Selling an inherited house can be a tax minefield. Learn about stepped-up basis, capital gains, and how to keep more of your inheritance from the IRS.
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I’ll never forget the phone call I got from a close friend last year. She was grieving the loss of her father, but beneath the sadness, she was utterly panicked. “I just found out I’m getting the house,” she told me. “But I can’t afford to keep it, and I’m terrified that if I sell it, the government is going to take half the money in taxes.”
It is a common fear, and honestly, it’s a valid one. Dealing with an inherited house is an emotional rollercoaster, and the last thing you want to think about is a stack of IRS forms. You’re already sifting through old photos and deciding which furniture to keep; trying to calculate “cost basis” feels like a cruel joke.
But here is the good news: the tax rules for an inherited house are actually much friendlier than the rules for a house you bought yourself. In fact, if you play your cards right, you might end up paying very little in taxes—or even nothing at all. Let’s break down the “secret sauce” of estate taxes so you can make an informed decision without the late-night anxiety.
The Holy Grail: Stepped-Up Basis Explained
If there is one thing you remember from this article, let it be this: Stepped-up basis. This is the single most important tax benefit you receive when you take ownership of an inherited house.
Normally, when you sell a property, your profit is calculated based on what you paid for it. If your parents bought their home in 1975 for $40,000 and it’s now worth $500,000, a normal sale would trigger a massive tax bill on that $460,000 gain.
However, when you receive an inherited house, the IRS “steps up” the value to the fair market value on the day the original owner passed away. If the house was worth $500,000 on the day your father died, your new “cost basis” is $500,000. If you sell it a few months later for $510,000, you only owe taxes on the $10,000 difference. It’s a massive financial reset that saves families billions every year.
Capital Gains: Long-Term vs. Short-Term
Another huge win for the inherited house owner is the holding period rule. Usually, the IRS charges you a higher tax rate (short-term capital gains) if you sell an asset after holding it for less than a year.
But for an inherited house, the IRS automatically considers your holding period to be “long-term.” It doesn’t matter if you sell the property two weeks after the funeral; you will still qualify for the lower long-term capital gains tax rates, which typically top out at 15% or 20% depending on your income level.
The Probate Reality: It Isn’t Always Instant
I’ve seen plenty of heirs try to list their inherited house the same week they get the keys. Hold your horses. Unless the home was in a living trust, it likely has to go through probate.
Probate is the court-supervised process of distributing a deceased person’s assets. During this time, the “Estate” technically owns the home, and an executor or administrator is in charge. You can’t legally sign a deed for an inherited house until the court gives you the green light.
- The Executor’s Role: They ensure all of the deceased’s debts are paid before the house is transferred to you.
- The Appraisal: You must get a professional appraisal immediately after the death to document that “stepped-up” value for the IRS. Don’t rely on Zillow; get a licensed appraiser.
Selling a House with Multiple Heirs
Things get a little more complicated when you aren’t the only one who got the inherited house. If you and your three siblings are now 25% owners, you all have to agree on the sale price and the listing agent.
I’ve seen many families get stuck in “analysis paralysis” here. One sibling wants to fix it up and flip it; another wants the cash immediately. My advice? Be the voice of reason. Selling an inherited house is usually a business transaction, not a family reunion. If you can’t agree, the court can force a “partition sale,” but that usually results in lower prices and higher legal fees. Better to play nice and move the property quickly.
Reporting the Sale to the IRS
When the deal is done, the title company or attorney will issue a Form 1099-S. This tells the IRS that you sold a property. Even if you don’t owe any money because of the stepped-up basis, you must report the sale of the inherited house on your tax return.
You’ll use Schedule D and Form 8949 to show the IRS the math. You’ll list the sales price, subtract the stepped-up basis, and subtract your closing costs. In many cases, after you account for the 5–6% real estate commission and other fees, you might actually show a “capital loss” on the inherited house, which can actually lower your other taxes!
The $250,000 Exclusion: Can You Use It?
You might have heard of the “Primary Residence Exclusion,” where you can sell your home and pay zero taxes on the first $250,000 of profit ($500,000 for couples).
Can you use this on an inherited house? Only if you move in. To qualify, you must live in the house as your primary residence for at least two of the five years before the sale. For most heirs, this isn’t practical. However, if you decide to keep the inherited house and make it your home for a few years, you could potentially save even more on taxes down the road.
Don’t Forget the State Taxes
While we’ve been talking mostly about federal rules, your state might want a piece of the action too. Most states follow the federal “stepped-up” rules, but some have their own inheritance tax or estate tax thresholds.
For example, if the inherited house is in a state like Pennsylvania or New Jersey, there might be a specific tax based on your relationship to the deceased. Always check with a local tax professional who knows the specific quirks of the state where the property is located.
FAQ Section
1. Is an inherited house considered income? No. At the federal level, an inherited house is not considered “income” like your salary. You don’t pay income tax on the value of the house when you receive it. You only pay capital gains tax if you sell it for more than its value on the date of the original owner’s death.
2. What if the house has a mortgage? When you take over an inherited house, you generally take over the debt too. Most mortgages have a “due on sale” clause, but federal law (the Garn-St. Germain Act) prevents banks from calling the loan just because the owner passed away. You can keep making the payments, or you can pay off the loan when you sell the property.
3. Do I have to pay taxes if I sell the house immediately? If you sell the inherited house shortly after the owner’s death for its appraised value, you likely won’t owe any federal capital gains tax. This is because the sales price will be almost identical to your stepped-up basis.
4. Can I sell an inherited house for $1 to a family member? You can, but it’s a tax nightmare. Doing this triggers “gift tax” rules and ruins the stepped-up basis benefits for the person you sold it to. If you want to keep the home in the family, it’s much better to have the inherited house appraised and sold at a fair price.
5. How do I prove the value of the house when I inherited it? A professional, written appraisal from a licensed real estate appraiser is your best defense. If the IRS ever audits the sale of your inherited house, that appraisal report is the “gold standard” of proof.
Conclusion
Losing a loved one is hard enough without having to navigate the labyrinth of the tax code. If you find yourself holding the keys to an inherited house, take a deep breath. The system is designed to give you a fresh start through the stepped-up basis rule.
As long as you get a professional appraisal early, document your expenses, and work with an experienced real estate agent who understands estate sales, you can turn that inherited house into a financial blessing rather than a burden. You don’t have to be a tax expert to come out ahead; you just need to know which questions to ask.