How capital gains tax works on inherited property

When you inherit property, you do not pay capital gains tax on the value it had when the person died. Instead, the property gets a stepped-up basis — meaning the IRS treats the property's value on the date of death as your starting point for tax purposes. If you sell it shortly after inheriting it at roughly that same value, you owe no federal capital gains tax.

Capital gains tax only applies to the profit you make after you inherit. If the property was worth $400,000 when you inherited it and you sell it for $420,000 a year later, you owe tax on $20,000 of gain, not on the full $420,000. This is the single largest tax break in the U.S. tax code, and it applies to nearly all inherited property — real estate, stocks, bonds, vehicles, art.

The tax rate on that gain depends on how long you hold the property and your income level. If you sell within a year, it is taxed as ordinary income at your regular tax bracket. If you hold it longer than a year, it is taxed as a long-term capital gain, which ranges from 0% to 20% depending on your total income for that year.

Key Takeaways

  • Inherited property receives a stepped-up basis equal to its value on the date of death, so you owe no capital gains tax on that increase in value.
  • You only owe capital gains tax on profit you make after inheriting — the difference between what it was worth when you got it and what you sell it for.
  • If you sell within one year, the gain is taxed as ordinary income; if you hold longer than one year, it qualifies for long-term capital gains rates of 0%, 15%, or 20%.
  • State capital gains taxes vary widely — some states have no capital gains tax, while others tax it like ordinary income or at a flat rate.
  • The stepped-up basis rule may change in future years depending on federal legislation, though it has remained stable for decades.

When you owe capital gains tax on inherited real estate

You owe federal capital gains tax only when you sell the inherited property and realize a gain. Simply owning it, renting it out, or living in it does not trigger the tax. The tax is calculated on the sale price minus the stepped-up basis (the value on the date of death).

If you inherit a house worth $300,000 and sell it for $310,000, you owe capital gains tax on $10,000. The rate depends on your holding period. Sell within 12 months and that $10,000 is taxed at your ordinary income rate — potentially 10%, 12%, 22%, 24%, 32%, 35%, or 37% depending on your total income for the year. Hold it longer than 12 months and it qualifies for long-term rates: 0% if your income is below $44,625 (single) or $89,250 (married filing jointly), 15% for income above that up to $492,300 (single) or $553,850 (married), and 20% above those thresholds.

You do not owe capital gains tax if you sell at a loss. If you inherit property worth $250,000 and sell it for $240,000, there is no tax. You also do not owe tax if you sell for exactly what it was worth when you inherited it.

State capital gains taxes on inherited property

State tax treatment varies significantly. Most states follow the federal stepped-up basis rule, meaning you owe state capital gains tax only on gains you make after inheriting. However, the rate and structure differ by state.

Nine states have no capital gains tax at all: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming, and New Hampshire (though New Hampshire taxes investment income differently). In these states, you owe no state capital gains tax on inherited property sales.

Other states tax capital gains as ordinary income, meaning the rate matches your state income tax bracket. California, for example, taxes capital gains at the same rate as wages — up to 13.3% for high earners. A few states, including Maryland and Vermont, have separate capital gains tax rates. You will owe state tax in the state where you live when you sell, not necessarily where the property is located, though some states tax non-residents on property sales within their borders.

How to calculate your capital gains tax liability

Start with the property's fair market value on the date of death. This is usually the date the person died, though executors can elect to use the value six months later if that is lower. You will find this value in the estate tax return (Form 706) if one was filed, or in a professional appraisal ordered for probate.

When you sell, subtract that stepped-up basis from the sale price. The result is your capital gain. Multiply that gain by the applicable tax rate — your ordinary income rate if you sell within one year, or the long-term capital gains rate if you hold longer. Add any state capital gains tax owed in your state.

Example: You inherit a rental property appraised at $500,000 on the date of death. You hold it for two years and sell for $530,000. Your gain is $30,000. If you are in the 24% federal income bracket but may have access to for the 15% long-term capital gains rate, you owe $4,500 in federal tax on that gain. If you live in California, you also owe state tax at your marginal rate — potentially another $7,200 if you are in the top bracket. Total: $11,700 on a $30,000 gain.

Primary residence exemption and inherited property

The $250,000 capital gains exclusion for primary residences (or $500,000 for married couples) does not automatically apply to inherited property. You can only use this exclusion if you owned the home and lived in it as your primary residence for at least two of the five years before the sale.

If you inherit a house, move into it, and live there for two years before selling, you may may have access to for the exclusion. However, the stepped-up basis already eliminates most of the tax benefit in this scenario — you would need the property to appreciate significantly during your ownership for the exclusion to matter. If you inherit a vacation home or rental property and never live in it, the exclusion does not apply.

Inherited rental property and depreciation recapture

If you inherit rental property and the previous owner claimed depreciation deductions, you may owe an additional tax called depreciation recapture when you sell. This tax applies to the depreciation that was deducted in prior years, even though you did not claim those deductions yourself.

Depreciation recapture is taxed at 25% on the portion of the gain attributable to depreciation, separate from the capital gains tax on the remaining gain. If you inherit a rental property with a stepped-up basis, the depreciation recapture tax applies only to depreciation claimed after you inherited it, not before. This is another reason the stepped-up basis is valuable for rental property — it erases the depreciation recapture liability on appreciation that occurred before you inherited it.

What documentation you need for the IRS

When you sell inherited property, you will report the sale on Schedule D (Capital Gains and Losses) attached to your tax return. You need to document the stepped-up basis — the property's value on the date of death.

Gather the death certificate, any professional appraisal ordered for probate or estate tax purposes, and the Form 706 (estate tax return) if one was filed. If no appraisal exists, you may need to order one to establish the stepped-up basis value. Keep the settlement statement from the sale showing the sale price and closing date. The IRS does not require you to submit these documents with your return, but you must keep them for your records in case of an audit.

If the estate was large enough to require a federal estate tax return (generally over $13.61 million in 2024, though this threshold changes yearly), the stepped-up basis value should be documented on that return. If no estate return was filed, a professional appraisal becomes more important as proof of the value on the date of death.

Frequently Asked Questions

Do I owe capital gains tax if I inherit property and never sell it?

No. Capital gains tax applies only when you sell and realize a gain. You can own inherited property for decades, rent it out, live in it, or leave it to your heirs without owing capital gains tax. Your heirs will receive another stepped-up basis when you die, resetting the tax calculation again.

What if I inherit property with a mortgage or debt attached?

The debt does not change your capital gains tax calculation. Your stepped-up basis is the property's fair market value on the date of death, regardless of what you owe on it. When you sell, you calculate gain as sale price minus stepped-up basis, the same way.

Can I avoid capital gains tax by keeping inherited property instead of selling?

Yes. If you never sell, you never owe capital gains tax. You may owe property tax, income tax on rental income if you rent it out, or estate tax if the property is part of a very large estate, but not capital gains tax. When you die, your heirs receive another stepped-up basis.

What happens if I inherit property jointly with other heirs?

Each heir receives a stepped-up basis on their share of the property. If you and your sibling inherit a house worth $400,000 equally, you each get a $200,000 stepped-up basis on your half. If you later sell your half for $210,000, you owe tax on $10,000 of gain.

Does the stepped-up basis apply to inherited IRAs or retirement accounts?

No. Inherited retirement accounts do not receive a stepped-up basis. You owe income tax on distributions from inherited traditional IRAs, 401(k)s, and similar accounts at your ordinary income rate, regardless of how long you hold them. Inherited Roth IRAs are distributed tax-free if certain conditions are met, but there is no stepped-up basis involved.