Do I have to pay capital gains tax when I sell an inherited house?

You are taxed on the gain since the date of death

Your parents bought the house in 1979 for the price of a nice pickup truck today. Good news: that number mostly stops mattering the day they pass.

Federal tax law says the basis of property you get from someone who died is generally its fair market value on the date of death (Internal Revenue Code section 1014(a)). Basis is the starting number the IRS uses to figure your gain. People call this the stepped-up basis, because in most families the value went way up since the original purchase.

The IRS puts it simply: if you sell the inherited property for more than your basis, you have a taxable gain. If you sell for about what it was worth on the date of death, there may be little or no gain at all.

There is one exception worth knowing. If the estate files a federal estate tax return, the executor can elect an alternate valuation date, and the basis becomes the value on that date instead. Your CPA will know whether that applies to you.

How the math works, with made-up numbers

Say a house down the street was bought decades ago for $90,000. The owner dies, and an appraisal shows it was worth $1,000,000 on the date of death. The heirs sell it eight months later.

• Basis: $1,000,000 (the date-of-death value, not the $90,000)
• Sale price: $1,050,000
• Selling costs: say $50,000 in commissions and fees
• Gain: roughly zero

IRS Publication 544 explains that selling expenses reduce the amount you realize from a sale, which lowers the gain. So in this example the heirs owe little or nothing in federal capital gains tax.

Now picture the same heirs with no date-of-death value at all. If they cannot prove the basis, they are guessing on a tax return, and guessing is a bad hobby to take up with the IRS. Every dollar you cannot support as basis is a dollar that can get taxed as gain.

These numbers are hypothetical. Your real figures depend on the house, the market and the costs of sale.

Selling fast does not cost you extra

Normally you have to own something for more than a year to get long-term capital gains treatment, which usually carries a lower federal rate than short-term gains.

Inherited property gets a break. Under Internal Revenue Code section 1223(9), if your basis comes from the date-of-death rule and you sell within one year of the death, you are treated as having held it for more than one year. Your gain is long-term no matter how quickly you sell.

That matters because a lot of families want the house sold quickly. Nobody wants to pay the utilities, the insurance and the gardener on a house no one lives in while three siblings argue over who gets the dining set.

One more thing to know: if the house sells for less than your basis, that is a loss. IRS Publication 544 says a loss on property held for personal use is not deductible. Whether yours can be deducted depends on how the property was used after the death, which is a CPA question.

You still report the sale, even with no gain

Many heirs assume that no gain means no paperwork. The IRS disagrees. It says the gross proceeds from selling inherited property count toward deciding whether you have to file a return, and if you have a filing requirement, the sale goes on Schedule D and Form 8949.

The value on the date of death is the number your return leans on. The IRS says to get it from the executor of the estate. If the estate filed a federal estate tax return, you may receive a Schedule A (Form 8971) showing the reported value, and IRS Publication 551 says certain beneficiaries are required to use that value as their basis.

If no estate tax return was filed, someone still has to come up with a defensible date-of-death value. That is usually where I come in. Your accountant can do a lot of things, but they cannot pull a value for a house out of a spreadsheet without evidence.

This is general information only. Tax treatment depends on your facts, so confirm the details with a CPA or tax attorney.

Why the date-of-death value has to be proven

A date-of-death appraisal is a retrospective appraisal: an appraisal of the value as of a past date. I look at sales that happened around that date and the condition of the house at that time, then show how I got to the number.

Kiplinger reports that property tax assessments and agent price opinions are not acceptable substitutes, and that assessments are usually well below market value. A low basis means a bigger taxable gain later. Using the tax bill to set basis is like weighing yourself on the bathroom scale your mom set back ten pounds.

Here is what I see in the field. Families often start fixing up the house before anyone records what it looked like on the date of death. Kiplinger makes the same point: ideally the home is not renovated or staged before the appraiser documents its condition. New paint is great for the sale. It is a headache for proving what the house was worth before the paint.

My view is facts over feelings. A basis number should come with sales, dates and reasoning a reviewer can follow, not a round number someone liked.

What to do before you sell the inherited house

1. Get the date of death in writing and ask the executor or trustee whether an estate tax return will be filed.
2. Take photos of the house as it is before any cleanout, repairs or staging. Date them.
3. Order a date-of-death appraisal from a state-certified appraiser who can explain the comps and adjustments.
4. Keep every closing document from the sale, including the settlement statement showing commissions and fees.
5. Hand it all to your CPA with the appraisal, so they can report basis, proceeds and costs on the right forms.
6. Ask about state tax. This post covers federal rules only.