Capital Gains Tax on Inherited Property

Your basis is the value on the date of death, so only the growth after death is taxed

Section 1014(a) sets the basis of property acquired from a decedent at its fair market value on the date of death, or at the alternate valuation date if the executor elects it under section 2032. Whatever your parent paid in 1985, and whatever improvements they made, drops out of the calculation. Your gain is the sale price less selling costs, minus that date-of-death value.

Where to get the number depends on the estate. Publication 551 says that when an estate tax return is filed, beneficiaries generally receive a Schedule A of Form 8971 reporting the estate tax value, and certain beneficiaries must use it; with no Schedule A, basis can be the appraised value at death for state inheritance or transmission tax purposes. In practice most heirs order a date-of-death appraisal, because the 2026 basic exclusion amount of $15,000,000 under Rev. Proc. 2025-32 means most estates file no estate tax return.

Where an estate tax return was required, section 1014(f) requires your basis to be consistent with the final estate tax value, and section 6662 applies a 20% accuracy penalty to an underpayment from an inconsistent estate basis.

Inherited property is always long-term, and selling costs often turn a quick sale into a loss

Section 1223(9) treats a person whose basis is set by section 1014 and who sells within a year of death as having held the property for more than a year. Publication 544 puts it plainly: inherited property is considered held longer than one year regardless of how long you actually held it. There is no short-term exposure, and the 2026 long-term breakpoints apply.

Commissions, transfer taxes and other selling costs reduce the amount realized. Because the basis is a recent appraisal, a sale within months of death commonly lands close to that value, and the costs push the result to a loss. A loss is deductible only if the property was not held for personal use: Publication 544 states that loss on personal-use property is not deductible, so an heir who moves into the house gives up the loss, while one who lists it as an investment can claim a capital loss, deductible against gains and up to $3,000 a year of other income under the Form 4797 instructions.

Any gain is net investment income under section 1411, so the 3.8% tax applies if your modified AGI including the gain passes $250,000 joint or $200,000 single.

The step-up is partial for spouses who held as joint tenants, and full for community property

Section 1014 steps up only what passes from the decedent. Section 2040(b) includes one-half of a qualified joint interest between spouses in the gross estate, whoever paid for it. Publication 551 gives the result: the surviving spouse keeps the original cost of their half, reduced by their share of depreciation, and adds the date-of-death value of the half inherited.

Community property works differently. Section 1014(b)(6) treats the surviving spouse's half as passing from the decedent if at least half of the community interest is included in the estate, and Publication 551 lists Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin and explains that the whole property generally takes a new basis. For non-spouse joint tenants, the inclusion and the step-up follow the share the decedent paid for.

One trap: under section 1014(e), if you gave appreciated property to someone within one year of their death and it comes back to you or your spouse, your basis is the decedent's old basis, not the date-of-death value.

Worked example: an inherited house sold seven months after death, and the same house sold years later

Hypothetical, round figures. A parent bought a house for $120,000 in 1990 and died in March 2026 when it was appraised at $700,000. The child, who never lives in it, sells in October 2026 for $720,000 and pays $45,000 in commissions and closing costs. Amount realized is $675,000 against a $700,000 basis: a $25,000 long-term capital loss, which offsets other gains and up to $3,000 of other income a year.

Without the step-up, the gain would have been $555,000 on the parent's $120,000 basis. Suppose instead the child rents the house out and sells in 2031 for $850,000, net $800,000 after costs. The gain is measured from $700,000 less the depreciation taken since 2026, and that depreciation is taxed first at up to 25%; inherited, rented, now selling works that case through. Run your own numbers with your CPA.

Selling now, holding for another step-up, or exchanging are the three paths

An heir who wants income rather than a house to manage can sell soon after death, when the gain is small, and reinvest without much tax. If the property has risen since death, an heir who holds it for investment can defer that gain with a section 1031 exchange; inherited rental 1031 options covers the timing and title questions, including when the estate rather than the heirs should sell, which taxes when an estate sells a rental before distribution addresses.

Replacement property can be a fractional interest in a traditional DST, which removes management and can be divided among heirs at a later death. Holding until your own death resets basis again, the trade-off weighed in 1031 versus holding for step-up.