Since data shows that 39% of people in the U.S. report real estate as part of their past or expected inheritance, it is no surprise that subject comes up a lot at the tax desk. While most people decide to sell it, there are others who turn it into a rental while others decided to move into it. The big question always is 'What am going to have to pay in taxes when I receive this?' After you read this, you should have a better understanding of that question.
What if you inherit a house
First of all, you’ll need to decide what to do with the property. Whether you sell it, keep it, or turn it into a rental, each option has different tax implications.
One of the most important tax rules for inherited property is the step-up in basis. A home’s basis is the amount the IRS uses as the starting point for calculating your capital gains tax.
The home’s basis is like a car’s trip odometer. Resetting the trip odometer doesn’t erase the miles already driven. Instead, it creates a new starting point, tracking only the miles driven from that point forward.
When you inherit a home, the IRS resets the clock and views the home’s fair market value on the date of death instead of what the previous owner originally paid. For example, your parents bought a home decades ago for $100,000. By the time you inherit it, it’s worth $700,000. If you later sell the home for $750,000, your taxable gain would be $50,000, not $650,000.
That’s because your taxable gain is based on the appreciation that occurred after you inherited the home, not when your parents owned it..
Selling your inherited property
Selling an inherited home is often one of the biggest financial decisions you’ll make after inheriting property. A Real Estate Inheritance Report from Trust & Will finds that 56% of heirs choose to sell an inherited home, making it the most common choice.
If the house is sold with a couple of months after inheriting it, then the fair market value and the sale price will probably be the same - so you will show no profit to take taxes on. When you add in the cost of sale like realtor fees, title fees and so on, you actually may end up with a loss. So, it best to sell it as soon as possible before real estate values go up to make it a non-taxable event.
But what if you need to make some upgrades to make it sell for a better price? It really depends on the price of the upgrades and how much the increase in sale price is. The price of the upgrades is added to the fair market price to get your cost basis.
For instance, if your fair market value is $100,000 and you spent $50,000 on upgrades, then your basis is $150,000. If you sell it for $150,000 you have no profit. If you can then sell it for $200,000, then you have a $50,000 profit to pay capital gains on.
Keeping or renting your inherited house
Keeping an inherited home doesn’t create an immediate federal tax bill. Remember that if you eventually decide to sell the home, the stepped-up basis will determine how your capital gains are calculated. So you still need to document how you determined the fair market value of the property on the date of death before you move in. You will need this if it is sold.
Other beneficiaries—roughly 17%—decide to turn an inherited home into a rental property. If you do, make sure you know all of the tax implications of creating rental income. You may also be able to deduct certain expenses related to the property such as property taxes and depreciation, which can affect both your annual taxes and your capital gains calculation if you eventually sell. From a legal standpoint, you should probably create an LLC and transfer the deed to operate under it to protect yourself.
Overall inheritance tax considerations
If you’ve inherited a house, most families will not any owe inheritance tax or estate tax. The federal government doesn’t impose an inheritance tax, and only a handful of states do. Furthermore, the federal sits at $15 million per individual ($30 million for married couples), which means it applies only to exceptionally large estates. Overall it depends on factors like the overall size of the estate, where the deceased lived, and state law.
Where you live matters
While most people are focused on the federal tax rules, state-level rules can create unexpected financial surprises. But the rules are basically the same: Nearly all state tax codes conform to the federal step-up in basis, resetting the property's starting value to its fair market value on the date of death for state capital gains purposes. However, state rules diverge from IRS rules in several key areas:
- State Capital Gains Rates: If you hold the home and sell it after it appreciates further, any post-inheritance gain is subject to state income tax in addition to federal capital gains tax. In high-tax states like California, New York, or Minnesota, state capital gains tax rates can add 8% to 13%+ to your tax bill.
- State Inheritance and Estate Taxes: Five states—Pennsylvania, New Jersey, Maryland, Kentucky, and Nebraska—levy a state inheritance tax on certain heirs. Also, twelve states and Washington, D.C. enforce state estate taxes with exemptions far lower than the federal threshold—in places like Oregon or Rhode Island, kicking in on estates valued as low as $1 million or $1.8 million.
- Local Property Tax Reassessments: In some jurisdictions, just transferring a title causes a local property tax reassessment. The capped property tax rate the previous owner enjoyed could reset to current fair market value, significantly increasing annual holding costs.
Finally, things to consider before making a decision
Before deciding whether to sell, keep, or rent an inherited home, take time to evaluate a few financial factors:
- What is the home’s official stepped-up valuation? Securing a professional, independent appraisal as of the date of death establishes your baseline basis and protects you if you sell later. If you know a good realtor, they should be able to steer you in the right direction to accomplish this.
- Can you afford the ongoing carrying costs? If you plan to keep the home, calculate the true cost of holding it — including updated local property taxes, insurance premiums, utilities, and deferred maintenance. Going from renting to owning a home is a whole different set of figures in your budget.
- Are there co-heirs or sibling dynamics to navigate? If you inherit with siblings, clarify whether everyone agrees on selling or keeping the property, or if one party needs to buy out the others. This is probably the first thing that needs to happen when inheriting property.
- What are the local property tax reassessment rules? Check with the local tax assessor to see if transferring title triggers an immediate tax reassessment that could increase annual property taxes. In many states that have homesteaded property this often happens.
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