Preparing Your Family for Capital Gains Tax on Inherited Property

When families inherit property, they often face a mix of emotion, responsibility, and uncertainty. Understanding capital gains tax, valuation rules, and what happens when you sell inherited property helps protect your family’s legacy and provides clarity during a complicated time. Whether you plan to inherit the property, pass it on to the next generation, or are navigating the sale of inherited property, thoughtful estate planning can help you minimize or even avoid unnecessary taxable gain.

SKY Investment Group offers families expert guidance and customized planning to protect their legacy and support effective family wealth transfers.

Key Takeaways

• Inheriting property is not a taxable event. You only owe capital gains tax if you sell for more than the stepped-up basis.
• The stepped-up basis resets the property’s value to its fair market value at the time of inheritance, often reducing future taxable gain.
• Estates are responsible for paying estate tax, not the inheritee.
• Selling soon after inheritance, tracking improvements, or using available exclusions may significantly reduce capital gains tax.

When Do You Pay Capital Gains Tax on Inherited Property?

Many families worry they will owe capital gains tax immediately after receiving an inheritance. The good news is that you do not pay capital gains tax simply because you inherit property. There is no federal inheritance tax at the individual level, and income tax does not apply to the transfer itself.

You pay capital gains tax only if and when the inherited property is sold for more than its stepped-up basis. The stepped-up basis reflects the fair market value of the property as of the date of death, not the original purchase price. This tax advantage often wipes out decades of appreciation for tax purposes, which may dramatically lower your future taxable gain.

For example:
If the decedent owned the property and purchased it decades ago for an original purchase price of $30,000, and the value of the property was $430,000 on the date of death, your new tax basis becomes $430,000. If you sell the property for close to that amount, you may owe little or no capital gains tax.

This rule applies whether you inherit a home, investment land, or rental property.

Understanding the Types of Taxes That May Apply When You Inherit Property

Families often hear about several different taxes and wonder which ones matter. Not all taxes apply in every situation.

Capital Gains Tax

This tax applies only when the property you inherited is sold for more than the stepped-up basis. The gains tax on the difference between the sale price and the stepped-up basis creates the taxable gain. This is the main type of tax on inherited property most families are concerned about.

Federal Estate Tax

The estate tax applies only at the estate level if the estate tax threshold is exceeded. For most families, estate tax only applies in large estates. Estates worth more than $13.99 million in 2025 and $15 million in 2026 can face federal estate taxes, which are paid out of the estate itself and therefore lower the amount ultimately passed on to beneficiaries. Beneficiaries do not directly pay this tax.

Inheritance Tax

A few states impose a formal inheritance tax, but many have eliminated it. The federal government does not impose a federal inheritance tax.

How the Stepped-Up Basis Helps Reduce Capital Gains Tax

The stepped-up basis is one of the most important tax rules that helps families avoid paying capital gains tax unnecessarily. When you inherit the property, its tax basis resets to the fair market value as of the date of death.

This means:

• Earlier appreciation is no longer subject to capital gains tax
• Only gain since you inherited the property may create taxable income
• You may eliminate years of potential tax liability

For example:
If the property you inherited is valued at $430,000 at inheritance and you later sell it for $480,000, your taxable gain is only $50,000.

If you sell inherited property for less than the stepped-up basis, you may be able to claim a capital loss, which can offset other gains on your tax return, especially if the property is an investment or rental property.

When Do You Owe Capital Gains Tax on the Sale of Inherited Property?

You owe capital gains tax only when:

1. The inherited property is sold, and
2. The sale price exceeds the stepped-up basis.

If you sell inherited property soon after the inheritance, the value often aligns closely with the market value on the date of death, meaning you may owe little or nothing.

If you keep the inherited home for several years, market appreciation can create long-term capital gain, which may be taxed at a long-term capital tax rate. Holding the property longer may increase your potential capital gains tax.

Primary Residence Exclusion

If you inherit property and live in the home for at least two of the five years before the sale, you may qualify to exclude:

• Up to $250,000 of capital gain, or
• Up to $500,000 if married filing jointly

How Capital Gains Are Calculated When Inherited Property Is Sold

Your capital gain is calculated as:

Sale Price – Stepped-Up Basis – Documented Improvements After Inheritance = Taxable Gain

Important notes:

• Improvements raise your tax basis, reducing taxable income
• Repairs and maintenance generally do not increase the basis
• Selling costs (commissions, closing costs) may reduce tax liability
• If multiple heirs inherit the property, each heir reports their share

If you sell the property for less, you may claim a capital loss when the property is an investment or rental. You must report the sale on Schedule D and Form 8949 to show gains and losses.

Inheriting Rental or Investment Real Property

When you inherit rental property or an investment property, additional tax rules apply.

Important considerations

• Depreciation does not carry over. You start a new depreciation schedule even if the decedent owned the property as a rental for years or rented the property for at least two decades.
  
  
• Your tax basis resets to the market value on the date of death, reducing future capital gain.
• Rental income becomes part of your tax return and must be reported as taxable income.
• Holding a rental provides ongoing cash flow, but it also requires careful record-keeping for tax purposes.

Retaining an investment or rental property may create opportunities but also responsibilities — especially if several heirs must coordinate.

If You Do Not Want to Sell the Inherited Property Immediately

Families often hesitate to sell right away. It is normal to need time to grieve or to decide whether to live in the home, rent it, or hold it as an investment.

If you wait to sell inherited property, be sure to:

• Document the fair market value as of the date of death
• Track all improvements and major expenses
• Understand that appreciation over time may create long-term capital gain
• Consider your tax bracket and how future gain may affect taxable income
• Discuss intentions early if multiple heirs are involved

Delaying the sale can support thoughtful planning, but it may also increase your capital gains tax liability.

Practical Ways to Maximize Your Tax Savings

Families often ask how to avoid capital gains or minimize capital gains tax on the property you inherited. While every situation is unique, helpful strategies include:

1. Selling Soon After Inheritance

This avoids gains caused by market appreciation.

2. Tracking Improvements After Inheritance

Documented improvements increase your basis of property, reducing taxable gain.

3. Moving In and Qualifying for the Home Sale Exclusion

Living in the home for two of the past five years before the sale may help eliminate capital gains tax.

4. Considering a 1031 Exchange for Investment Property

If the property is an investment, a 1031 exchange may defer gains tax on inherited property.

5. Reviewing State Rules

Some states have estate tax, inheritance tax, or other tax rules that affect how families pay capital gains tax or file an estate tax return.

6. Working with a Tax Professional

A tax professional can evaluate nuances such as long-term capital rates, whether you may owe capital gains, and whether certain choices could trigger capital gains tax unnecessarily.

How SKY Investment Group Helps Families Navigate Inherited Property

At SKY, our goal is to bring thoughtful guidance to every family we serve. Inheriting property is a major moment, and you should never feel like you are navigating complex tax rules or big financial decisions alone. We take the time to explain each step, build a plan that reflects your family’s values, and help you make choices that help protect your long-term legacy. We are here to guide you forward with thoughtful planning and trusted expertise.