Do You Pay Capital Gains on an Inherited House?

Capital gains tax applies to the profit realized from the sale of an asset, which is the difference between its sale price and its cost basis. While inheriting a house does not immediately create a taxable event, selling that inherited property later can trigger capital gains tax obligations for the beneficiary. The tax treatment of an inherited house differs significantly from a property acquired through purchase, primarily due to how its value is established for tax purposes at the time of inheritance.

Cost Basis of Inherited Property

The cost basis is the value used to determine the investment in a property for tax purposes. For property acquired through inheritance, the cost basis is generally its fair market value (FMV) on the date of the decedent’s death. This is often referred to as the “step-up in basis” rule, adjusting the asset’s basis to its market value at inheritance, rather than the deceased’s original purchase price. This rule can significantly reduce the potential capital gains tax for the heir.

In certain situations, the executor of the estate may elect an alternate valuation date, which is six months after the decedent’s death. If this election is made, the FMV on that alternate date becomes the basis. This option is typically considered if the property’s value has decreased since the date of death. The primary goal of the step-up in basis is to prevent capital gains that accrued during the decedent’s ownership from being taxed when the heir sells the property.

To determine the fair market value of an inherited property, a professional appraisal is generally the most reliable method. An appraiser assesses the property’s condition, features, and location, comparing it to similar properties recently sold in the area. This “date-of-death” appraisal provides an official valuation that can be used for estate settlement and tax reporting. While real estate agents can provide a comparative market analysis, a formal appraisal offers a more accepted valuation for tax purposes.

The original purchase price paid by the deceased owner, or any improvements they made during their ownership, do not directly affect the heir’s initial stepped-up basis. The heir’s basis begins anew at the property’s FMV on the date of death. This means any appreciation in value that occurred during the decedent’s lifetime is effectively removed from the capital gains calculation for the beneficiary.

Calculating Capital Gains or Losses

Once the cost basis of an inherited property is established, calculating any capital gain or loss upon sale involves a straightforward formula. The capital gain or loss is determined by subtracting the adjusted basis and selling expenses from the property’s final sale price. This calculation is expressed as: Sale Price – Selling Expenses – Adjusted Basis = Capital Gain or Loss.

Selling expenses are costs directly associated with the sale of the property. These expenses reduce the amount realized from the sale and can include real estate broker commissions, attorney fees, appraisal fees, advertising costs, closing costs, and transfer taxes. For instance, if a property sells for $500,000 and commissions and other selling expenses total $30,000, the net sale proceeds for tax calculation would be $470,000.

The “adjusted basis” starts with the stepped-up basis (FMV at the date of death) and includes certain additions or subtractions. Any capital improvements made by the beneficiary after inheriting the property can be added to this basis. Examples of such improvements include major renovations, room additions, a new roof, or upgraded systems that significantly add value or extend the property’s useful life. Routine repairs and maintenance, such as painting or minor upkeep, are not considered capital improvements and cannot be added to the basis.

Additionally, if the inherited property was rented out by the beneficiary, any depreciation deductions taken during the rental period would reduce the adjusted basis. This reduction accounts for the wear and tear on the property recognized for tax purposes. Property taxes paid by the beneficiary during their ownership are generally deductible as an expense on their income tax return and do not adjust the property’s basis.

Tax Rates and Reporting Requirements

The taxation of capital gains on inherited property depends on the length of time an asset is held. Profits from assets held for one year or less are considered short-term capital gains and are taxed at ordinary income tax rates. In contrast, profits from assets held for more than one year are long-term capital gains, which typically benefit from lower, preferential tax rates.

For inherited property, a special Internal Revenue Service (IRS) rule simplifies this distinction: all inherited property automatically qualifies for long-term capital gains treatment, regardless of how long the beneficiary actually owned it before selling. This means even if a beneficiary sells the property immediately after inheritance, any gain is taxed at the more favorable long-term capital gains rates.

Current long-term capital gains tax rates are 0%, 15%, or 20%, depending on the taxpayer’s overall taxable income. For the 2025 tax year, for single filers, the 0% rate applies to taxable income up to $48,350. The 15% rate applies to taxable income between $48,351 and $533,400. For taxable income above $533,400, the 20% rate applies. These thresholds are adjusted annually for inflation and vary based on filing status, such as married filing jointly or head of household.

To report the sale of an inherited house, taxpayers must use IRS Form 8949, Sales and Other Dispositions of Capital Assets. This form details each transaction, including the date acquired, date sold, sale price, and cost basis. When reporting an inherited property, the acquisition date should be entered as “Inherited” to ensure it receives long-term capital gain or loss treatment. The totals from Form 8949 are then transferred to Schedule D (Form 1040), Capital Gains and Losses, which summarizes all capital gains and losses for the tax year.

Common Scenarios and Considerations

Selling an inherited house quickly after receiving it often results in little to no capital gain subject to tax. This outcome is a direct benefit of the stepped-up basis rule, which sets the property’s cost basis to its fair market value on the decedent’s date of death. If the property is sold soon after inheritance, its sale price is likely to be very close to this stepped-up basis, minimizing or eliminating any taxable gain.

If a beneficiary decides to make the inherited house their primary residence, they might eventually qualify for the Section 121 primary residence exclusion. This provision allows eligible taxpayers to exclude up to $250,000 of capital gain ($500,000 for those married filing jointly) from the sale of their main home. To qualify, the beneficiary must have owned and lived in the property as their main home for at least two of the five years immediately preceding the sale. This exclusion can further reduce or eliminate a capital gain if the property appreciates during the beneficiary’s residency.

Inheriting a house with an existing mortgage does not impact the property’s cost basis or the calculation of capital gains. The mortgage represents a liability against the property, not an addition to its value for tax purposes. The beneficiary assumes responsibility for the mortgage, and the outstanding loan balance will reduce the net proceeds received from a sale, but it does not alter the taxable gain.

In situations where an inherited house sells for less than its stepped-up basis, a capital loss occurs. This capital loss may be deductible for tax purposes, provided the property was held for investment or business use, such as being rented out, rather than for personal use. If the property was never converted to an income-producing asset and was held solely for personal purposes, any loss on its sale is generally not deductible.