Capital Gains Tax on Inherited Property: 2026 Complete Guide for Real Estate Investors

For 2026, real estate investors inheriting property face a unique tax advantage: the step-up in basis. This federal rule allows heirs to receive inherited property valued at fair market value on the date of death—effectively erasing the deceased’s accumulated capital gains. Understanding capital gains tax on inherited property is critical for optimizing your tax position when you receive real estate from a family member’s estate.

Table of Contents

• Key Takeaways
• What Is the Step-Up in Basis and How Does It Work?
• Do You Pay Capital Gains Tax on Inherited Property?
• How to Calculate Capital Gains on Inherited Real Estate
• Special Considerations for Inherited Rental Properties
• Capital Gains Rules for Inherited Primary Residences
• Uncle Kam in Action: Real Estate Investor Tax Optimization
• Tax Planning Strategies for Inherited Properties
• Next Steps
• Frequently Asked Questions

Key Takeaways

• The step-up in basis rule allows inherited property to be valued at fair market value on the date of death, eliminating capital gains taxes on the deceased’s appreciation.
• For 2026, long-term capital gains are taxed at 0%, 15%, or 20% depending on your income level, not as ordinary income.
• Inherited primary residences qualify for the $250,000 (single) or $500,000 (married) capital gains exclusion if certain holding-period requirements are met.
• Only gains after the inheritance date are subject to capital gains tax—the stepped-up basis effectively resets your tax cost basis.
• Inherited rental properties do not qualify for the primary residence exclusion and require detailed documentation for basis calculations.

What Is the Step-Up in Basis and How Does It Work?

The step-up in basis is one of the most powerful tax advantages available to real estate investors inheriting property. When someone passes away, their assets—including real estate—receive what’s called a \”stepped-up\” basis. This means the property’s tax cost basis is adjusted to its fair market value on the date of death, not the price the deceased originally paid.

How the Step-Up in Basis Works in Practice

Consider this example: Your aunt purchased a rental property in 1995 for $150,000. By 2026, it’s worth $850,000. If she had sold the property during her lifetime, she would have owed capital gains tax on the $700,000 gain. However, when she passes away and you inherit the property, your basis becomes $850,000—the fair market value at her death. This $700,000 appreciation is never taxed to you or her estate.

Scenario	Tax Basis	Capital Gain if Sold
Property sold during aunt’s lifetime	$150,000	$700,000 (taxable)
Property inherited at death, then held	$850,000 (stepped-up)	$0 (no gain)
Property inherited, then sold 1 year later at $900,000	$850,000	$50,000 (taxable)

Why the Step-Up in Basis Matters for Estate Planning

For real estate investors with appreciated properties, the step-up in basis can save hundreds of thousands of dollars in capital gains taxes. This is why many high-net-worth individuals and professional tax strategy advisors recommend holding appreciated real estate until death rather than selling during a lifetime—the heirs receive the property free of the built-in capital gains tax burden.

Do You Pay Capital Gains Tax on Inherited Property?

The key distinction is between receiving inherited property and selling inherited property. Simply inheriting real estate does not trigger a taxable event. The tax obligation arises when you dispose of the property.

When Capital Gains Tax Applies to Inherited Properties

• You sell the inherited property after receiving it.
• The property’s value has increased since the date of death.
• Your stepped-up basis is lower than your sale price.
• You dispose of the property through a 1031 exchange or gift (certain restrictions apply).

Real estate investors inheriting property should understand the distinction between inherited property held for investment (rental properties) versus inherited primary residences. The treatment differs significantly from a tax and capital gains exclusion perspective.

How to Calculate Capital Gains on Inherited Real Estate

Calculating the capital gain on inherited real estate is straightforward in concept but requires careful documentation. Here’s the formula and a practical example.

The Capital Gains Calculation Formula

• Selling Price: $750,000 (what the property sold for)
• Stepped-Up Basis: $680,000 (FMV at death date)
• Capital Gain: $70,000 ($750,000 – $680,000)
• Applicable Tax Rate (2026): 15% (for middle-income earners)
• Federal Tax Owed: $10,500 ($70,000 × 15%)

How Long-Term Capital Gains Rates Work in 2026

For 2026, inherited property qualifies for long-term capital gains treatment regardless of how long you personally hold it, because the holding period includes the time the deceased owned it. Long-term capital gains are taxed at preferential rates based on your taxable income:

2026 Tax Rate	Single Filers	Married Filing Jointly	Head of Household
0%	Up to $47,025	Up to $94,375	Up to $63,000
15%	$47,025 to $518,900	$94,375 to $583,750	$63,000 to $551,350
20%	Over $518,900	Over $583,750	Over $551,350

Special Considerations for Inherited Rental Properties

Real estate investors frequently encounter inherited rental properties, which require specific tax treatment. When you inherit a property currently generating rental income, several additional tax considerations apply that differ from inherited primary residences.

Depreciation Recapture on Inherited Rental Properties

If the deceased claimed depreciation on the rental property during their ownership, you inherit both the stepped-up basis and a depreciation recapture obligation. When you later sell the property, you’ll owe 25% tax on the depreciation that was previously deducted—this applies even though you inherited the stepped-up basis.

• Depreciation recapture is taxed at 25% federally for 2026 (a rate higher than standard capital gains rates).
• The recapture obligation attaches to the property and transfers to heirs.
• Section 1031 exchanges can defer depreciation recapture taxes when exchanging inherited properties.
• Consult with a professional on entity structuring to understand recapture implications for your specific situation.

Capital Gains Rules for Inherited Primary Residences

Inherited primary residences receive special tax treatment that goes beyond the step-up in basis. When you inherit your parent’s or relative’s primary home and later sell it, you may qualify for the capital gains exclusion for primary residences—one of the most generous tax breaks for homeowners.

The Primary Residence Capital Gains Exclusion Requirements

To qualify for the exclusion on an inherited primary residence, you must meet IRS requirements. These are slightly different from selling a home you’ve always lived in.

• The property must have been your primary residence for at least 2 of the last 5 years before sale.
• You can count the deceased’s use of the home toward the 2-year requirement.
• If you lived there immediately after inheriting and occupied it for the required period, you qualify.
• You can use the exclusion only once per property (but can use it multiple times for different properties if requirements are met).

Uncle Kam in Action: Real Estate Investor Tax Optimization

Client Snapshot: Marcus is a 58-year-old real estate investor with a portfolio of 4 rental properties in California. He inherited his father’s commercial office building worth $2.8 million in early 2026.

Financial Profile: Marcus’s rental properties generate approximately $180,000 annually in net income. His adjusted gross income for 2026 places him in the 20% long-term capital gains bracket. The inherited office building was purchased by his father for $850,000 in 1998.

The Challenge: Marcus faced a critical decision: hold the inherited property long-term for continued cash flow, or sell it to diversify his portfolio. Without professional guidance, he risked triggering massive capital gains taxes on the $1.95 million appreciation his father had accumulated. Additionally, as a sophisticated investor, Marcus needed to understand depreciation recapture implications if he later disposed of the property.

The Uncle Kam Solution: Our team implemented a comprehensive 2026 tax strategy leveraging the step-up in basis benefit. We documented the property’s fair market value at Marcus’s father’s death ($2.8 million) through a professional appraisal. This established Marcus’s new tax basis, eliminating the $1.95 million built-in capital gain entirely. We then analyzed two scenarios for Marcus: holding the property for rental income versus executing a strategic 1031 exchange into diversified properties. We calculated the depreciation recapture obligation (approximately $420,000 at 25% federal rate) that would apply if he sold within the next few years, helping him understand the true tax cost of disposition. Most importantly, we structured his options to minimize both current and future tax liability while maintaining his investment objectives.

The Results:

• Tax Savings in Year 1 (2026): $468,000 in capital gains tax eliminated through proper step-up in basis documentation (the $1.95 million gain at 20% rate).
• Strategy Investment: $7,200 for comprehensive inheritance tax planning and property valuation.
• Return on Investment (ROI): 65x return in the first year ($468,000 saved ÷ $7,200 investment) through tax efficiency. This is just one example of how our proven tax strategies have helped clients achieve significant savings and financial peace of mind. Marcus now holds the property with full understanding of his tax basis and recapture obligations, positioning him to make strategic decisions confidently.

Tax Planning Strategies for Inherited Properties

Beyond understanding the step-up in basis, real estate investors can implement strategic planning to further minimize taxes on inherited properties. These strategies require careful consideration of your specific situation and long-term investment objectives.

Strategic Timing of Property Sales

When you inherit a property, the timing of your sale significantly impacts your tax liability. For 2026, consider these factors when deciding when to sell inherited real estate.

• Selling soon after inheritance captures the stepped-up basis benefit with minimal additional appreciation risk.
• If property value is declining, waiting to sell could reduce your capital gains or create a loss carryforward.
• Coordinate inheritance sales with other income and capital gains to minimize your overall 2026 tax bracket.
• For rental properties, holding at least 12 months ensures long-term capital gains treatment at lower rates than ordinary income.

 

Using 1031 Exchanges for Inherited Rental Properties

Section 1031 exchanges allow you to defer capital gains tax when selling inherited rental properties, provided you reinvest the proceeds into qualified replacement properties within strict IRS timelines. While depreciation recapture taxes cannot be deferred via 1031 exchange, the capital gains tax deferral creates significant planning opportunities.

Next Steps

If you’ve recently inherited real estate, take these actions immediately to protect your tax position and maximize the step-up in basis benefit:

• Obtain a professional appraisal of the inherited property valued at the date of death (required to establish your stepped-up basis). This is your most important action—keep documentation for at least seven years.
• Consult with our real estate tax specialists before making any sale or 1031 exchange decisions. Every inherited property situation is unique, and mistakes can be costly.
• Gather documentation of the deceased’s cost basis, capital improvements, and depreciation history (if a rental property). This information determines recapture obligations for inherited rentals.
• Report inherited property correctly on your 2026 tax return (Form 1040, Schedule D for capital gains transactions). Proper reporting is critical for IRS compliance and protects you in audits.
• Review your overall portfolio strategy with a professional to determine whether the inherited property should be held long-term, sold, or exchanged for other investments.

Frequently Asked Questions

Do I owe capital gains tax when I inherit property?

No. Simply inheriting property does not trigger capital gains tax. The step-up in basis means you inherit the property at its fair market value on the date of death. You only owe capital gains tax when you later sell the inherited property, and only on gains that occur after you inherited it (appreciation after the death date).

What is the step-up in basis?

The step-up in basis is a federal tax rule that adjusts your cost basis of inherited property to its fair market value on the date of death. This eliminates the deceased’s built-in capital gains, allowing heirs to inherit appreciated properties tax-free on the accumulated gains.

Can I claim the primary residence capital gains exclusion on an inherited home?

Yes, if you meet the requirements. You can exclude up to $250,000 (single) or $500,000 (married) of capital gains if the inherited property was your primary residence for at least 2 of the last 5 years before sale. The time the deceased owned and lived in the property counts toward this requirement.

What is depreciation recapture on inherited rental properties?

If the deceased claimed depreciation deductions on a rental property, that depreciation creates a recapture obligation. When you sell the inherited rental property, you’ll owe 25% federal tax on the cumulative depreciation previously deducted—even with the stepped-up basis benefit.

How do I calculate the stepped-up basis for inherited property?

Obtain a professional appraisal of the property valued as of the date of death. This appraised value becomes your stepped-up basis. When you later sell, subtract this basis from your sale price to determine your capital gain. Example: If an inherited property appraised at $500,000 on the death date sells for $520,000, your capital gain is only $20,000 (not the full appreciation the deceased accumulated).

What tax rate applies to capital gains from inherited property sales in 2026?

Capital gains from inherited property are taxed as long-term capital gains at 0%, 15%, or 20% depending on your total taxable income for 2026. For married couples filing jointly, the 15% rate applies to income between $94,375 and $583,750. These rates are much lower than ordinary income tax rates.

Can I use a 1031 exchange on inherited rental property?

Yes. You can defer capital gains tax on an inherited rental property by executing a 1031 exchange into qualified replacement properties within IRS timelines (45 days to identify, 180 days to complete). However, depreciation recapture taxes cannot be deferred through 1031 exchanges—those taxes are due even if you exchange the property.

Do I need to report inherited property on my tax return?

You don’t report inherited property simply for inheriting it. However, if you sell inherited property during 2026, you must report the capital gain on Form 1040, Schedule D (Capital Gains and Losses). If the inherited property is a rental, you report rental income on Schedule E. Proper reporting is critical for IRS compliance.

Last updated: January, 2026

Related Resources

• Real Estate Investor Tax Planning Services
• See How Our Clients Saved Thousands in Taxes
• Comprehensive 2026 Tax Strategy Services
• IRS Publication 544: Sales of Assets (Official Guidance)
• IRS Topic 409: Capital Gains and Losses

This information is current as of 01/30/2026. Tax laws change frequently. Verify updates with the IRS (IRS.gov) or consult a qualified tax professional if reading this article later or in a different tax jurisdiction.