Do I Pay Capital Gains Tax on Inherited Property?

Inheriting property can bring both emotional and financial considerations. While the act of inheriting property itself generally does not trigger an immediate income tax liability, the subsequent sale of that inherited asset can lead to capital gains tax. The tax implications depend on several factors, including the asset’s value at the time of inheritance and when it is eventually sold.

The Stepped-Up Basis Rule

The “cost basis” refers to the original value of an asset for tax purposes, typically its purchase price plus any improvements or acquisition costs. However, inherited property receives a special adjustment known as a “stepped-up basis.” This rule allows the cost basis of the inherited asset to be adjusted to its fair market value on the date of the previous owner’s death. This adjustment can significantly reduce the potential capital gains tax for the heir.

For example, if an individual purchased a stock for $10,000 many years ago, and it was worth $100,000 on the date of their death, the heir’s basis in that stock would become $100,000. If the heir then sells the stock for $105,000, their taxable gain would only be $5,000 ($105,000 sale price minus the $100,000 stepped-up basis), rather than $95,000 ($105,000 sale price minus the original $10,000 basis). This adjustment effectively eliminates the appreciation that occurred during the original owner’s lifetime from the heir’s capital gains calculation.

Regardless of how long the decedent actually owned the asset or how long the heir holds it before selling, inherited property is generally considered to have been held for more than one year for capital gains tax purposes. This classification ensures that any taxable gains are subject to the lower long-term capital gains tax rates, rather than the typically higher short-term rates that apply to assets held for one year or less.

Calculating Capital Gains or Losses on Sale

The formula is: Sale Price – Adjusted Basis – Selling Expenses = Capital Gain/Loss. For inherited assets, the “adjusted basis” is typically the stepped-up basis, which is the fair market value on the date of the decedent’s death. Selling expenses, such as real estate agent commissions or legal fees, are added to the basis, effectively reducing the taxable gain.

For instance, consider an inherited property valued at $400,000 on the date of death, which becomes the heir’s stepped-up basis. If the heir sells the property for $420,000 and incurs $15,000 in selling expenses, the capital gain would be $5,000 ($420,000 – $400,000 – $15,000). This $5,000 gain would be subject to long-term capital gains tax rates, which for 2025 are typically 0%, 15%, or 20%, depending on the heir’s overall taxable income.

If the sale results in a capital loss, meaning the selling price minus expenses is less than the adjusted basis, this loss can be used to offset other capital gains. If capital losses exceed capital gains, up to $3,000 ($1,500 if married filing separately) of the excess loss can be deducted against ordinary income in a given tax year. Any remaining capital loss can be carried forward to offset gains or income in future tax years.

Special Rules for Inherited Real Estate and Other Assets

If an heir moves into an inherited primary residence and meets specific occupancy requirements, they might qualify for the Section 121 exclusion. This allows a taxpayer to exclude up to $250,000 of gain ($500,000 for married couples filing jointly) from the sale of a principal residence if they have owned and used it as their main home for at least two out of the five years before the sale. The decedent’s period of ownership and occupancy can be added to the heir’s for meeting the two-year use test.

For inherited rental properties, the stepped-up basis applies, eliminating any accumulated depreciation recapture liability from the previous owner. Depreciation recapture is a tax on the portion of a gain from selling depreciated property that represents prior depreciation deductions. While the heir receives a new basis, if they continue to operate the property as a rental, they will begin a new depreciation schedule, and any future depreciation they claim could be subject to recapture upon their eventual sale.

Inherited stocks and other investment securities also benefit from the stepped-up basis rule, making their capital gains calculation straightforward. The heir’s basis becomes the fair market value of the securities on the date of the decedent’s death.

Certain inherited assets, such as collectibles (e.g., art, antiques, coins), are subject to a higher long-term capital gains tax rate if sold for a gain. While they still receive a stepped-up basis, any gain realized from their sale is taxed at a maximum rate of 28%, which is higher than the typical 0%, 15%, or 20% long-term capital gains rates. This specific rate for collectibles applies regardless of the heir’s income level, unless their ordinary income tax rate is lower, in which case the ordinary rate would apply.