Quick answer
Inherited capital assets usually receive a basis equal to their fair market value (FMV) at the decedent’s date of death, which often reduces or eliminates taxable gain if you sell soon after inheriting. The holding period for an inherited asset is treated as long‑term regardless of how long you personally hold it, and sales may trigger depreciation recapture or other special rules.
Why this matters
The tax cost of selling inherited property depends less on what the decedent paid and more on what the asset was worth when they died. That “step‑up” (or sometimes “step‑down”) in basis can materially reduce income tax due on sale proceeds, affecting estate planning, liquidity choices, and timing for heirs.
How the step‑up (or step‑down) in basis works
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Basic rule: The beneficiary’s basis in most inherited property is the asset’s FMV on the decedent’s date of death. This is explained by the IRS (Publication 551: Basis of Assets) and is the foundation for most inherited‑asset tax outcomes (IRS Publication 551: https://www.irs.gov/forms-pubs/about-publication-551).
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Alternate valuation: An estate executor can elect an alternate valuation date — six months after death — but only if it lowers estate tax liability and meets other requirements. If the alternate date is used, the beneficiary’s basis is the FMV on that date.
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Step‑down: If FMV at death is lower than the decedent’s original basis, the beneficiary’s basis steps down and the inherited asset may create a deductible loss when sold.
Establishing the inherited basis: practical steps
- Gather documentation immediately. Obtain the estate’s appraisal for real estate, recent broker statements for securities, closing statements for property sales, and the estate tax return if one was filed.
- Order a professional appraisal for real estate. A dated appraisal close to the date of death is strong evidence of FMV if the IRS questions your basis (in my practice, a timely appraisal prevents months of back‑and‑forth with examiners).
- Check for Form 8971. Many estates now file Form 8971 — Information Regarding Beneficiaries Acquiring Property From a Decedent — and must provide beneficiaries a Schedule A that lists values used by the executor (see Form 8971 guidance: https://finhelp.io/glossary/form-8971-information-regarding-beneficiaries-acquiring-property-from-a-decedent/ and IRS instructions for Form 8971: https://www.irs.gov/forms-pubs/about-form-8971).
- Reconcile competing valuations. Broker quotes, county assessor values, and appraisals can differ. Use the most supportable FMV for the date the estate used (date of death or the alternate valuation date).
Special situations and exceptions
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Joint ownership and survivorship: If property was held jointly with rights of survivorship, the basis for the surviving owner depends on how ownership was structured and whether the decedent contributed to the purchase price. Joint ownership rules can be complex; see related guidance on joint tenancy and community property.
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Community property states: In community property states, the entire community property may receive a full step‑up in basis at the first spouse’s death. That can produce a larger tax benefit compared with common‑law states where only the deceased spouse’s share is stepped up.
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Spousal transfers and marital deduction: Property passing to a surviving spouse generally receives a step‑up in basis (and transfers between U.S. spouses are often tax‑free under the unlimited marital deduction), but special trust structures (QDOTs, qualified terminable interest property) have their own rules.
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Depreciable business or rental property: If the decedent claimed depreciation before death, the beneficiary’s basis for depreciation and for determining gain is generally the stepped‑up FMV. However, when selling a depreciable asset, previously allowed depreciation may be subject to recapture (Sections 1245 and 1250), which can be taxed as ordinary income to the extent of prior depreciation deductions. This is a common trap for inherited rental properties.
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Retirement accounts and non‑capital assets: Assets that are taxable under different rules — such as inherited IRAs, retirement plans, or certain annuities — have their own tax regimes (income tax on distributions) and are not subject to capital gains rules the way stocks or real estate are.
Holding period and capital gains classification
Inherited property is treated as long‑term property for capital gains purposes, no matter how long the beneficiary actually holds it. That means any gain on sale will be taxed at long‑term capital gains rates (subject to your taxable income and surtaxes such as the Net Investment Income Tax) rather than short‑term ordinary income rates (IRS: Pub 544 and Pub 551; IRS Topic on Capital Gains).
Valuation issues and estate reporting
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Form 8939/Form 8971 and Schedule A: Estate executors now commonly report values to beneficiaries on Form 8971 and associated Schedules A. Keep copies of these and the estate’s appraisals; they are strong evidence of the basis you will use when you sell.
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Estate tax returns: If Form 706 (United States Estate (and Generation‑Skipping Transfer) Tax Return) was filed, its valuations are important evidence. Even if no estate tax return was required, an appraisal and consistent documentation are essential.
Common tax planning strategies
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Don’t rush to sell: If the house or stock market is down at the decedent’s date of death but you expect appreciation, waiting can preserve the step‑up and let you time a sale for better tax or cash outcomes.
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Consider timing and income: Capital gains tax rates depend on your taxable income. In some years you may qualify for a lower long‑term capital gains rate, so timing a sale can matter. Also consider the 3.8% Net Investment Income Tax (NIIT) for higher‑income taxpayers.
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Use improvements to increase basis for future gains: For property you keep and improve, documented capital improvements increase your basis for later sales (keep receipts and permits). Routine repairs don’t increase basis.
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Beware depreciation recapture: For inherited rental or business property, track depreciation that was claimed by the decedent — recapture can convert part of your gain to ordinary income.
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Evaluate state taxes: Many states tax capital gains as ordinary income or have different rules; check state law or consult a CPA. State treatment can change the overall tax picture significantly.
Real‑world examples (simplified)
1) Residential property with step‑up: Decedent bought house for $100k. FMV at death = $400k. Beneficiary sells for $420k. Taxable gain ≈ $20k (difference between sale price and stepped‑up basis), treated as long‑term gain.
2) Step‑down/loss: Decedent’s basis $200k, FMV at death = $120k. Beneficiary sells for $100k. Beneficiary may recognize a capital loss of about $20k (subject to loss rules and whether property is capital asset vs. business/inventory), because basis is stepped down to FMV.
3) Rental property and depreciation recapture: Decedent owned rental bought for $200k, FMV at death = $400k, beneficiary sells later for $450k. If the decedent had taken $50k in depreciation, some portion of gain up to the depreciation amount may be recaptured and taxed as ordinary income — consult a tax advisor on Section 1245/1250 issues.
Common mistakes to avoid
- Failing to document the date‑of‑death valuation (appraisal or Schedule A/Form 8971).
- Assuming the decedent’s original purchase price is your basis.
- Overlooking depreciation recapture on former rental or business property.
- Forgetting state tax implications or the NIIT.
Recordkeeping checklist
- Estate appraisal(s) for real property
- Broker statements dated at or near the date of death for securities
- Form 8971 and Schedule A from the estate (if filed) — see https://finhelp.io/glossary/form-8971-information-regarding-beneficiaries-acquiring-property-from-a-decedent/
- Copies of Form 706 (if estate tax return filed)
- Receipts and permits for capital improvements made after inheritance
How I help clients (professional insight)
In my practice, a timely appraisal and careful collection of estate valuations usually resolves most basis questions before a sale. When the numbers are large, confirming whether Form 8971 or Form 706 was filed saves weeks of tax preparation work. For rental properties, I always run a depreciation‑recapture analysis before recommending a sale.
Frequently asked questions
Q: Do I pay capital gains tax when I inherit property?
A: Not at the moment of inheritance. You typically pay capital gains tax only when you sell, and then generally only on the appreciation above the stepped‑up (or stepped‑down) basis.
Q: Is inherited property automatically long‑term?
A: Yes. The holding period for inherited capital assets is always treated as long‑term for capital gains tax purposes (IRS Pub 551).
Q: What if the estate used the alternate valuation date?
A: If the executor elected the alternate valuation date, the beneficiary’s basis is the FMV on that date (six months after death) — but the election is only valid if it decreases estate tax liability and meets IRS rules.
Next steps and when to get professional help
- Order a professional real estate appraisal if you haven’t already.
- Locate the estate’s Form 8971/Schedule A, brokerage statements, and any estate tax returns.
- Consult a CPA or tax attorney before selling large inherited assets, especially rentals or business property where depreciation recapture may apply.
Internal resources
- See our glossary entry on the step‑up in basis for more background on basis adjustments.
- Read our detailed piece on the basis of inherited property for valuation tips and examples.
Professional disclaimer
This article is educational and does not constitute tax, legal, or investment advice. Tax rules change and individual circumstances vary; consult a qualified tax professional or attorney before acting on this information.
Authoritative sources
- IRS Publication 551, Basis of Assets: https://www.irs.gov/forms-pubs/about-publication-551
- IRS instructions for Form 8971: https://www.irs.gov/forms-pubs/about-form-8971
- IRS Topic: Capital Gains and Losses and related publications (see IRS.gov)
