What happens to capital gains tax when you inherit property

When you inherit property, you do not pay capital gains tax on the value it had when the person who owned it died. Instead, the property's value is "stepped up" to what it was worth on the date of death. If you sell it shortly after inheriting it at that same price, you owe no federal capital gains tax on the sale.

Capital gains tax only applies to the profit you make after you inherit. If the property was worth $300,000 when you inherited it and you sell it for $320,000 a year later, you would owe capital gains tax only on the $20,000 gain — not on the original $300,000.

This step-up in basis is a federal rule that applies to most inherited property. However, some states have their own rules, and the rules can be different if you inherited property before 2010 or if the property is held in certain types of trusts.

Key Takeaways

  • Inherited property receives a "step-up in basis" to its value on the date of death, so you typically owe no capital gains tax when you inherit.
  • You only pay capital gains tax on the profit you make after inheriting — the difference between what you inherited it for and what you sell it for.
  • The federal long-term capital gains rate depends on your income and filing status, ranging from 0% to 20% for most people.
  • Some states tax capital gains on inherited property, and a few states have inheritance taxes that work separately from capital gains tax.
  • If you inherited property before 2010, different rules may explore, and you should check with a tax professional about your specific situation.

How the step-up in basis works

The step-up in basis is the key to understanding inherited property and capital gains tax. When someone dies and leaves you property, the IRS treats the property as if its cost basis — the value used to calculate profit — is reset to what it was worth on the date of death.

Here is a concrete example: suppose your parent bought a house in 1990 for $150,000. When they died in 2024, the house was worth $500,000. You inherit it. Your cost basis is now $500,000, not $150,000. If you sell it when ready for $500,000, you have zero gain and owe no federal capital gains tax. If you sell it for $520,000, you owe capital gains tax only on the $20,000 gain.

Without the step-up, you would inherit the $150,000 basis from your parent, and selling at $500,000 would trigger a $350,000 taxable gain. The step-up eliminates that tax burden for inherited property.

Federal capital gains tax rates on inherited property

If you do sell inherited property at a profit, the capital gains tax rate you pay depends on how long you hold it and your income level. The IRS treats inherited property as long-term property for tax purposes, even if you sell it weeks after inheriting it. This is important because long-term capital gains rates are lower than short-term rates.

For 2024, the federal long-term capital gains rates are 0%, 15%, or 20%, depending on your taxable income and filing status. A single filer with income under roughly $47,000 may pay 0%. Income between roughly $47,000 and $518,000 is typically taxed at 15%. Income above that threshold is taxed at 20%. These income thresholds change each year.

You will also owe the 3.8% Net Investment Income Tax if your modified adjusted gross income exceeds certain thresholds — $200,000 for single filers and $250,000 for married couples filing jointly. This tax applies to the lesser of your net investment income or the amount your income exceeds the threshold.

State capital gains taxes and inheritance taxes

Some states tax capital gains on inherited property separately from federal tax. As of 2024, California, New York, Illinois, Oregon, Minnesota, and Washington have capital gains taxes. The rates and rules vary by state. For example, California taxes long-term capital gains at the same rate as ordinary income, while Washington has a flat 7% capital gains tax on certain sales.

A few states also have inheritance taxes, which are separate from capital gains tax. These states tax the person who receives the inheritance, not the estate itself. Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania have inheritance taxes. The rate and whether you owe anything depends on your relationship to the person who died and the value of what you inherited. Spouses and direct descendants often pay nothing or a lower rate.

You should check your state's tax rules if you inherited property there or if you live in a state with a capital gains tax. State rules can significantly change what you owe.

When you might owe capital gains tax on inherited property

You will owe capital gains tax if you sell inherited property for more than it was worth when you inherited it. The timing of the sale matters for determining the tax rate, but not for the step-up itself.

If you rent out inherited property and collect rent, you do not owe capital gains tax on the rent itself — that is ordinary income. However, if you later sell the property, you will owe capital gains tax on any profit from the sale price, calculated from the stepped-up basis.

If you inherited property as part of a trust, the rules can be more complex. Some trusts do not receive the step-up in basis, or receive it only partially. If the property was held in a revocable living trust, you typically still get the step-up. If it was held in an irrevocable trust, the rules depend on the trust's terms and type.

Property inherited before 2010

If you inherited property before January 1, 2010, different rules may have applied at that time. The step-up in basis rules changed in 2010, and some property inherited before that date may have received a different treatment called "carryover basis" or may have had special elections made by the estate.

If you inherited property before 2010 and have not yet sold it, you should consult a tax professional. They can determine what basis was used when you inherited it and what you will owe if you sell now. The records from the original inheritance may be important, so gather any documents the estate provided to you at the time.

What records you need to keep

When you inherit property, keep the death certificate and any estate documents that show the property's value on the date of death. This value establishes your stepped-up basis. If you later sell the property, you will need this documentation to prove to the IRS what your basis was.

You should also keep records of any improvements you make to the property after inheriting it. These improvements can increase your basis, which lowers your taxable gain when you sell. For example, if you inherit a house and then spend $50,000 on a new roof and foundation work, your basis increases by $50,000.

If you received a property appraisal as part of the estate settlement, keep that too. An appraisal from the date of death is strong evidence of the property's stepped-up basis value.

Frequently Asked Questions

Do I owe capital gains tax just for inheriting property?

No. You owe capital gains tax only if you sell the inherited property for more than it was worth when you inherited it. straightforward receiving the property does not trigger any capital gains tax. The step-up in basis means you start with a clean slate at the property's value on the date of death.

What if I inherited property from my spouse?

Spouses have special rules. If you inherited property from your spouse, you may be able to treat it as if you owned it jointly, which can provide additional tax benefits. You should consult a tax professional about your specific situation, as the rules depend on whether you are filing jointly and the type of property involved.

Can I avoid capital gains tax by not selling inherited property?

Yes. If you keep the inherited property and never sell it, you will not owe federal capital gains tax on the appreciation. However, you may owe property tax, and if you rent it out, you will owe income tax on the rental income. When the property eventually passes to your heirs, they will receive their own step-up in basis at that time.

What if the property decreased in value after I inherited it?

If inherited property decreases in value and you sell it for less than the stepped-up basis, you have a capital loss. You can use capital losses to offset capital gains from other sales. Unused capital losses can offset up to $3,000 of ordinary income per year, with any remaining loss carried forward to future years.

Do I need to report the inherited property to the IRS?

You do not need to report the inheritance itself to the IRS. However, if you sell the property, you must report the sale on your tax return and calculate the capital gains tax owed. The stepped-up basis is what you use to calculate your gain, so keep your inheritance documents to support that basis.