Capital Gains Tax: capital gains on inherited property

I specialize in estate and trust taxation and want to clarify how capital gains on inherited property actually work, because this is an area where people frequently get bad advice. The most important concept is the stepped-up basis rule under IRC Section 1014. When you inherit property, your cost basis is not what the deceased originally paid for it. Instead, your basis is stepped up to the fair market value on the date of death.

For example, if your parent bought a house in 1985 for 80,000 dollars and it was worth 450,000 dollars on the date of their death, your basis is 450,000 dollars, not 80,000 dollars. If you sell it shortly after inheriting for 460,000 dollars, your capital gain is only 10,000 dollars, not 380,000 dollars. This is an enormous tax benefit that many people are not aware of ngl.

There are a few important exceptions and complications to be aware of. First, if the property was held in a revocable living trust apparently, you still get the step-up. However, if the property was in an irrevocable trust that the decedent transferred more than three years before death, the step-up rules can vary depending on the trust structure. Second, if you inherit property from a non-citizen non-resident, the step-up may not apply to certain types of property.

One practical issue that catches many heirs: you need to establish the fair market value at the date of death. Get a qualified appraisal done as close to the date of death as possible. If the estate filed a federal estate tax return (Form 706), the value reported there is typically the basis. If no estate tax return was filed because the estate was below the filing threshold, an independent appraisal is your best documentation in case of an IRS audit.