How is Inherited Property Taxed When Sold?

Selling inherited property can trigger taxes, but not always in the way many people expect. In most cases, you don’t pay tax when you inherit the home. Instead, taxes may apply when you sell, based on how much the property increased in value after inheritance. Understanding capital gains, stepped-up basis, and holding time helps you estimate what you might owe and plan your next move with confidence.

Types of Taxes on Inherited Property

There are several different types of taxes that are assessed on inherited property. Let’s take a look at each one and how and when they apply below.

Estate Taxes

When someone passes away, the first tax assessed is a tax on their assets, which are collectively referred to as their estate. This could include everything from their bank accounts and investments to their vehicle, home, and anything else they owned at the time of their death.

Federal Estate Taxes

Estate tax is levied by the federal government. Any taxes due must be paid by the estate prior to any assets being passed along to heirs or beneficiaries. If the estate does not have enough cash to cover the taxes due, then some of the assets may need to be liquidated in order to free up enough funds. 

Fortunately, most estates don’t end up triggering the federal estate tax, as the IRS has set a minimum value threshold. As of 2024, this minimum is $13.61 million. Of course, this is always subject to change, so we strongly suggest doing some research or speaking to a tax professional to be sure the information you have is current and accurate.

State Estate Taxes 

Depending on where the property is located, the estate may also be subject to state taxes. These are assessed based on the state in which the deceased person resided at the time of their death. 

Only certain jurisdictions levy estate taxes, and each has its own minimum threshold. Unfortunately, this minimum is typically much lower than the federal one. For instance, some states set the threshold as low as $1 million. So, even if the estate is exempt from federal taxes, it may still be taxed on the state level.

Again, the executor or estate administrator must do their due diligence and settle any tax liabilities prior to distributing any inheritance.

Inheritance Tax

Once any applicable estate taxes have been paid and the assets are ready to be passed along to the heirs or beneficiaries, an inheritance tax may be levied.

As the name implies, inheritance tax is imposed on the recipients of the inherited assets. Currently, only a handful of states assess inheritance tax. What you owe will depend on the state where the decedent lived, the value of the inheritance, and the relationship between you and the person who passed away. It is not based on where the beneficiary lives.

Calculating Inheritance Tax

As with estate taxes, inheritance tax will typically only apply to a tiny percentage of people (typically around 2%), as there are certain thresholds to be met. 

If the value of your inheritance does happen to meet the minimum threshold, you’d only owe taxes on the amount that exceeds that threshold.

So, if you were to inherit a home valued at $200,000 and the state it’s located in sets a minimum of $175,000, you would only owe taxes on the difference of $25,000. If the state assesses an inheritance tax rate of 10%, then your tax obligation would be $2,500.

• $200,000 – $175,000 = $25,000
• $25,000 x .10 = $2,500
• Tax bill = $2,500

Additionally, some states specify that certain relationships are exempt from inheritance taxes. For instance, surviving spouses are exempt in all states that currently assess inheritance taxes. Children of the deceased are not exempt, but they may pay a rate that is lower than a beneficiary who is not related. 

To determine whether you fall into any of these categories, speak with an experienced tax advisor.

Is there a federal inheritance tax?

As of the time of publishing, there is no federal inheritance tax. Again, there’s always a chance that could change, so be sure to do your homework.

Capital Gains Taxes

Another tax associated with inherited property is capital gains tax. The federal government, as well as several states, assess capital gains taxes, which are due when the property is sold.

Calculating Capital Gains Taxes

Generally speaking, capital gains taxes are assessed on the difference in value between the date of purchase and the date of sale. So, if you purchased a stock ten years ago for $100 per share, and sold it today for $250 a share, you would owe capital gains on the difference of $150.

When selling inherited property, capital gains are calculated from the date of the deceased owner’s death, not the purchase date. This is known as a “stepped-up” basis.

Let’s say you inherited a house appraised at $200,000 at the time of the decedent’s death. If you sell that property for $225,000, you would only owe capital gains taxes on the increase in value of $25,000. You wouldn’t owe any capital gains if you sold it for $200,000.

• Purchase Price: $100,000
• Appraised Value at Date of Death: $200,000
• Sale Price: $225,000
• Stepped-Up Basis: $225,000 – $200,000 = $25,000

Because of how this is calculated, many people who inherit a home choose to sell as soon as possible. That way, the property doesn’t have as much time to appreciate, so they can save on taxes.

Property Taxes

The last type of tax associated with an inherited home is property taxes. These can vary significantly based on the location of the property and are due on an ongoing basis as part of the upkeep and maintenance of the home. 

When you inherit a property, you may find that there are property taxes that are past due. These are typically settled out of the estate before any inheritance is passed along. Or you may discover that they are due shortly after you inherit the home. In a case like that, whoever has taken possession of the property will be responsible for paying the taxes.

If you decide to keep the property, whether it’s to live there, rent it out, or use it as a vacation home, the taxes on that property will become part of your ongoing expenses. 

When and How Do Taxes Have to Be Paid?

Because each tax has its own purpose, when they are due will vary. For instance, estate taxes, if applicable, are typically paid as part of the probate process. 

Inheritance Taxes

Inheritance taxes are usually reported separately from income, using a specified form. Each state that assesses inheritance taxes determines when these taxes are to be paid. For instance, one state may require payment within one year of the decedent’s death, while another might set the limit at a certain number of months.

If you are subject to inheritance taxes, we advise you to speak with an expert to ensure that you file the appropriate paperwork within the designated timeline set forth in that state.

Capital Gains Taxes

Because capital gains taxes are calculated based on the appreciation in value, they are only due upon the sale of the property. The amount owed, if any, should be reported and paid with your regular tax return in the year of the sale, using an IRS Schedule D form. 

Property Taxes

Lastly, property taxes are due on an ongoing basis if you decide to keep the property.

How to Avoid or Minimize Taxes on Inherited Property

Some taxes, such as property taxes, cannot be avoided. However, others, like inheritance, estate, and capital gains, can be minimized and possibly even eliminated. All it takes is a little planning. 

Avoiding Taxes as an Heir or Beneficiary

If you’ve already inherited the property and are looking to minimize your tax obligation, there are a few options. 

For instance, to avoid paying inheritance taxes altogether, you can choose to disclaim the inheritance. Of course, you’ll want to weigh the pros and cons of doing so. A nominal tax payment may be worth it in the long run if you can keep or sell the property for a profit.

With capital gains taxes, you can reduce your obligation by selling the property quickly. In some instances, such as with a cash buyer, you can sell your inherited property in just days. This limits the amount of appreciation, thereby mitigating capital gains.

There are a few other ways you can avoid or reduce your capital gains tax obligation as well.

Protecting Your Assets

If you are the person doing the estate planning, you can help minimize the tax burden on your beneficiaries in many ways.

For example, if you reside in a state that assesses inheritance taxes, you might consider one or more of the following:

• Move to a state that does not levy inheritance tax.
• Gift the assets (note: you may be required to pay a gift tax, but your heirs will not).
• Use tax-sheltered vehicles, such as a living trust, an irrevocable trust, or a grantor-retained annuity trust.
• Consider charitable donations to reduce your estate’s value.

Another option would be to sell your home now and then use the proceeds to purchase a life insurance policy. Generally speaking, the payout from life insurance is not taxable, so in doing so, your beneficiaries would inherit the value of the home without having to deal with selling it themselves and possibly paying inheritance or capital gains taxes.

Again, we cannot understate the importance of working with a qualified tax professional or certified financial planner. These experts can help you plan your estate so your heirs or beneficiaries won’t face substantial tax obligations once you’ve passed on.