What happens to capital gains tax when you inherit property

When you inherit property, the IRS resets its tax value to what it was worth on the date of death — not what the previous owner paid for it. This reset is called a stepped-up basis. If you sell the property soon after inheriting it, you owe capital gains tax only on the increase in value from the death date forward, not on decades of appreciation the original owner built up.

This is the main legal mechanism that reduces or eliminates capital gains tax on inherited property. You do not have to do anything to claim it — the stepped-up basis applies automatically when property transfers through a will or trust. The executor or trustee reports the property's value on the date of death to the IRS, and that becomes your starting point for calculating gain or loss if you later sell.

The stepped-up basis applies to real estate, stocks, bonds, and most other assets. It does not apply to retirement accounts like IRAs or 401(k)s, which have their own tax rules. If you inherit a house worth $400,000 that the deceased bought for $150,000, your basis is $400,000, not $150,000. If you sell it a year later for $410,000, you owe tax on $10,000 of gain, not $260,000.

Key Takeaways

  • The stepped-up basis resets inherited property's tax value to its worth on the date of death, which usually eliminates capital gains tax if you sell soon after inheriting.
  • You must report the property's death-date value to the IRS on the estate tax return (Form 706) if the total estate exceeds the filing threshold, which varies by year.
  • If you hold the inherited property for years before selling, you will owe capital gains tax on any increase in value after the death date.
  • The stepped-up basis applies to real estate, stocks, and most investments, but not to IRAs, 401(k)s, or other retirement accounts.
  • Some states impose inheritance tax or estate tax in addition to federal rules, which can affect your total tax bill.

When you must file an estate tax return to document the stepped-up basis

The stepped-up basis only works if the property's death-date value is reported to the IRS. This happens on Form 706, the federal estate tax return. You must file Form 706 if the total value of the estate exceeds a threshold amount. That threshold changes each year — it was $13.61 million in 2024 and $13.99 million in 2025 — and it applies to the combined value of all the deceased's assets, not just real estate.

If the estate is below the threshold, you do not have to file Form 706. In that case, you and the executor should still document the property's fair market value on the date of death using a professional appraisal, a tax assessor's valuation, or comparable sales data. Keep this documentation with your records. If you later sell the property and the IRS questions your basis, you will need proof of what it was worth when you inherited it.

The executor or estate attorney usually handles filing Form 706 if it is required. They have nine months from the date of death to file, though they can request a six-month extension. If you are the executor or beneficiary and unsure whether the estate is large enough to require filing, consult a tax professional or estate attorney — the cost of filing is usually far less than the tax penalty for not filing when required.

How holding the property longer affects your tax bill

The stepped-up basis saves you tax only on appreciation that happened before you inherited the property. Any increase in value after the death date is treated as your gain, and you owe capital gains tax on it when you sell.

If you inherit a house worth $300,000 and sell it two years later for $330,000, you owe capital gains tax on $30,000 of gain. The tax rate depends on how long you held it. If you sell within one year of inheriting, the gain is taxed as short-term capital gains, which are taxed at your ordinary income tax rate (up to 37% federally). If you hold it longer than one year, it is taxed as long-term capital gains, which are taxed at 0%, 15%, or 20% depending on your income level.

For this reason, many people who inherit property and do not need to live in it or keep it as an investment choose to sell quickly. The stepped-up basis is most valuable if you sell within a year or two of inheriting, before the property appreciates further. If you plan to hold it for years, you will eventually owe tax on the new appreciation regardless.

The primary residence exclusion and inherited homes

If you inherit your primary residence and live in it for at least two of the five years before you sell, you can exclude up to $250,000 of gain from tax (or $500,000 if you are married filing jointly). This is separate from the stepped-up basis — they work together.

Example: You inherit a house worth $400,000. You live in it for three years, then sell it for $450,000. Your gain is $50,000. Because you lived there for two of the five years before sale, you can exclude $250,000 of gain (or $500,000 if married). Since your actual gain is only $50,000, you owe no capital gains tax.

The primary residence exclusion applies only if the property was your main home, not a vacation house or rental property. You must have owned it and lived in it for at least two of the five years before the sale. If you inherit a home, rent it out immediately, and then sell it, you do not may have access to for the exclusion. If you inherit a home, live in it for two years, and then sell it, you do may have access to.

What to do if the property was owned outside the United States

Foreign real estate does not receive a stepped-up basis under U.S. tax law. If you inherit property located in another country, you owe capital gains tax on the full appreciation from the original purchase price to the sale price, just as the deceased owner would have.

You may owe tax to both the U.S. and the country where the property is located. The U.S. taxes you on the gain; the foreign country may tax you on the sale itself or on rental income if you rent it out. You can usually claim a foreign tax credit on your U.S. return for taxes paid to the other country, but the rules are complex and vary by country. If you inherit foreign property, consult a tax professional who handles international returns before you sell.

State inheritance and estate taxes that may apply

Twelve states and the District of Columbia impose their own estate or inheritance taxes in addition to federal tax. These are separate from capital gains tax and apply to the total value of the estate, not just to gains on sale.

Estate tax states (tax the estate itself): Connecticut, Delaware, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. Inheritance tax states (tax the beneficiary) include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Maryland has both.

The thresholds and rates vary. Some states exempt spouses and children; others do not. If you inherit property in a state with an estate or inheritance tax, the executor must file a state return in addition to the federal Form 706. This can increase the total tax cost even if you do not owe federal capital gains tax. Check your state's tax agency website or consult a local tax professional to understand what applies to your situation.

Frequently Asked Questions

Do I have to pay capital gains tax if I sell inherited property right away?

Usually no, if you sell within a few months of inheriting. The stepped-up basis resets the property's value to the date of death, so if you sell at or near that value, you have little or no gain to tax. You will owe tax only if the sale price exceeds the death-date value by a significant amount.

What if I inherit property with my siblings and we want to sell it?

Each of you receives a stepped-up basis on your share of the property. If you own it as tenants in common and sell it, each owner pays capital gains tax only on their portion of the gain. If you own it as joint tenants with right of survivorship, the basis rules are different — consult a tax professional before selling.

Can I avoid capital gains tax by keeping the inherited property forever?

Yes, if you never sell it. The stepped-up basis applies when you inherit, and you owe no tax unless you sell or transfer the property. However, you may owe property tax, maintenance costs, and possibly rental income tax if you rent it out. Holding property indefinitely is not always the best financial choice.

Do I owe capital gains tax on inherited rental property?

The stepped-up basis applies to rental property the same way it applies to residential property. You owe capital gains tax on appreciation after the death date if you sell. You also owe ordinary income tax on rental income each year you own it, regardless of whether you sell.

What if the person who left me the property had already paid capital gains tax on it?

That does not affect your basis. The stepped-up basis is based on the property's value on the date of death, not on what the previous owner paid or what taxes they paid. You start fresh with a new basis regardless of the deceased's tax history.