Beneficiaries usually do not pay immediate capital gains tax upon receiving property through a Transfer on Death (TOD) deed, as they receive a "stepped-up basis" to the property's fair market value at the time of the owner's death. Capital gains taxes are only owed if the beneficiary sells the property for more than this new stepped-up value.
While they simplify asset transfer, TOD accounts don't eliminate tax obligations. Taxes like estate, inheritance, and capital gains may still apply.
You can avoid capital gains taxes on inherited property by minimizing the time for appreciation. Selling immediately after inheritance typically results in minimal capital gains tax because there's little time for the property to appreciate beyond its stepped-up basis.
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.
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 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.
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.
However, several important considerations must be made before proceeding. First, there is no way to avoid "tax involvement" when transferring real estate. Even when no money changes hands, the IRS and state tax authorities still view property transfers as taxable events.
Tax-free lump sum payments (where the individual dies under 75) must be made within two years of the scheme administrator being notified of the death of the individual. Any lump sum payments made after the two-year period will be taxed at the recipient's marginal rate of income tax.
6 options for passing down your home
The beneficiaries or heirs who inherit properties from the estate may also have a responsibility to pay capital gains taxes. Capital gains taxes are a federal tax imposed on the revenue generated after the sale of an asset that has appreciated in value.
On a $100,000 capital gain, you'll likely pay 15% for long-term gains, resulting in about $15,000 in federal tax (plus potential state tax), but it could be 0% or 20% depending on your total taxable income and filing status, while short-term gains are taxed as ordinary income (potentially 22-24%).
The "6-year rule" for Capital Gains Tax (CGT) in Australia allows you to treat a former main residence as tax-exempt for up to six years after you move out, even if you rent it out, enabling you to avoid CGT on any growth during that period. You qualify by moving out, choosing to treat it as your main home for tax, and can reset the rule by moving back in. If you rent it out for longer than six years, only the portion of the gain after the six-year mark becomes taxable.
To qualify for 0% capital gains tax, you must have long-term capital gains (assets held over a year) and your taxable income (after deductions) must fall below specific IRS thresholds, which change annually but are roughly <$48,350 for single filers and <$96,700 for married filing jointly for the 2025 tax year, allowing for higher total income when combined with deductions like the standard deduction. The key is keeping your adjusted gross income (AGI) low enough so that after subtracting deductions, your taxable income remains within these limits.
As policymakers search for equitable and efficient ways to address the large looming federal deficits, one option should top their list: closing the “Angel of Death” loophole. This refers to the fact that if a person dies holding assets with capital gains, the increase in the asset value escapes the income tax.
Capital gains tax (CGT) is paid either by the deceased estate or by the beneficiary. Never both. But which one applies depends on who sells the asset and when. This distinction matters more than people realise.
Common Estate Planning Mistakes We See
At our firm, we frequently encounter these errors that can put families at risk: Not filing Form 706 because the estate falls below the exemption threshold. Incomplete or inaccurate asset valuations that trigger IRS audits.
The taxable portion of capital gains are included in income
Generally, a change in the fair market value of a capital property between the time it was purchased or acquired and the date of death results in a capital gain or capital loss, which must be reported in the Final Return of the person who died.