryover basis and the stepped-up basis land close together, and the gift moves the property sooner. For property that has appreciated meaningfully, the TOD deed wins on taxes almost every time.
Probate-Free Does Not Mean Tax-Free
A TOD deed keeps the property out of probate, but it does not remove the property from the decedent’s estate for federal estate tax purposes. The full fair market value at death is included in the gross estate. For 2026, the basic exclusion amount is $15 million per person, so most estates fall well below the threshold and owe no federal estate tax.
For estates large enough to require Form 706, there is an additional reporting layer that directly affects the beneficiary’s basis. The executor must file Form 8971 and furnish a Schedule A to each beneficiary reporting the value of inherited property. The form is due no later than 30 days after the Form 706 filing deadline or the actual filing date, whichever comes first.6Internal Revenue Service. Instructions for Form 8971 and Schedule A The beneficiary’s basis cannot exceed the value reported on Schedule A, so what the executor puts on the estate tax return and what you claim as basis on a later sale need to match.
Estates below the filing threshold have no Form 8971 obligation. Even then, document the date-of-death value with an appraisal. The IRS can still question the basis you claim when the property is eventually sold, and contemporaneous documentation is what protects the number you rely on.