Inheriting a home can be both a blessing and a challenge. While it may provide financial security, it also comes with important legal and tax implications—especially when you decide to sell the property. One of the biggest questions homeowners ask is: What are the tax consequences when selling an inherited house?
The good news is that tax laws are designed to ease the burden on heirs, often allowing for reduced tax liability compared to selling a home you originally purchased. However, understanding concepts like capital gains tax, the step-up in basis, and estate taxes is essential to avoid unexpected costs.
In this guide, we’ll break down navigating the process on inheriting a house, how taxes are calculated, and strategies to minimize what you owe. Whether you’re selling immediately or holding onto the home for a while, this article will help you make informed decisions for what's next for you and your family.
Understanding the Step-Up in Basis Rule
One of the biggest tax advantages of inheriting a house is the step-up in basis rule. This rule adjusts the value of the inherited property to its fair market value (FMV) at the time of the original owner’s death, rather than what they originally paid for it.
How Does the Step-Up in Basis Work?
Let’s say your loved one bought the home 30 years ago for $100,000, but at the time of their passing, it was worth $300,000. Instead of being taxed on the original purchase price, your new basis in the home is stepped up to $300,000.
If you sell the house for $320,000, your taxable gain would only be $20,000 ($320,000 - $300,000) rather than $220,000 ($320,000 - $100,000) if the step-up in basis rule didn’t exist.
This rule can significantly reduce or even eliminate capital gains taxes, making it one of the most important tax benefits of selling an inherited house.
Why does it matter?
- If you sell the home soon after inheriting it, you may owe little to no capital gains tax because the market value likely hasn’t changed much.
- If you hold onto the home and its value increases over time, you’ll owe taxes on the appreciation beyond the stepped-up basis.
Capital Gains Tax When Selling an Inherited House
Once you inherit a house, you may wonder how much you'll owe in taxes if you decide to sell it. The good news is that, thanks to the step-up in basis rule (covered in the previous section), you’ll likely pay less in capital gains tax than you might expect.
How Does Capital Gains Tax Work?
Capital gains tax applies when you sell an asset for more than its basis. Since an inherited home gets a stepped-up basis, your taxable gain is calculated as:
Capital Gains = Sale Price - Stepped-Up Basis - Selling Costs
If you sell the inherited home for the same value as the stepped-up basis, you owe no capital gains tax because there’s no gain.
Long-Term vs. Short-Term Capital Gains
Unlike other real estate sales, inherited property is always considered a long-term asset, regardless of how long you've held it. This means you'll be taxed at long-term capital gains rates rather than higher short-term rates.
Capital Gains Chart for 2024 (Federal) - NOTE: These numbers are subject to change each year based on IRS updates
CASE STUDY: Example of Capital Gains Tax Calculation
Let’s say you inherit a home with a stepped-up basis of $300,000 and sell it for $350,000 after deducting closing costs.
📌 Taxable gain = $350,000 - $300,000 = $50,000
If you fall into the 15% capital gains tax bracket, you’d owe $7,500 in capital gains tax ($50,000 × 15%).
NOTE: One thing to keep in mind is that there are way to reduce you capital gains and even avoid it, be sure to reach out to a CPA to understand your options.
Estate Taxes vs. Inheritance Taxes – Do They Apply to You?
Many people worry about hefty taxes when inheriting a home, but the reality is that most estates won’t be subject to federal estate taxes. However, some state-specific inheritance taxes may apply. Let’s break it down.
Estate Taxes: Paid by the Estate, Not the Heirs
Estate taxes are levied on the deceased’s total assets before distribution to heirs. However, the federal estate tax exemption for 2024 is $13.61 million. This means that unless the estate’s value exceeds this amount, no federal estate taxes will be due.
📌 Key Takeaway: If the total estate is worth less than $13.61 million, you won’t owe any federal estate taxes when inheriting a house.
Inheritance Taxes: Do You Owe Taxes on What You Receive?
Unlike estate taxes, inheritance taxes are paid by the heirs, not the estate itself. The good news? There is no federal inheritance tax, and only a handful of states impose one.
States with Inheritance Taxes in 2024: Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania, and Iowa
Each state has different rules and tax rates depending on your relationship to the deceased. For example, spouses and children often receive exemptions or lower tax rates, while distant relatives or non-relatives may pay higher rates.
📌 NOTE: If you live in Nevada, you're in luck! Nevada residents don’t have to worry—Nevada has no state inheritance tax or estate tax.
When Do You Owe Taxes on an Inherited Property?
The taxes you owe on an inherited home largely depend on what you do with it. Here’s a breakdown of three common scenarios:
Scenario 1: Selling the House Immediately
If you sell the inherited home soon after inheriting it, you’ll likely owe little to no capital gains tax. Thanks to the step-up in basis rule, the property’s value is reset to its fair market value (FMV) at the time of inheritance.
For Example:
- Your inherited home has a stepped-up basis of $400,000.
- You sell it for $410,000 after closing costs.
- Your taxable capital gain is only $10,000—far less than if you had to pay tax on the original purchase price.
✅ Best for: Heirs who don’t want to hold onto the property long-term and want to minimize tax liability.
Scenario 2: Holding the Property and Selling It Later
If you hold onto the home and sell it later, you could face higher capital gains taxes if the property appreciates.
For Example:
- You inherit a home with a stepped-up basis of $300,000.
- 5 years later, the home is worth $400,000 and you sell it.
- Your taxable capital gain is $100,000 ($400,000 - $300,000).
✅ Tax Strategy: If you live in the home for at least two years, you may qualify for the home sale exclusion ($250,000 for single filers, $500,000 for married couples), significantly reducing or eliminating capital gains taxes.
Scenario 3: Renting Out the Property
If you decide to rent out the inherited home, you won’t owe capital gains tax right away. However:
- Rental income is taxable, reported as ordinary income on your tax return.
- You can deduct property expenses (mortgage interest, maintenance, insurance, property taxes).
- You can depreciate the property over 27.5 years, reducing taxable rental income.
📌 Tax Planning Tip: If you rent the home and later sell it, your tax liability could be higher due to depreciation recapture, which adds to your taxable income later when you do sell.
✅ Best for: Those looking for long-term passive income but willing to navigate tax complexities
FINAL THOUGHTS
Selling an inherited house comes with both financial and emotional challenges, but understanding the tax consequences when selling an inherited house can help you make informed decisions. While estate taxes and capital gains taxes may seem daunting, the step-up in basis rule often minimizes your tax burden—especially if you sell the property soon after inheriting it. However, if you hold onto the home, taxes can become more complex, particularly as property values appreciate.
There are strategies to reduce or avoid taxes when selling an inherited home, so be sure to reach out to your financial planner or accountant to make sure you have an informed decision when that time comes. Doing so will only help you avoid the many common mistakes when selling an inherited home.
By planning ahead and understanding your options, you can maximize your inheritance while minimizing unnecessary costs. If you’re considering selling, it’s worth exploring the best approach for your situation—whether that means selling quickly, renting the property, or holding onto it as an investment.
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