Inheriting a home or other appreciated assets can be a meaningful event. But capital gains taxes on inherited property can erode your wealth if you don’t plan carefully. The good news is that several proven strategies can help you preserve the value of your inheritance and minimize what you owe.
While searching “how to avoid paying capital gains tax on inherited property” may yield some results, know that there is no legal way to do so. But when you understand how capital gains work and how you can legally defer them, you gain the ability to make the most of what’s been passed down to you.
Start With the Step-Up in Basis
When you inherit a home or other asset, the IRS typically resets its value through a process known as a “step-up in basis.” This adjustment changes the cost basis of the property to its fair market value at the time of the decedent’s death. In simple terms, if your parent bought the home for $100,000 and it’s worth $500,000 when you inherit it, the IRS considers your new basis to be $500,000, not the original purchase price.
Step-up bases are powerful. If you sell the property shortly after inheriting it, and its market value hasn’t changed much, your taxable gain could be minimal or even zero. That’s one of the most effective ways to defer capital gains tax after an inheritance.
Sell the Property Soon After Inheriting
Timing is crucial when selling an inherited property. If you plan to sell the home, doing so soon after taking ownership can help you avoid significant tax consequences. Because of the step-up in basis, there’s usually very little appreciation in the short window after inheritance.
By acting quickly, you reduce the chance of the property appreciating further and creating a new, taxable gain. It’s a clean exit strategy that preserves most of your inherited value, especially in stable or slow-moving markets.
Turn the Property Into Your Primary Residence
If you decide to keep the home, living in it for a period of time may create additional tax benefits. When a property is your primary residence for at least two of the five years before selling, you may qualify for the IRS home sale exclusion.
This exclusion lets you exclude up to $250,000 of gain from taxes if you’re single, or up to $500,000 if you’re married filing jointly.1 Combined with the step-up in basis, this strategy could shield a significant amount of appreciation from taxes. It’s especially useful in fast-appreciating markets where holding onto the property for a few years can lead to a higher sale price.
Use a Trust to Maintain Tax Benefits
Trusts provide an additional layer of planning and protection. If the original owner placed the property in a revocable living trust, the step-up in basis still applies. However, the trust also streamlines the inheritance process, allowing the property to transfer to you without going through probate. This saves you time and money as the beneficiary.
You can also use trusts to manage how property is held and sold, helping you control tax recognition and preserve income opportunities. Irrevocable trusts may have more restrictions, but can still play a role in long-term estate planning and wealth preservation.
Don’t Forget the Impact of Depreciation Recapture
If the property you inherited was used as a rental and claimed depreciation deductions, you may need to watch out for depreciation recapture when you sell. This tax applies to the portion of the gain tied to depreciation deductions taken by the previous owner.
The good news is inheriting a property typically resets the depreciation schedule. That means the recapture risk is minimized or eliminated entirely in most inheritance cases. Still, if the property had been held in a different structure or trust, it’s worth reviewing with a qualified tax advisor to understand what’s at stake.
Work With Professionals to Optimize Your Outcome
Even with the best intentions, inheritance and tax rules can be complex. By working with a qualified capital gains tax advisor, you can determine which strategy best fits your situation. They can help you time a sale, convert the property for personal use, or use estate tools like a Deferred Sales Trust (DST) to create even more flexibility and deferral opportunities.
Keep These Strategies in Mind
Inheriting property can be a life-changing event. If you want to reduce capital gains tax and preserve more of your inheritance, consider:
- Leveraging the step-up in basis to minimize taxable gains
- Selling quickly if you don’t plan to keep the property
- Making it your primary residence to unlock IRS home sale exclusions
- Using tools like DSTs to maintain flexibility and reduce costs
By combining these strategies, you ensure that more of what was left to you stays with you. Whether your goal is financial security or honoring a loved one’s gift, smart tax moves can make all the difference.
1https://www.irs.gov/taxtopics/tc701#:~:text=In%20general%2C%20to%20qualify%20for,to%20the%20two%2Dyear%20rule.