Do You Have to Pay Capital Gains on Inheritance?

Capital gains tax is generally applied to the profit realized from the sale of an asset, such as real estate, stocks, or other investments. This tax applies when an asset is sold for more than its original cost or adjusted basis. Understanding how capital gains tax applies to inherited assets can be complex, as the rules differ from those for assets acquired through purchase. The process involves specific considerations regarding the asset’s value at the time of inheritance and when it is subsequently sold.

Tax Implications at the Time of Inheritance

An individual inheriting an asset does not immediately owe capital gains tax. Tax implications arise when the inherited asset is later sold, primarily due to the “stepped-up basis” rule.

The stepped-up basis rule adjusts the cost basis of an inherited asset to its fair market value on the date of the decedent’s death. This means appreciation in the asset’s value during the decedent’s lifetime is not subject to capital gains tax for the inheritor. For example, an asset purchased for $50,000 and worth $200,000 at death has an inheritor’s basis of $200,000.

This rule benefits beneficiaries by reducing or eliminating capital gains tax if the asset is sold shortly after inheritance for a price close to its stepped-up value. Without this rule, the inheritor would be responsible for capital gains on the entire appreciation from the original purchase price. The stepped-up basis resets the starting point for calculating future gains or losses, reducing potential tax liability.

Capital Gains When Selling Inherited Assets

Capital gains tax applies when an inherited asset is sold. The stepped-up basis, established at inheritance, serves as the new cost basis for calculating gain or loss. The asset’s sale price is compared to its stepped-up basis to determine this.

For instance, if an inherited stock had a stepped-up basis of $100 per share and sold for $110, the capital gain would be $10 per share. Conversely, if sold for $90, a capital loss of $10 per share would be realized.

Inherited assets are considered to have a long-term holding period, regardless of how long the decedent or inheritor owned them. Any gain from the sale qualifies for long-term capital gains tax rates. These rates are often lower than ordinary income tax rates, varying based on the taxpayer’s income bracket, with common rates including 0%, 15%, or 20%.

Specific Types of Inherited Assets and Their Tax Treatment

The tax treatment of inherited assets varies by type; some receive a stepped-up basis, while others have different rules. For inherited real estate, the stepped-up basis rule applies. The property’s cost basis adjusts to its fair market value at the decedent’s death. If income-producing, like a rental property, depreciation recapture may apply if sold for more than its adjusted basis. Still, the stepped-up basis applies to overall appreciation for capital gains.

Stocks and other investment securities also benefit from the stepped-up basis rule. Their value on the date of death becomes the new cost basis for the inheritor. Selling stocks shortly after inheritance for approximately the same value results in minimal or nonexistent capital gains, effectively eliminating tax on appreciation before death.

Inherited retirement accounts (IRAs, 401(k)s) are treated differently; they do not receive a stepped-up basis. Distributions are “Income in Respect of a Decedent” (IRD) and taxed as ordinary income upon withdrawal. This rate is the beneficiary’s ordinary income tax rate, which can be higher than capital gains rates.

For non-spouse beneficiaries of inherited retirement accounts, the SECURE Act requires distribution of the entire account balance within 10 years of the owner’s death. Exceptions exist for eligible designated beneficiaries. Spouses have more flexibility, including rolling over the inherited IRA into their own.

Other assets, including collectibles (e.g., art, antiques, rare coins) and personal property, receive a stepped-up basis to their fair market value at death. Capital gains on collectibles are subject to a maximum long-term capital gains tax rate of 28%, higher than rates for most other long-term capital gains.