Paying Tax on The Inherited House

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 capital gains tax.

Think of the home’s basis 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 generally measures your gain from the home’s fair market value on the date of death instead of what the previous owner originally paid.
• The step-up in basis doesn’t change what the house is worth. It changes where the IRS starts measuring your gain.

For example, your parents bought a home decades ago for $150,000. 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 $600,000.

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, keeping, or renting 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 path forward.

• Fortunately, you won’t pay capital gains tax on the difference between what the original owner paid for the home and its fair market value when you inherited it. Instead, the IRS uses the home’s stepped-up basis as the starting point for calculating your taxable gain.
• That means when you sell, you’ll owe capital gains tax only on any appreciation that occurs after you inherit the home.
• If you sell the home soon after inheriting it for about its fair market value, your taxable gain may be minimal.

What if you decide to keep the house? 

Keeping an inherited home doesn’t create an immediate federal tax bill. You’ll still be responsible for ongoing costs like maintenance. If you eventually decide to sell the home, the stepped-up basis will determine how your capital gains are calculated.

Some beneficiaries—roughly 17%—decide to turn an inherited home into a rental property. If you do, rental income is typically taxable. You may also be able to deduct certain expenses related to the property. Depending on your situation, you might qualify to claim depreciation, which can affect both your annual taxes and your capital gains calculation if you eventually sell.

Estate and inheritance tax considerations

If you’ve inherited a house, you may also be wondering whether you’ll owe inheritance tax or estate tax. For most families, the answer is no. 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), meaning it generally applies only to exceptionally large estates. Whether either tax applies depends on factors like the overall size of the estate, where the deceased lived, and state law.

Where you live matters with inheritance

While federal tax rules dominate the conversation, state-level rules can create unexpected financial surprises. But the baseline rule is 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 alongside 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.  Additionally, 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, transferring title triggers 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.

 Key questions 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. 
• 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. 
•  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.
• 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.