How to Avoid Paying Capital Gains Tax on Inherited Property

Inheriting property from a loved one often comes with an unexpected surprise: a potential capital gains tax bill when you sell. In 2024 and beyond, long-term capital gains rates sit at 0%, 15%, or 20% depending on your taxable income—and selling that family home without a plan could push you into a higher tax bracket.

Here’s what many people don’t realize: there’s no federal inheritance tax for most Americans. The real issue is the capital gains tax you’ll face when you eventually sell the property for more than your tax basis. A $600,000 Atlanta home your parents bought in 1995 for $80,000 could trigger a significant tax burden if you don’t understand your options.

This guide will walk you through practical, legal strategies to reduce or even avoid capital gains on inherited property—including selling immediately, living in the home, 1031 exchanges, charitable planning, and trust structures. At Third Act Retirement Planning, we’re a fee-only fiduciary firm in Marietta, Georgia, helping sudden-wealth heirs (including those who’ve recently inherited real estate) integrate tax, retirement, and legacy planning with biblical stewardship principles.

Introduction to Inherited Property

Inheriting property can be both a blessing and a challenge, especially when it comes to navigating the tax landscape. One of the most significant concerns for heirs is the potential capital gains tax that may arise when selling inherited property. Capital gains tax is triggered if you sell the property for more than its fair market value at the time you inherited it, creating a potential gains tax on inherited property that can impact your financial future.

Understanding the fair market value of the property at the date of inheritance is crucial, as this figure becomes your new tax basis. If you sell the property immediately after inheriting it, you may be able to avoid paying capital gains tax altogether, since the sale price is likely to match the market value at inheritance. Alternatively, making the property your primary residence or renting it out can also influence your tax liability and the strategies available to you.

The tax rules surrounding inherited property are complex, and the decisions you make can have lasting tax implications. Whether you’re concerned about paying capital gains, minimizing your tax on inherited property, or simply want to avoid paying unnecessary taxes, understanding your options and the relevant tax rules is the first step toward making informed decisions and protecting your inheritance.

Types of Inherited Property

Inherited property isn’t one-size-fits-all—what you inherit can range from a family home to a rental duplex or even a vacation cabin. Each type of inherited property comes with its own set of tax rules and potential capital gains tax implications.

If you inherit real estate that was used as a primary residence, you may be eligible for special exclusions that can help you avoid capital gains tax when you sell. On the other hand, if the property is an investment property, such as a rental home or commercial building, you’ll need to consider not only capital gains tax but also depreciation recapture, which can increase your tax liability.

Personal use property, like a vacation home, is treated differently from rental property or other investment property for tax purposes. Understanding whether your inherited property is classified as a primary residence, investment property, or personal use property is essential for applying the correct tax rules and minimizing your gains tax exposure.

Knowing the type of property you’ve inherited allows you to choose the most effective strategies to reduce or avoid capital gains tax and helps ensure you’re meeting all your tax obligations.

How Capital Gains Tax on Inherited Property Actually Works

You don’t pay taxes simply by inheriting property. The federal government only collects capital gains tax when you sell the property for more than your tax basis—the value the IRS uses to calculate your gain or loss. Federal tax on capital gains applies regardless of state inheritance tax rules.

Here’s where inherited property gets interesting: rather than using the original purchase price your parents paid decades ago, you receive what’s called a stepped-up basis. This means your tax basis resets to the property’s fair market value on the date of death. The stepped up basis rule ensures that the property's tax basis is adjusted to its fair market value at the time of the original owner's death, which can significantly reduce your taxable gain.

Consider this example: Your parents bought a Cobb County home in 1994 for $150,000. When your mother passes away in 2025, that home is worth $550,000. Your new stepped-up basis value is $550,000—not the original $150,000. If you sell immediately for $550,000, your taxable gain is essentially zero.

You only owe capital gains tax if you sell the property for more than its stepped-up basis.

For 2024, long-term capital gains tax rates look like this:

The applicable tax rate depends on your income bracket and can influence how much you pay when selling inherited property.

An important distinction: inherited property is always treated as a long-term capital gain, even if you sell it the very next day. Inherited property is automatically treated as a long-term asset by the IRS, qualifying for lower capital gains rates regardless of ownership duration. This means you’ll never face short term capital gains rates (which match ordinary income taxes) on inherited real estate.

Don’t confuse estate taxes with capital gains. Estate taxes only apply to estates exceeding roughly $13 million per person in 2024—affecting less than 1% of Americans. Capital gains tax, however, can hit anyone who sells inherited property at a profit above their stepped-up basis.

Six Proven Ways to Reduce or Avoid Capital Gains Tax on Inherited Property

There’s no single magic loophole that works for everyone. However, six well-established strategies can dramatically lower or even eliminate capital gains tax on inherited property, depending on your specific situation. These strategies are designed to help you reduce capital gains and reduce capital gains taxes when selling inherited property.

Here’s a preview of your options:

• Sell the property soon after inheriting it

• Make the inherited home your primary residence

• Use a 1031 exchange for investment property

• Rent the property now and plan a tax-smart sale later

• Donate inherited property or use charitable vehicles

• Use trusts and proactive estate planning

Some strategies permanently avoid paying capital gains tax (such as charitable gifts), while others only defer taxes (like 1031 exchanges or renting). The right approach depends on your financial goals, timeline, and whether the property is residential or rental property.

Let’s walk through each strategy with concrete examples, pros, cons, and the key IRS rules you need to know.

1. Sell the Inherited Property Soon After Death

Selling the property quickly—often within months of the date of death—typically means little or no capital gain because the sale price stays close to your stepped-up basis.

Here’s how this works in practice: The estate obtains an appraisal valuing a Marietta home at $500,000 on your mother’s date of death in June 2025. You complete probate and sell the property in December 2025 for $505,000. After subtracting selling expenses (realtor commissions, closing costs, legal fees), your actual taxable gain might be zero or even show a small loss.

Getting the basis right matters. The IRS could question your claimed basis years later, so obtain a formal appraisal or compile solid market comparables documenting the property’s fair market value at death. This documentation becomes your defense if questions arise.

Selling expenses work in your favor here. Standard costs that reduce your taxable gain include:

• Realtor commissions (typically 5-6% of sale price)

• Title insurance and transfer taxes

• Attorney fees for closing

• Staging or required repairs tied to the sale

This strategy makes the most sense when you don’t want to be a landlord, live far from the property, or need liquidity to fund retirement, pay off debt, or diversify investments. For many heirs, selling quickly represents the simplest path to avoid paying taxes on significant assets they’ve inherited.

2. Make the Inherited Property Your Primary Residence

The IRS Section 121 home sale exclusion offers a powerful way to shelter gains—but it requires you to actually live in the property. If you occupy the inherited home as your primary residence for at least 2 of the 5 years before you sell, you may exclude up to $250,000 of gain ($500,000 if married filing jointly).

The two years don’t need to be continuous. They just need to fall within the five-year window ending on your sale date. One restriction: you generally can’t have used this exclusion on another home sale within the previous two years.

Example scenario: A married couple inherits a $600,000 home in 2024. They move in and live there from 2024 through 2027, then sell in 2028 for $900,000. Their current value gain is $300,000 ($900,000 sale minus $600,000 stepped-up basis). With the $500,000 married exclusion, they owe federal capital gains tax on… nothing. The entire gain is sheltered.

This approach often fits people planning to downsize, relocate closer to family, or who genuinely need housing anyway. You’re turning a lifestyle decision into a tax opportunity.

Documentation matters. Keep records proving the home was truly your primary residence:

• Voter registration at the address

• Driver’s license showing the property address

• Utility bills in your name

• Homestead exemption filings

Pros: Large exclusion potential; no complicated structures required Cons: Delays access to sale proceeds; may not fit your lifestyle if you already have a home you love

3. Use a 1031 Exchange for Inherited Investment Property

If the inherited property functions as an investment (rental property, commercial real estate) rather than a personal residence, a Section 1031 like-kind exchange can defer capital gains tax when you sell and reinvest in other investment real estate.

This strategy defers—not eliminates—capital gains. The gain embeds into your replacement property, meaning you’ll eventually face tax consequences when you sell the new property (unless you execute another exchange). However, repeated exchanges can push your tax liability decades into the future, and some investors defer capital gains tax until death, when their heirs receive a fresh step-up in basis.

Critical timing rules you cannot miss:

• 45 days from sale to identify potential replacement properties

• 180 days to complete the purchase of replacement property

• Must use a qualified intermediary to hold funds (you cannot touch the money directly)

Example: You inherit a small rental duplex in Savannah with a stepped-up basis of $400,000. In 2026, you sell it for $475,000. Rather than paying capital gains on the $75,000 gain, you work with a qualified intermediary to roll the proceeds into a $550,000 Atlanta rental property through a properly structured 1031 exchange. All $75,000 of gain is deferred.

Key requirements for 1031 exchanges:

• Must be investment property (not your personal residence)

• Must use a qualified intermediary

• Must meet 45-day identification and 180-day closing deadlines

• Replacement property must be of equal or greater value to defer the full gain

This strategy works best for serious investors who want to stay in real estate—not for someone looking to exit entirely.

4. Rent the Property Now and Plan a Tax‑Smart Sale Later

Renting provides a way to delay selling, generate steady income, and keep your options open while you decide on a long-term plan. This doesn’t erase potential capital gains tax, but it can allow better timing—perhaps waiting for a lower-income year when you’d fall into a lower tax bracket.

Once the property becomes rental property, you can deduct operating expenses and depreciation, which reduce your taxable rental income each year. However, depreciation creates a catch: when you eventually sell, you’ll face depreciation recapture taxed at up to 25%, in addition to regular capital gains.

Example: You inherit a $450,000 condo in 2025 and rent it out for 5 years. During that time, you claim $60,000 of depreciation. In 2030, you sell for $525,000. Your tax obligations include capital gains tax on the $75,000 appreciation ($525,000 minus $450,000 basis) plus depreciation recapture tax on the $60,000 you previously deducted.

A powerful combination: convert the inherited home to a rental, hold it for several years generating rental income, then execute a 1031 exchange into another one investment property to continue deferring gains.

Consider the lifestyle and risk factors:

• Landlord responsibilities (repairs, tenant issues, property management)

• Local rental laws and tenant protections

• Vacancy risk between tenants

• Cash flow after mortgage, taxes, insurance, and maintenance

Some heirs rent for a period, then move into the property themselves to capture the Section 121 primary residence exclusion later. This requires careful planning but can shelter significant gains.

5. Donate Inherited Property or Use Charitable Vehicles

For those with charitable intentions, donating appreciated inherited property directly to a qualified charitable organization can completely eliminate capital gains tax on the appreciation. You’ll also receive an itemized charitable deduction equal to the property’s fair market value (subject to AGI limits—typically 30% of AGI for appreciated property). The deduction is calculated based on the property's fair market value at the time of donation, which is key for maximizing your tax benefit.

Example: An heir in Georgia inherits a commercial lot with a stepped-up basis of $780,000. The property appreciates to $1,000,000 over the next few years. Rather than selling and paying capital gains on the $220,000 gain, she donates the property to her church’s building fund. Result: no capital gains, and she can deduct up to $1,000,000 (spread over several tax years if needed to stay within AGI limits).

Charitable Remainder Trusts (CRTs) offer another option. You place the property into a CRT, the trust sells it without immediate tax, and you receive income payments for life (or a term of years). The remainder eventually goes to charity. This can provide both income and a partial charitable deduction while deferring the tax bill.

This strategy aligns powerfully with biblically informed generosity and legacy goals. For Christian families wanting to support their church, faith-based ministries, or community organizations, donate inherited property represents a way to multiply giving while eliminating tax obligations.

Implementation requires coordination among your financial planner, estate planning attorney, and CPA. The rules are specific, and proper structuring matters.

6. Use Trusts and Proactive Estate Planning to Shape Future Capital Gains

The best capital gains planning often happens before death—while the original owner is still alive. Thoughtful estate planning through revocable living trusts, careful titling, and understanding community property rules (in some states) can dramatically influence heirs’ future tax liability.

Here’s the key principle: assets included in the taxable estate at death typically receive a stepped-up basis. When you inherit assets at death, you generally benefit from this step-up, which can significantly reduce capital gains tax if you later sell. Gifts made during life, however, carry the donor’s original cost basis—potentially increasing future capital gains for heirs.

Contrast these scenarios:

• Gift during life: Grandma gives her rental house (current value $600,000, original purchase $100,000) to grandchildren in 2024. When they sell, they’ll owe tax on gains above the $100,000 original purchase price.

• Inheritance at death: Grandma keeps the property until death, leaving it by will or revocable trust. Grandchildren receive a $600,000 stepped-up basis and can potentially sell with little or no tax.

The difference? Potentially $100,000+ in federal and state income taxes saved.

Irrevocable trusts add another layer of complexity. Certain trust strategies can trade off estate tax exposure versus capital gains exposure. For high-net-worth families, these tools require specialized legal advice to balance competing priorities. If you are considering disclaiming property or trust interests, remember: once you choose to disclaim an inheritance, you cannot change your mind later.

At Third Act Retirement Planning, we coordinate with estate planning attorneys to design trust structures that balance taxes, family control, and biblical stewardship of wealth across generations.

Other Key Tax Rules for Inherited Property You Can’t Ignore

Beyond the six core strategies, several technical rules about basis, improvements, and documentation can quietly save thousands in tax if handled correctly. Understanding these mechanics matters as much as choosing the right overall strategy.

Step‑Up in Basis and Adjustments After Inheritance

Your stepped-up basis starts with the property’s fair market value on the date of death (or an alternate valuation date six months later, if the estate elects). For tax purposes, you need documentation—typically a professional appraisal—establishing this value.

Co-owned property receives different treatment depending on state law. In Georgia and most other common law states, when one spouse dies, only the deceased spouse’s half receives a step-up. In community property states like California or Texas, the surviving spouse may receive a full step-up on the entire property.

Your adjusted basis evolves over time:

• Start with stepped-up value at death

• Add capital improvements (new roof, major additions, significant remodels)

• Subtract depreciation if you use the property as a rental

Example: Stepped-up basis of $500,000 + $40,000 kitchen remodel – $10,000 depreciation = $530,000 adjusted basis when you sell.

Keep copies of the estate’s appraisal, closing statements from any sale, and estate tax returns (if filed). These documents support your basis on future tax filings.

Capital Improvements, Selling Costs, and Record‑Keeping

Not all expenses increase your basis. The IRS distinguishes between capital improvements (which add to basis) and routine maintenance (which doesn’t).

Capital improvements that increase basis:

• Room additions or structural changes

• Major HVAC replacement

• Full kitchen or bathroom remodels

• New roof installation

• Significant electrical or plumbing upgrades

Routine maintenance (not basis adjustments):

• Lawn care and landscaping maintenance

• Interior painting

• Minor repairs

Legitimate selling expenses reduce your taxable gain rather than being separately deductible. These include realtor commissions, attorney fees, transfer taxes, title insurance, and repairs required as conditions of sale.

Example: You sell an inherited house for $510,000 with a $500,000 basis. Before considering selling expenses, you have a $10,000 gain. But you incur $30,000 in selling expenses (6% commission plus closing costs and legal fees). Result: a $20,000 capital loss rather than a taxable gain.

Keep receipts, contractor invoices, and your Closing Disclosure as proof for potential IRS audits.

Special Situations: Multiple Heirs, Estates, Trusts, and Losses

When siblings inherit together, basis and sale proceeds typically split according to ownership percentage. Each heir reports their share on their individual tax return.

Sometimes the estate or trust sells the property before distributing cash to heirs. In these cases, the estate or trust pays any capital gains tax, and heirs receive net proceeds. A tax advisor can help determine which approach—selling within the estate versus distributing the property first—results in a lower overall tax burden.

What about losses? If the property sells for less than its stepped-up basis, you may have a deductible capital loss. Rules differ for personal use property versus investment property, so confirm with a tax professional before claiming a loss.

State taxes add complexity. Some states impose their own capital gains or inheritance tax. Georgia generally conforms to federal rules, but heirs with property in multiple states should verify specific obligations.

Estate Tax Considerations

When inheriting property, it’s important to look beyond just capital gains tax and consider the impact of estate taxes as well. The federal government imposes estate taxes on estates that exceed a certain value—currently $13.61 million per individual. While most Americans won’t owe federal estate taxes, some states have their own estate tax rules, with rates that can range from less than 1% up to 20% of the estate’s value.

Even if you’re not subject to estate taxes, you may still face capital gains tax when you sell inherited property. Both estate taxes and capital gains tax can significantly affect your overall tax liability, so it’s essential to plan ahead and understand how these taxes interact.

By considering both estate taxes and capital gains tax when planning for inherited property, you can minimize your tax liability and avoid paying unnecessary taxes. Consulting with a tax professional or estate planning attorney can help you navigate these complex rules and ensure you’re making the most of your inheritance.

Tax Rules for Foreign Inherited Property

Inheriting property located outside the United States adds another layer of complexity to your tax planning. The federal government taxes U.S. citizens and residents on their worldwide income, which means capital gains from the sale of foreign inherited property are subject to U.S. tax rules. This can create a potential tax liability, especially if the property has appreciated in value since the date of inheritance.

To avoid double taxation, you may be eligible for foreign tax credits if you pay taxes to another country on the sale of the property. However, the rules for claiming these credits can be intricate, and compliance with both U.S. and foreign tax obligations is essential.

Given the complexities of international tax rules and the potential for significant tax consequences, it’s wise to consult a tax professional or estate planning attorney with experience in cross-border inheritance issues. They can help you understand your tax obligations, take advantage of available credits, and minimize your overall tax liability when dealing with foreign inherited property. Proper estate planning can also help you avoid paying unnecessary taxes and ensure your inheritance is managed efficiently.

Reporting the Sale of Inherited Property on Your Tax Return

Most individuals report the inherited property sale on IRS Form 8949 and Schedule D of Form 1040. When completing Form 8949, you’ll mark the asset as “inherited” to ensure the IRS applies long-term treatment regardless of your holding period.

The IRS expects these key data points:

• Date of the decedent’s death (which establishes your holding period start)

• Date you sold the property

• Your stepped-up basis (fair market value at death)

• Sale price

• Selling expenses

• Any depreciation you claimed if the property was used as a rental

If your sale qualified for the Section 121 primary residence exclusion, special reporting applies—you may not need to report the sale at all if the entire gain is excluded. For 1031 exchanges, you’ll file Form 8824 in addition to your regular return.

A word of caution: don’t inflate your basis or invent improvements. The IRS can audit returns years later, and misreporting basis can lead to penalties, interest, and significant tax consequences. Proper documentation protects you.

Real‑Life Style Examples: How Different Heirs Minimized Capital Gains

These illustrative scenarios show how different choices produce different tax outcomes.

Scenario 1: The 1031 Exchange Investor In 2025, Michael inherited his late father’s Kennesaw rental property with a stepped-up basis of $380,000. Rather than selling and paying tax on the $90,000 gain when property values reached $470,000, he worked with a qualified intermediary to execute a 1031 exchange. He reinvested in two smaller rental properties in growing Atlanta suburbs, deferring all capital gains while diversifying his real estate portfolio.

Scenario 2: The Sibling Buyout Sisters Karen and Lisa inherited their mother’s Tybee Island beach house in 2024, valued at $650,000. Karen wanted to keep it; Lisa wanted cash. Karen bought out Lisa’s half for $325,000. Karen then moved into the property, living there for three years. When she sold in 2028 for $850,000, she used the Section 121 exclusion to shelter her $200,000 gain completely—paying zero federal capital gains.

Scenario 3: The Charitable Legacy Robert, a widower, inherited a commercial building from his brother. Rather than selling and facing capital gains on $180,000 of appreciation, he donated the property to a Christian ministry his brother had supported for decades. The donation eliminated all capital gains and generated a charitable deduction Robert used over five years to offset his retirement accounts withdrawals and reduce his income taxes.

Scenario 4: The Strategic Loss Amanda inherited her aunt’s condo in 2025, receiving a stepped-up basis of $320,000. Unfortunately, the local market declined, and she sold in 2026 for only $295,000. The $25,000 capital loss offset gains from a small business she sold that same year, reducing her overall tax bill by several thousand dollars.

When to Get Professional Help—and How Third Act Retirement Planning Fits In

Certain situations signal the need for professional guidance:

• Property located in multiple states

• Significant appreciation (gains exceeding $250,000)

• Multiple heirs with potential conflicts

• Existing trust structures

• Plans involving charitable giving or complex strategies

• High-value estates approaching gift taxes or estate tax thresholds

A fee-only fiduciary planner like Third Act Retirement Planning coordinates with CPAs and estate planning attorneys to estimate the tax impact of different sell, hold, or rent options. We help design 1031 or charitable strategies and integrate inherited property into a broader retirement and legacy plan.

Our firm specializes in sudden-wealth situations—including significant inheritances—and our commitment to biblical stewardship means we help families use wealth to provide for loved ones, care for the vulnerable, and fund gospel-centered generosity.

Your next steps:

1. Schedule a discovery call to discuss your situation

2. Gather key documents: will or trust, deed, appraisal, recent property tax bills

3. List your primary goals for the property: income, liquidity, legacy, or charitable giving

With careful planning and the right guidance, you can honor your loved one’s legacy while keeping more of what they worked so hard to leave you. The strategies in this article can save money—often tens of thousands of dollars—but implementation matters as much as knowledge.

Contact Third Act Retirement Planning today to explore how we can help you navigate your inherited real estate with wisdom, purpose, and a plan that reflects your values.