What happens to capital gains tax when you inherit property

When you inherit property, the IRS resets its value to what it was worth on the date of the owner's death. This reset—called a step-up in basis—is the main reason most inherited property avoids capital gains tax. If the original owner bought a house for $200,000 and it was worth $500,000 when they died, your basis (the value the IRS uses to calculate gains) becomes $500,000, not $200,000. If you sell it shortly after inheriting it for $510,000, you owe capital gains tax only on the $10,000 difference, not the $300,000 the property actually gained in value during the original owner's lifetime.

This step-up applies to most inherited assets—real estate, stocks, bonds, mutual funds, and retirement accounts (with some exceptions). It is one of the largest tax breaks in the U.S. tax code, and it happens automatically when property passes through an estate. You do not need to file anything special to receive it; the executor or administrator of the estate reports the stepped-up value to the IRS on the estate tax return (if one is required), and that value becomes your starting point.

Key Takeaways

  • The step-up in basis resets inherited property's value to its worth on the date of death, which eliminates most capital gains tax on appreciation that happened before you inherited it.
  • This benefit applies automatically to property that passes through a will or intestacy, and to property held in a revocable living trust.
  • Property transferred during the owner's lifetime does not receive a step-up, so gifts and properties placed in irrevocable trusts before death keep their original basis.
  • Inherited IRAs, 401(k)s, and other retirement accounts do not receive a step-up and are taxed as ordinary income when you withdraw from them.
  • If you inherit property jointly with the original owner, only the deceased owner's share receives a step-up; your share keeps its original basis.

How the step-up in basis actually works

The step-up in basis is determined by a professional appraisal or fair market value assessment as of the date of death. The executor of the estate (or the successor trustee if the property was in a revocable living trust) arranges this valuation and reports it to the IRS. For real estate, this is often done by a licensed appraiser; for stocks and bonds, the value is the closing price on the date of death; for other assets, the executor uses whatever valuation method is appropriate.

Once that value is established, it becomes your basis. When you eventually sell the property, you calculate your capital gain or loss using that stepped-up value as your starting point, not the original purchase price. The longer the original owner held the property and the more it appreciated, the larger the tax benefit to you. A property that doubled in value over 40 years will have zero capital gains tax owed if you sell it within a year or two of inheriting it, because the stepped-up basis captures all that appreciation.

The step-up applies whether the property passes through probate or through a revocable living trust. It also applies to property that passes by operation of law—for example, a house held as "tenants by the entirety" (a form of joint ownership available to married couples in some states) automatically passes to the surviving spouse and receives a step-up on the deceased spouse's share.

What does not receive a step-up in basis

Property transferred as a gift during the owner's lifetime does not receive a step-up. If your parent gives you a house worth $500,000 that they bought for $200,000, your basis is $200,000, not $500,000. If you sell it later for $550,000, you owe capital gains tax on $350,000 of gain. This is why the timing of a transfer matters: a gift made years before death leaves the recipient with the original basis and a larger tax bill later.

Inherited retirement accounts—IRAs, 401(k)s, 403(b)s, and similar plans—do not receive a step-up. The balance in these accounts is taxed as ordinary income when you withdraw it, regardless of how long the original owner held the account or how much it grew. This is a significant exception: a $1 million inherited IRA will be taxed as ordinary income on withdrawal, not at capital gains rates, and the tax is owed by you as the beneficiary, not by the estate.

Property held in an irrevocable trust does not receive a step-up, because it was removed from the owner's estate before death. Property placed in a revocable living trust does receive a step-up, because the owner retained control and the property is still part of their taxable estate at death.

When you inherit property jointly with someone else

If you inherit property that was owned jointly, only the deceased owner's share receives a step-up. Your share—if you were already on the deed—keeps its original basis. This matters most when property is held as "joint tenants with rights of survivorship" or as "tenants in common."

For example: you and your parent own a rental property as joint tenants. Your parent bought it for $300,000; it is now worth $600,000. When your parent dies, their 50% share receives a step-up to $300,000 (half of the current value). Your 50% share keeps its original basis of $150,000 (half of the original purchase price). If you sell the property for $600,000, you owe capital gains tax on $150,000 of gain (the difference between $300,000 and $600,000 on your share), even though the property appreciated $300,000 total.

The exception is property held by married couples as "tenants by the entirety" in states that recognize this form of ownership. In those states, the entire property receives a step-up when one spouse dies, not just the deceased spouse's share.

Inherited real estate and state taxes

The step-up in basis applies to federal capital gains tax. Most states do not have a capital gains tax on real estate, but a few do. California, Hawaii, and a handful of others tax capital gains on all assets, including inherited property. The step-up in basis reduces your federal tax bill, but you may still owe state capital gains tax depending on where the property is located and where you live.

Some states also have inheritance taxes or estate taxes separate from the federal estate tax. These are paid by the estate, not by you as the beneficiary, but they reduce the value of what you inherit. A few states—Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania—have inheritance taxes that explore to property passing to beneficiaries outside the when ready family. The step-up in basis does not reduce these state-level taxes.

How to document the stepped-up basis for the IRS

The executor or trustee of the estate is responsible for reporting the stepped-up value to the IRS on Form 706 (the federal estate tax return) if the estate is large enough to require one. The threshold for filing Form 706 changes yearly; in recent years it has been over $12 million for individuals and $24 million for married couples, but check the current year's threshold with the IRS or a tax professional.

If the estate is small enough that no Form 706 is required, the stepped-up basis is still valid—you do not lose the benefit. However, you should keep records of the property's value on the date of death. When you eventually sell the property, you will need to show the IRS what your basis was. Obtain a copy of the death certificate, the appraisal or valuation used by the estate, and any documents the executor or trustee prepared showing the property's fair market value on the date of death. Keep these with your tax records.

When you sell inherited property, report the sale on Schedule D (Capital Gains and Losses) using the stepped-up basis as your cost basis. If the sale price is very close to the stepped-up value, your capital gain will be small or zero. The IRS may ask for documentation of the basis, especially if the property appreciated significantly between the date of death and the date of sale.

Selling inherited property soon after inheriting it

One of the simplest ways to avoid capital gains tax on inherited property is to sell it relatively soon after inheriting it. Because your basis is reset to the value on the date of death, if you sell within a few months or a year, the sale price will be close to your basis, and your capital gain will be minimal or zero.

This strategy works best when the property has not changed much in value between the date of death and the date of sale. If you inherit a house worth $400,000 and sell it six months later for $410,000, you owe capital gains tax on only $10,000 of gain, even if the original owner bought it for $150,000 decades earlier. The longer you hold the property after inheriting it, the more it may appreciate, and the larger your eventual capital gains tax bill will be.

This is not a requirement—you can hold inherited property as long as you want—but it is a straightforward way to minimize tax if you do not plan to keep the property long-term.

Frequently Asked Questions

Do I have to pay capital gains tax on inherited property?

Usually no, because of the step-up in basis. Your basis is reset to the property's value on the date of death, so if you sell it soon after inheriting it, you owe little or no capital gains tax. You only owe tax on gains that occurred after you inherited it.

What if the property was worth less when the owner died than when they bought it?

The step-up in basis still applies, but it works in reverse. Your basis becomes the lower value on the date of death. If you sell it for more than that, you owe capital gains tax on the difference. If you sell it for less, you have a capital loss.

Can I avoid capital gains tax by putting property in a trust before I die?

A revocable living trust does not avoid the step-up—property in a revocable trust still receives a step-up when you die. An irrevocable trust does avoid it, but the property is removed from your control and taxed to the trust, which is usually not worth the trade-off.

Do inherited stocks and bonds get a step-up too?

Yes. Inherited stocks, bonds, mutual funds, and other securities all receive a step-up in basis to their fair market value on the date of death. This is one reason inherited investment accounts often have little or no capital gains tax owed when you sell the holdings.

What about inherited rental property—do I still get a step-up?

Yes, rental property receives a step-up just like any other real estate. However, if you continue to rent it out, you will depreciate the building over time, which reduces your basis and creates a tax liability when you eventually sell. Consult a tax professional about depreciation recapture if you inherit rental property.