Capital Gains on Inherited House: What the Step-Up in Basis Means for Your Family

Why Most Families Overpay Taxes on an Inherited Home

Your parent's house has probably appreciated substantially since they bought it. A home purchased for $45,000 in 1978 might be worth $420,000 today — and at first glance, that looks like $375,000 in taxable capital gains. But in most cases, the actual tax bill is far smaller than families expect, thanks to a provision called the step-up in basis.

The problem is that families often don't know about the step-up, or they misunderstand how it works for surviving spouses versus inheriting children. That confusion leads to two costly mistakes: selling too quickly without documenting the stepped-up value, or avoiding a necessary sale because they're afraid of a tax bill that may not exist.

How the Step-Up in Basis Works

For property inherited from a decedent, the basis is generally its fair market value on the date of death; an alternate valuation date or special-use value can apply when estate tax rules permit. The basis can move down as well as up. This adjustment is commonly called a step-up in basis under IRC Section 1014.

Here's what that means in practice. Say your father bought the family home in 1985 for $80,000. He dies in 2026, and an appraisal shows the home is now worth $450,000. Without the step-up, selling the home would trigger capital gains tax on $370,000 of appreciation. With the step-up, the new cost basis becomes $450,000 — the date-of-death value. If the family sells the home shortly after for $455,000, the taxable gain is only $5,000.

The basis adjustment generally applies to inherited real property in the United States, including a family home, rental property, and vacant land. It does not apply to property received as a gift during the owner's lifetime; gifts generally carry over the donor's adjusted basis, which is why estate planning attorneys sometimes advise against gifting appreciated property before death.

Surviving Spouses Get Different Treatment

The step-up rules work differently depending on whether the surviving spouse lives in a common-law state or a community property state, and the difference can be worth tens of thousands of dollars.

Common-Law States (Most of the Country)

In common-law property states — which include the majority of U.S. states — the basis adjustment generally applies to the deceased spouse's share. For a home held by a married couple as a qualified joint interest, that's typically 50%.

Using the same example, assume the spouses jointly owned the home and split its original $80,000 basis equally. Now worth $450,000, the deceased spouse's half gets stepped up to $225,000. The surviving spouse's half retains its $40,000 basis. The combined new basis is $265,000. If the surviving spouse sells for $450,000, the gain is $185,000.

That gain might still be tax-free, though. The surviving spouse may qualify for the $250,000 capital gains exclusion under IRC Section 121 (the primary residence exclusion) if they meet its ownership, residence, look-back, and other eligibility tests. The residence test generally requires living in the home as a main home for at least two of the five years before the sale. In this scenario, $185,000 is below the $250,000 maximum if the surviving spouse qualifies.

Community Property States

In the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), qualifying community property generally receives a basis adjustment to its full fair market value when one spouse dies, provided at least half its value is included in the deceased spouse's gross estate. A sale near the date-of-death value would generally produce little gain.

This double step-up is one of the most valuable tax provisions in estate law, and it's the reason estate planners in community property states sometimes advise couples to hold appreciated assets as community property rather than in separate accounts.

Alaska allows couples to opt into community property treatment through a community property trust — worth exploring if there's significant real estate appreciation.

What the Surviving Spouse Needs to Do Before Selling

If your widowed parent is considering selling the house — whether to downsize, move closer to family, or cover living expenses — there are several steps to protect the stepped-up basis.

Get a date-of-death appraisal. This is the single most important document. Hire an appraiser to determine the home's fair market value as of the date of death. An appraisal can help document the basis; if an estate tax return reported a value, some beneficiaries must use a consistent basis. Keep the executor's valuation records because the IRS can question unsupported estimates.

Determine whether the property was held as community property or joint tenancy. This affects how much of the value receives a basis adjustment. Review the deed and ownership records; state law and how the property was acquired can also matter.

Understand the two-year window for the $500,000 exclusion. A surviving spouse who has not remarried may qualify for the $500,000 exclusion if they sell within two years of the spouse's death, neither spouse used the exclusion on another home sold less than two years before the sale, and the ownership and residence tests are met. Filing jointly for the year of death does not by itself qualify the sale for the $500,000 exclusion. After the two-year window, the surviving spouse may qualify for the usual $250,000 individual maximum if the applicable tests are met.

Don't rush. Financial advisors generally recommend waiting six to twelve months before making major housing decisions after a spouse's death. The stepped-up basis itself does not expire, but timing can affect the $500,000 surviving-spouse home-sale exclusion. The primary residence exclusion also has ownership, residence, and look-back requirements; the two-of-five-year residence test is only one of them.

When Adult Children Inherit the House

If both parents have died and the children inherit the property from the second parent's estate, its basis is generally reset to fair market value at that parent's death, subject to applicable valuation rules. The parents' original purchase price is generally not the starting basis.

Adult children who inherit a home face a different decision tree than surviving spouses:

Selling promptly usually produces little or no taxable gain, since the stepped-up basis and the sale price are close together. This is the simplest scenario.

Keeping the property as a rental preserves the stepped-up basis for depreciation purposes — you can depreciate the building portion of the property's eligible basis after placing it in service as a rental. Land is not depreciable.

Moving in starts the clock on the primary residence exclusion. After owning and using the home as a main residence for at least two of the five years before a sale, an individual may qualify to exclude up to $250,000 of gain. A married couple filing jointly may qualify for up to $500,000 if both spouses meet the residence and look-back tests and at least one meets the ownership test.

The one thing to avoid: adding a child's name to the deed while the parent is still alive. That can be a gift, and the child generally takes the parent's adjusted basis in the gifted share instead of a date-of-death value. The parent's retained share can generally receive a separate date-of-death basis adjustment if later inherited. A home bought for $50,000 in 1975 and worth $500,000 today could carry substantial taxable gain after a lifetime gift, while an inherited share generally starts with a basis based on its date-of-death value.

Multi-Country Considerations

Capital gains rules on inherited property differ substantially outside the United States:

United Kingdom. Inheritance Tax (IHT) is generally charged at 40% on the taxable estate above the £325,000 nil-rate band. A qualifying home passed to direct descendants can add up to a £175,000 residence nil-rate band, subject to eligibility and a taper for estates over £2 million. For Capital Gains Tax (CGT), inherited property generally has a date-of-death market value as its acquisition value, so a later gain is measured from that value. In 2026, individuals generally pay CGT at 18% or 24% on taxable residential-property gains, depending on their taxable income and gains.

Canada. There is no separate inheritance tax, but death generally triggers a deemed disposition — the deceased is treated as if they disposed of capital property at fair market value immediately before death, and any gain is reported on the final tax return. A tax-deferred rollover generally applies when property passes to a surviving spouse or common-law partner, or to a qualifying spouse trust; in that case, the recipient's tax cost generally carries over instead of resetting to fair market value.

Australia. The deceased's acquisition date affects the beneficiary's cost base. If the deceased acquired the asset before 20 September 1985, the beneficiary generally uses its market value at the date of death. For later acquisitions, the beneficiary generally inherits the deceased's cost base; an exception gives a date-of-death market-value cost base for some inherited homes that were the deceased's main residence and were not being used to produce income. A full CGT exemption can apply if the inherited home is disposed of within two years of death and either the deceased acquired it before 20 September 1985 or it was the deceased's main residence and was not income-producing at death; otherwise, a partial exemption or CGT may apply.

Putting This Together for Your Family

The step-up in basis means that the capital gains tax on an inherited house is almost always far less than families fear. In many cases — especially when the surviving spouse qualifies for the primary residence exclusion — it's zero.

The critical action items are straightforward: get a date-of-death appraisal, verify how the property was titled, and understand whether you're in a common-law or community property state. These three facts shape the tax outcome.

If you're helping an elderly parent navigate this alongside everything else that follows a spouse's death — benefit claims, account transitions, household reorganization — our Helping Your Elderly Parent After Their Spouse Dies guide walks through the complete financial and practical timeline, including the property and tax transitions that most families miss.