The basis of an asset is its original cost for tax purposes. The "step-up" increases the property's basis to its fair market value (FMV) at the time of the decedent's death. For tax purposes, this step-up can eliminate much of the capital gains liability if the property is later sold.
There are four ways you can avoid capital gains tax on an inherited property. You can sell it right away, live there and make it your primary residence, rent it out to tenants, or disclaim the inherited property.
All About the Stepped-Up Basis Loophole. A stepped-up basis is a tax provision that allows heirs to reduce their capital gains taxes. When someone inherits property and investments, the IRS resets the market value of these assets to their value on the date of the original owner's death.
An easy and impactful way to reduce your capital gains taxes is to use tax-advantaged accounts. Retirement accounts such as 401(k) plans, and individual retirement accounts offer tax-deferred investment. You don't pay income or capital gains taxes on assets while they remain in the account.
A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.
Use a 1031 Exchange to Defer Capital Gains
It's a popular way to defer capital gains taxes when selling a rental home or even a business. Often referred to as a “like-kind” exchange, this tax deferment strategy is defined in Section 1031 of the Internal Revenue Code.
Upon selling an inherited asset, if the inherited property produces a gain, you must report it as income on your federal income tax return as a beneficiary.
The trust fund loophole refers to the “stepped-up basis rule” in U.S. tax law. The rule is a tax exemption that lets you use a trust to transfer appreciated assets to the trust's beneficiaries without paying the capital gains tax. Your “basis” in an asset is the price you paid for the asset.
When a house is transferred via inheritance, the value of the house is stepped up to its fair market value at the time it was transferred, according to the IRS. This means that a home purchased many years ago is valued at current market value for capital gains.
Many people worry about the estate tax affecting the inheritance they pass along to their children, but it's not a reality most people will face. 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.
Inherited properties can come with financial responsibilities such as existing mortgages, unpaid property taxes, maintenance costs, and insurance requirements. Be aware of hidden costs, including emergency repairs, property management fees, and legal expenses.
I live and do real estate in California. If the parent died in the property, you should wait at least three years to sell the property. You must disclose (tell) a buyer if a person died in that property if it happened within the last three years. After three years, no disclosure is required.
However, TOD does not avoid taxes.
But when gains are inherited, the loophole zeroes out the gain for tax purposes. As a result, an investment sale that would create a taxable gain for the original owner is tax-free for the inheritor. Example: an investor buys 100 shares of stock for $200. Ten years later, the stock is worth $500.
Revocable trusts are not a way to avoid capital gains tax. Instead, they are most often used to protect and manage assets during the grantor's lifetime and to provide direction and control over how assets are distributed after the grantor's death.
There are several ways you might reduce your estate, including spending assets, giving assets away, buying life insurance and putting assets in trusts. For most people who are impacted by the estate tax, trusts are integral to reducing an estate's size and may help to reduce estate taxes.
If you received a gift or inheritance, do not include it in your income. However, if the gift or inheritance later produces income, you will need to pay tax on that income.
Inheritance checks are generally not reported to the IRS unless they involve cash or cash equivalents exceeding $10,000. Banks and financial institutions are required to report such transactions using Form 8300. Most inheritances are paid by regular check, wire transfer, or other means that don't qualify for reporting.
Your share of sales proceeds (generally reported on Form 1099-S Proceeds From Real Estate Transactions) from the sale of an inherited home should be reported on Schedule D (Form 1040) Capital Gains and Losses in the Investment Income section of TaxAct.
This tax loophole allows property owners to defer capital gains on their sale as long as the proceeds are used to purchase another property within a set time frame.
Current tax law does not allow you to take a capital gains tax break based on your age. In the past, the IRS granted people over the age of 55 a tax exemption for home sales, though this exclusion was eliminated in 1997 in favor of the expanded exemption for all homeowners.
A 1031 exchange, named after Section 1031 of the Internal Revenue Code, allows you to defer paying capital gains taxes by reinvesting the proceeds from the sale of your investment property into a similar property.