The Inherited House
Do You Pay Capital Gains Tax on an Inherited House?
Most heirs owe little or no capital gains tax when they sell an inherited house. A federal rule called the step-up in basis resets the taxable value to the date-of-death market value. Here is what changes that.
Your Decision
Is this more or less than you expected?
In most cases, no. Heirs who sell an inherited house soon after the owner’s death owe little or no federal capital gains tax, even when the house gained hundreds of thousands of dollars in value over the decades. The reason is a federal rule called the step-up in basis: the home’s taxable starting value resets to its fair market value on the date of death. You owe capital gains tax only on appreciation after that date, not on the growth that happened during the original owner’s lifetime.
That is the usual outcome. Whether it is your outcome depends on three things: when you sell, what the house was worth at death, and whether you can prove that value. This guide covers all three, and the trap that catches heirs who confuse capital gains tax with inheritance tax, which is a different tax with a different deadline.
What the step-up in basis means
Cost basis is the number the IRS subtracts from your sale price to compute taxable gain. When you buy a house, your basis is what you paid. When you inherit one, federal law (26 U.S.C. §1014) replaces the deceased owner’s old basis with the fair market value on the date of death.
Worked example. A parent bought a house in 1989 for $95,000. On the day they died, it was worth $470,000. The estate sells it four months later for $478,000.
- Without the step-up, taxable gain would be $383,000.
- With the step-up, the basis is $470,000, so taxable gain is $8,000.
- Selling costs (commission, transfer tax, closing fees) reduce that further, often to zero or a small loss.
Two details work in your favor. Inherited property is automatically long-term, so even an immediate sale gets the lower long-term capital gains rates. And if the estate is large enough to file a federal estate tax return, the executor may use an alternate valuation date six months after death, though that choice affects the whole estate and belongs to the executor with professional advice.
The step-up is only as strong as your proof. A date-of-death appraisal from a licensed appraiser is the document that establishes your basis if the IRS ever asks. Order it early: appraisers can value a property retrospectively, but the job gets harder and less credible as months pass and the market moves.
When you do owe capital gains tax
The step-up does not make every sale tax-free. Heirs generally owe capital gains tax in three situations.
- The house appreciated after the death. Hold an inherited house for a few years in a rising market and the gap between the date-of-death value and your sale price is taxable gain. The clock on that gain starts at death, not at sale.
- The house became a rental. Renting the house out starts depreciation, and depreciation taken (or allowed) is recaptured at sale. The tax picture shifts enough that you want a CPA involved before you list.
- The basis cannot be proven. Without a credible date-of-death value, you may end up negotiating with the IRS from a weak position. This is the cheapest problem on this page to prevent and the most expensive to fix.
Renovation and repair receipts from the date of death forward also matter: capital improvements add to your basis and shrink the taxable gain when you sell.
Capital gains tax is not inheritance tax
These two taxes get conflated constantly, and the confusion is expensive in both directions. Capital gains tax is federal, applies only to gain above your stepped-up basis, and is usually small or zero for a prompt sale. Inheritance tax is a state tax on receiving the property at all, and it does not care about basis.
Pennsylvania charges inheritance tax by relationship: nothing for a surviving spouse, 4.5% for children and grandchildren, 12% for siblings, and 15% for everyone else, with a 5% discount for paying within three months of death. New Jersey exempts spouses, children, grandchildren, and parents entirely, but taxes siblings and in-laws starting at 11% above a $25,000 exemption, and most non-relatives at 15% to 16%, with the return due within eight months. Both states can hold up the transfer or sale of the house until the tax is resolved, which makes this the deadline that actually drives an estate’s timeline.
So a child inheriting a Pennsylvania house may owe zero capital gains tax and still owe a 4.5% inheritance tax bill. The reverse happens too: an heir who budgeted for inheritance tax sometimes assumes the capital gains bill will be just as bad and accepts a lowball cash offer to “get out before taxes eat it.” Run the real numbers first. They are usually better than you fear.
What to do now
- Order the date-of-death appraisal. This one document sets your basis, supports the estate’s tax filings, and anchors your sale price negotiation. A few hundred dollars now protects six figures later.
- Keep every receipt. Improvements, repairs tied to the sale, and selling costs all reduce taxable gain.
- Check your state’s inheritance tax deadline before setting the sale timeline. In Pennsylvania, paying within three months earns a discount. In New Jersey, the return is due within eight months and the house cannot transfer without a tax waiver.
- Bring the estate’s CPA in before you file, not after. The step-up, selling costs, and any depreciation history interact, and the filing is cheap compared to amending.
Do not let anyone rush you into a below-market sale with tax fear. For a typical prompt sale, the step-up in basis has already solved the problem people are warning you about.
Real Experiences
What people who have lived it say
YOU are going to owe taxes on the capital gains from the sale
MJ1929, AgingCare.com caregiver forum, 2020, warning a poster whose father had deeded the house directly to them instead of leaving it through the estate. Read the thread.
The recurring mix-up in public discussions of this exact tax question is the one this exchange captures. Heirs who inherit a house get the stepped-up basis, but a house signed over before death to avoid probate usually does not get the same treatment, and the difference is worth a real tax bill, not a technicality. Confirming which situation actually applies to your house, before assuming either way, is the cheap step that avoids the expensive surprise.
Your Decision
Ready to decide?
Common questions
What is the step-up in basis in one sentence?
Federal law resets an inherited home's cost basis to its fair market value on the date of death, so tax applies only to gain above that value, not above what the deceased originally paid. The rule is 26 U.S.C. §1014.
Do I get the step-up if the house was in a revocable living trust?
Generally yes. Property in a revocable living trust is included in the taxable estate, which is what triggers the basis step-up. Irrevocable trusts are more complicated, and the answer depends on how the trust was drafted, so ask the estate's attorney or CPA.
Is the gain short-term if we sell right away?
No. Inherited property is automatically treated as long-term, no matter how quickly the estate or the heirs sell it, so the lower long-term capital gains rates apply to any gain.
Does the home-sale exclusion of $250,000 apply?
Not unless you actually live in the house. The Section 121 exclusion requires the home to be your primary residence for 2 of the last 5 years. Heirs who sell without moving in rely on the step-up in basis instead, which usually does more work anyway.
Sources
- IRS Publication 551, Basis of Assets (inherited property)
- 26 U.S.C. §1014, Basis of property acquired from a decedent (Cornell LII)
- 26 U.S.C. §1015, Basis of property acquired by gifts and transfers in trust (Cornell LII)
- Pennsylvania Department of Revenue, Inheritance Tax
- NJ Division of Taxation, Inheritance and Estate Tax (Form O-10-C)