Do You Have to Pay Taxes on Inherited Property That You Sell?
Selling an inherited property has unique tax rules. Your gain is calculated from its value when you inherited it, which can significantly lower your tax liability.
The tax implications for an heir selling an inherited home are often different from what many people assume. Selling an inherited asset requires understanding specific tax rules that can alter the financial outcome of the sale.
Understanding the Tax Basis of Inherited Property
The tax treatment of inherited property uses a “stepped-up basis.” This rule adjusts the property’s cost basis to its fair market value (FMV) at the time of the original owner’s death, meaning any appreciation during the deceased’s lifetime is not taxed. For example, if a home was purchased for $50,000 and is worth $450,000 when inherited, the heir’s basis becomes $450,000, not the original $50,000.
Determining the fair market value requires a formal appraisal from a licensed real estate appraiser. The executor of the estate determines this value and reports it on the federal estate tax return, Form 706. Heirs should contact the executor for this official valuation, as the IRS requires the heir’s basis to be consistent with the value reported for estate tax purposes.
An exception is the “alternate valuation date” under Internal Revenue Code Section 2032. The executor can elect to value assets six months after the date of death. This election is only allowed if it reduces both the gross estate’s value and the federal estate tax owed. If an asset is sold during that six-month period, its value is fixed on the transaction date.
A special rule applies to surviving spouses in community property states, where the entire value of a jointly owned property is stepped up to its FMV upon one spouse’s death. This applies to both the deceased’s and the survivor’s half of the property. In common law states, only the deceased’s portion of the asset receives the stepped-up basis.
Calculating the Capital Gain or Loss
The taxable gain or loss is the property’s sale price, minus selling expenses, minus the stepped-up basis. A positive result is a capital gain; a negative result is a capital loss. For instance, if a home inherited with a stepped-up basis of $400,000 sells for $450,000, the capital gain is $50,000 before accounting for selling expenses.
Under Internal Revenue Code Section 1223, gains or losses from selling inherited assets are automatically treated as long-term. This applies regardless of how long the heir owned the property. This treatment means the gain is subject to more favorable long-term capital gains tax rates of 0%, 15%, or 20%, depending on the seller’s taxable income.
If the property sells for less than its stepped-up basis, the result is a deductible capital loss, as inherited property is considered an investment. Capital losses can offset other capital gains. If losses exceed gains, up to $3,000 per year can offset ordinary income, with any remainder carried forward to future tax years.
The Primary Residence Exclusion
The Section 121 exclusion allows a taxpayer to exclude up to $250,000 of gain from selling their main home, or $500,000 for a married couple filing jointly. To qualify, the seller must have owned and lived in the property as their primary residence for at least two of the five years leading up to the sale.
An heir can use this exclusion by moving into the inherited property and making it their primary residence. If the heir owns and lives in the home for at least two years before selling, they can qualify to exclude the gain like any other homeowner.
The two years for the ownership and use tests do not have to be continuous. For a married couple to qualify for the full $500,000 exclusion, both spouses must meet the use test, though only one needs to meet the ownership test. The exclusion generally cannot be claimed if it was used for another home sale within the two-year period prior to the current sale.
Reporting the Sale to the IRS
The sale of an inherited property must be reported to the IRS using Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D, Capital Gains and Losses. Form 8949 is used for the specific details of the sale, and these totals are then transferred to Schedule D to calculate the net capital gain or loss.
On Form 8949, you report the property’s sale price, acquisition date, and sale date. For the acquisition date, enter “Inherited” to signal long-term capital gain treatment. The cost basis you enter will be the stepped-up basis from the date of the original owner’s death.
You must report the sale if you receive a Form 1099-S, Proceeds From Real Estate Transactions, even with no taxable gain. If multiple heirs inherited the property, each reports their proportional share of the sale. The final tax liability from Schedule D is then included on your Form 1040.
Distinguishing Other Potential Taxes
The capital gains tax on the profit from selling an inherited property is distinct from other taxes related to an estate. One such tax is the federal estate tax, which is imposed on the deceased’s entire estate before assets are distributed.
The federal estate tax applies only to very large estates that exceed a high exemption amount, which is $13.99 million per individual for 2025. Most estates are valued below this threshold and do not owe any federal estate tax.
A few states also levy an inheritance tax, which is paid by the beneficiary who receives the assets, not the estate. The tax rate and exemptions depend on the heir’s relationship to the deceased, with closer relatives often facing lower rates. This state-level tax is separate from the federal capital gains tax you might owe when you sell the asset.