Yes, for most inherited capital assets (stocks, real estate, mutual funds), the cost basis is automatically adjusted—or "stepped up"—to the fair market value (FMV) at the date of the owner's death. This eliminates capital gains taxes on appreciation that occurred before the owner passed away.
At death, many capital assets (stocks, real estate, business interests, collectibles, crypto, etc.) are stepped up (or down) to their fair market value (FMV) as of the date of death (or, if elected by the executor, the “alternate valuation date” six months later).
The IRS "step-up in basis" is a tax rule that adjusts the cost basis of inherited assets (like stocks, real estate) to their fair market value (FMV) at the owner's date of death, eliminating capital gains tax on appreciation that occurred before death. Instead of heirs paying tax on the original low purchase price, they only pay capital gains tax on appreciation after inheriting the asset, making it a significant tax benefit for passing wealth down generations. Key points include valuation at the date of death, applicability to most inherited property, and recent IRS rulings (like Rev. Rul. 2023-02) affecting irrevocable trusts.
The main rule helping avoid large taxes on inherited property is the Step-Up in Basis, which resets the property's cost basis to its fair market value at the date of the original owner's death, drastically reducing capital gains tax if sold quickly. Other strategies include using trusts to avoid probate, making lifetime gifts, or, if it was your primary home, using the Section 121 exclusion after living in it for two years.
Inheriting property in California comes with financial opportunities and responsibilities. By leveraging the stepped-up basis, selling strategically, or using tax-saving tools like the principal residence exclusion or a 1031 exchange, you can minimize or avoid capital gains taxes.
You can typically inherit a very large amount from your parents without paying federal tax, as the federal estate tax exemption is around $15 million per person for 2026, meaning only estates larger than that pay tax, not you directly. While you generally don't pay income tax on inheritances (except for pre-tax retirement funds like IRAs/401(k)s, which are taxed as income when withdrawn), some states have their own estate or inheritance taxes with much lower thresholds, affecting a smaller portion of wealth.
As mentioned, if the inherited property was the deceased's principal residence, selling it within two years of their death can result in a full CGT exemption. This is one of the simplest and most effective ways to avoid paying CGT.
While inherited assets typically receive a step-up in basis (which can reduce or eliminate capital gains tax upon sale), improper titling, gifting during life, or incorrect trust setup could forfeit that benefit.
The most tax-efficient way to leave a home to a child usually involves leaving it in your will for them to inherit, which qualifies for a stepped-up tax basis (reducing capital gains tax if sold) and avoids immediate gift taxes, though trusts (like Revocable Living Trusts for probate avoidance or QPRTs for advanced planning) or Transfer-on-Death (TOD) deeds (where available) offer control and probate avoidance, while outright gifting is generally less tax-efficient due to inherited basis issues. Consulting an estate planning attorney is crucial to choose the best method for your specific situation.
A stepped-up basis changes the taxable value of inherited property by resetting it to the asset's fair market value at the time the previous owner dies.
Generally, you don't report the inheritance itself to the IRS because it's not considered taxable income for you federally; however, you must report income the inheritance generates (like interest or dividends), handle inherited retirement accounts (which are taxable), and report large foreign inheritances (using Form 3520). The deceased person's estate pays any federal estate tax (if applicable).
If a decedent had an interest in a life estate at death, the property does not receive a step up in basis unless the life estate was a retained life estate granted by the decedent. In this case, the life estate property remains in the decedent's gross estate.
Leave property to your spouse.
This is called the “spousal rollover.” This strategy is extremely useful for property with a large capital gain (e.g., cottage, investment property, land, non-registered investment). If you don't leave your property to your spouse, the capital gains tax will be due when you die.
The deceased estate 3-year rule refers to the time frame within which certain actions must be taken regarding a deceased person's estate. This rule is typically applied when the deceased individual did not have a valid will or testament in place at the time of their passing.
The 7 year rule
No tax is due on any gifts you give if you live for 7 years after giving them - unless the gift is part of a trust. This is known as the 7 year rule.
In 2025, the first $13,990,000 of an estate is exempt from federal estate taxes, up from $13,610,000 in 2024. Estate taxes are based on the size of the estate. It's a progressive tax, just like the federal income tax system. This means that the larger the estate, the higher the tax rate it is subject to.
Inheriting $100,000 or more is often considered sizable. This sum of money is significant, and it's essential to manage it wisely to meet your financial goals. A wealth manager or financial advisor can help you navigate how to approach this.
Charity exemption
Like the spousal exemption, assets passing to charity on death are exempt from inheritance tax. As such, if an entire estate passes to charity, there will be no inheritance tax due.
Give more money away
Lifetime gifting is a straightforward way to begin reducing your IHT bill. By gifting money during lifetime, that would have been part of an inheritance anyway, you reduce the size of your estate so that there is smaller amount subject to IHT on your death.
The straightforward answer is no, capital gains taxes are generally not due immediately upon inheritance. Instead, the deceased's estate is responsible for paying any capital gains tax related to the deemed disposition at death.