Calculating Capital Gains Tax (CGT) on a deceased estate involves determining the asset's "stepped-up" basis—its fair market value (FMV) on the date of the owner's death—and subtracting this from the sale price. Tax is only paid on the appreciation that occurs after the date of death. If sold immediately, gain is often minimal.
Capital gains on inherited property work a little differently than other assets. When you sell the home, your entire profit isn't taxable. Instead, you're taxed on the property's sale price minus its market value on the date of the owner's death.
Currently, the capital gains tax is not levied on assets held until death. These assets are included in the estate at market value and subject to estate taxes of 35% after a significant exemption (by historical standards) of $11.7 million, as well as other exclusions.
Capital Gains Tax (CGT) is only payable when a gain on the sale of an asset is crystalised. On death therefore, as no sale has actually taken place CGT is not applicable. Instead, the asset is valued as part of the deceased probate and is subject to Inheritance Tax (IHT).
In the case where an asset is owned by a deceased person for longer than 12 months and then sold by a beneficiary, a 50% CGT discount would apply, effectively halving the taxable capital gain.
How to Calculate the CGT Discount
You do not pay Capital Gains Tax from the estate if you transfer assets directly to a beneficiary, for example property. Read guidance on: tax when you sell property. tax when you sell shares.
Gift of an Existing Life Insurance Policy.
If an individual gifts a policy he or she owns on his or her life and continues to pay premiums and dies within three years of the transfer, the full death proceeds will be included in the insured's gross estate.
Sell Within Two Years of Inheritance: The most effective way to avoid CGT is to sell the property within two years of the deceased's date of death, provided it was their main residence and not used to generate income.
The "36-month rule" for capital gains tax (CGT) primarily refers to the UK's Principal Private Residence (PPR) Relief, where the final 36 months (or 9 months for most) of a property's ownership period are tax-exempt, even if not lived in, provided it was a main home at some point. In the US, the relevant rule for home sales is the "2-out-of-5-year rule" for the Section 121 exclusion, allowing up to $250k/$500k profit tax-free if owned and used as a main home for 2 of the 5 years before sale, with exceptions for unforeseen circumstances.
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 Two-Year Rule
One of the most significant tax benefits for surviving spouses is the ability to use the full $500,000 capital gains exclusion if they sell their home within two years of their spouse's death. This is a substantial advantage compared to the $250,000 exclusion available to single filers.
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.
The 20% rule for capital gains refers to the highest federal tax rate for long-term capital gains, applying to higher income brackets when you sell investments (stocks, real estate) held for over a year, with lower rates of 0% and 15% for lower incomes, and even higher rates for special assets like collectibles. This rate kicks in for single filers earning over approximately $492,300 (2024) or $533,401 (2025), and higher for joint filers, making holding assets over a year a key tax strategy.
No, inheriting property itself does not trigger a CGT bill. Instead, the property's value is established during probate, which is referred to as the "probate value." This value becomes the baseline for calculating any potential gains if the property is sold later.
Key Takeaways
The cost basis figure usually equals an asset's fair market value when the estate owner dies or the asset is transferred. A "step-up" in basis means the cost basis is raised to the asset's market value on the original owner's date of death for tax purposes.
Eligibility for CGT discount or indexation
For the purposes of qualifying for the CGT discount, you can treat an inherited asset as though you have owned it since: the deceased acquired the asset, if they acquired it on or after 20 September 1985. the deceased died, if they acquired the asset before 20 September 1985.
Capital gains tax only applies if you sell the inherited asset, but the step-up in basis rule usually reduces or eliminates this tax. Inherited IRAs or 401(k)s can create taxable income as distributions occur.
CGT doesn't usually apply at the time you inherit the dwelling, however it will apply when you later sell or dispose of the dwelling, unless an exemption applies. if you dispose of the inherited property within 2 years (or the within an extension period) of the deceased person's death.
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.
HMRC's view is that the probate valuation should reflect a fair open market value on the date of death, not what it happens to fetch later. So, if the house rises in value before it's sold, that uplift is potentially a capital gain, rather than something you adjust on the inheritance tax return.