Inherited Property? Here’s How to Potentially Avoid Capital Gains Taxes

Key Takeaways:

• Know Your Starting Point with a Stepped-Up Basis: Understanding how the stepped-up basis works is key to limiting capital gains. Combined with deductible selling costs or the primary residence exclusion, this adjustment can significantly reduce what you owe.
• Explore Strategic Paths to Keep More of Your Proceeds: From converting the home into your residence to using a 1031 exchange, there are several ways to delay or avoid capital gains. 
• Consider Donation for a Purpose-Driven Tax Advantage: Donating inherited property to a qualified nonprofit allows you to avoid capital gains entirely while claiming a charitable deduction. Just be sure your documentation is solid before moving forward.

Inheriting real estate often stirs up mixed emotions: gratitude, responsibility, and sometimes a fair amount of financial uncertainty. Texans who suddenly find themselves holding the deed to a family home, ranch, or commercial building are often left wondering what comes next. One of the most pressing questions? How capital gains taxes might factor into the picture if you choose to sell.

Our team at Texas Tax Protest works with people facing that same question every day. Sorting through tax terms like “stepped-up basis” or “adjusted gain” doesn’t come naturally to most folks, and it shouldn’t have to. We’re here to help clarify what applies to your situation and offer insight into strategies that can help preserve more of what you’ve inherited. This blog will break down the key considerations behind capital gains taxes on inherited property in Texas. 

Capital Gains Tax Basics On Inherited Property

Inheriting real estate comes with its own mix of emotions and questions once taxes enter the scene. One of the first terms you might come across is capital gains tax. This applies when a property sells for more than its tax basis and plays a big role in what, if anything, you’ll owe when you sell.

How The Stepped-Up Basis Impacts Your Tax Bill

When property changes hands through inheritance, the IRS resets the value using what’s called a stepped-up basis. Instead of using what the original owner paid, the property’s new value is based on its fair market worth at the time you inherited it. For example, say your parents bought a home for $100,000, and it’s worth $400,000 when you inherit it. That $400,000 becomes your new baseline. If you sell the house a year later for $420,000, you’d only be taxed on the $20,000 gain, not the full difference between the original purchase price and the sale.

Small Adjustments Can Add Up To Big Savings

Upgrades you make after inheriting, like a new roof, updated kitchen, or even a fresh coat of paint, can raise your adjusted basis. The higher that number, the smaller your taxable gain ends up being. You can also subtract selling costs, like realtor commissions, legal fees, and home staging expenses, from your sale price. Together, these numbers help narrow the gap between your basis and what the home sells for, which can trim what you owe in capital gains.

Why Good Records Make A Big Difference

Paperwork might not be exciting, but it matters. Appraisals, receipts, and closing statements all help confirm your numbers when tax time rolls around. The more detailed your documentation, the easier it is to spot where savings might be hiding.

Strategies That Can Help You Reduce Or Avoid Capital Gains On Inherited Property

After inheriting real estate, one of the biggest decisions you’ll face is what to do next. That choice plays a major role in how much capital gains tax you might owe. Selling can trigger immediate tax calculations, while renting or reinvesting opens other possibilities. The goal isn’t just to follow the rules—it’s to make them work in your favor. Below are practical strategies that can help reduce or even eliminate your capital gains liability.

Use Selling Expenses To Offset Capital Gains

Every dollar spent preparing an inherited property for sale could help reduce your taxable gain. Many heirs miss this opportunity simply because they overlook which expenses can be deducted. Realtor commissions, legal paperwork, staging, listing photography, and minor repairs all count as legitimate selling costs.

For example, say your stepped-up basis is $400,000 and the property sells for $420,000. That creates a $20,000 gain. But now factor in $3,000 in closing fees, $10,000 in commissions, and $4,000 in prep work. These expenses narrow your profit margin and reduce your taxable gain to just $3,000. Overall, these deductions are only useful when they’re documented properly, so save your receipts, itemize the costs, and review the details with a tax advisor. 

Live In The Home To Use The Primary Residence Exclusion

Moving into an inherited home might come with emotional value, but it also creates a tax advantage. Homeowners who live in a property for at least two of the five years before selling may qualify for the primary residence exclusion. This allows you to exclude up to $250,000 in capital gains, or $500,000 for married couples.

This rule applies even if the home was inherited. What matters is that you live there long enough and meet the ownership and use guidelines. Combine that exclusion with the stepped-up basis, and many heirs walk away from the sale without owing federal capital gains tax.

Proof of residency matters here. Voter registration, utility bills, and a driver’s license tied to the property address help build your case. Because Texas does not have a state capital gains tax, this combination of residency and documentation can give you one of the strongest tools for reducing taxes on a future sale.

Exchange Investment Property To Defer Taxes And Reinvest Gains

When inherited property is used as a rental or business investment, selling it may trigger a larger tax bill than expected. One way to delay that outcome is through a 1031 exchange. This IRS-approved move allows you to sell one investment property and reinvest the proceeds into another without paying capital gains taxes right away.

The clock starts once the sale closes. You have 45 days to identify a new property and 180 days to complete the purchase. The replacement must be used for investment purposes and should be of equal or greater value. Keeping your paperwork organized and your timeline tight makes a big difference in how smoothly this process plays out.

Before choosing a replacement property, compare several local sales. Look beyond price per square foot. Factor in upgrades, location, layout, and condition. These variables help justify your reinvestment and keep your tax deferral intact. When used correctly, a 1031 exchange gives you time to build value and plan without losing money to immediate taxes.

Rent The Property To Generate Income And Delay A Sale

Not ready to sell? Some heirs prefer to hold on to inherited property and earn income instead of selling right away. Renting allows you to generate revenue while keeping the option to sell later. This strategy also gives you time to prepare for future capital gains exposure.

The stepped-up basis still applies even if the home becomes a rental. That means your starting point for future tax calculations is the property’s value at the time of inheritance. Over the years, you can deduct operating costs like maintenance, property management, mortgage interest, and repairs from your rental income.

Depreciation offers another write-off, but it creates a separate challenge down the line. Each year you claim it, your adjusted basis decreases. That reduction can increase your taxable gain when you sell. You may also be subject to depreciation recapture, which applies to the total amount of depreciation claimed. Overall, renting can work well for those who want steady income and time to weigh their next move. 

Donate Inherited Property To Reduce Capital Gains And Support A Cause

Inherited a house but not sure what to do with it? Donating property to a qualified charitable organization can offer significant tax benefits while supporting a good cause. When you donate appreciated real estate, you may be eligible for a charitable deduction based on the property’s fair market value, which is typically determined by a professional appraisal.

Here’s why donation can be a smart move: If you sell the inherited property, you might have to pay capital gains tax on the appreciation since the decedent’s death. Donating lets you potentially sidestep that concern. The IRS generally allows you to claim a deduction for the property’s full market value, and you’ll avoid being taxed on any gain that occurred during your ownership.

However, navigating these rules can be challenging. For example, to claim the full deduction, you’ll need documentation, including a qualified appraisal if the property is valued above a certain threshold. Not every nonprofit is eligible, either, so make sure your chosen recipient is a recognized 501(c)(3) organization.

Final Thoughts

Navigating the world of inherited property and capital gains taxes can feel overwhelming. The rules aren’t always straightforward, and the stakes are high, so having the right information (and the right advocates) is essential for protecting your financial future. In Texas, understanding how property valuations, exemptions, and timing affect your tax obligations opens doors to real savings. From step-up bases to local tax nuances, each detail shapes the best strategy for your unique situation.

If you’ve inherited property and want clarity, advocacy, and a path toward lower taxes, Texas Tax Protest is in your corner. Have questions about your options or the next steps? Reach out and discover how much smoother the property tax process can be with the right experts by your side. 

Read more: 

• Texas Property Tax Rates Explained: What Every Homeowner Should Know
• Texas Property Tax Rates by City: Where Does Your Area Rank?
• Texas Disaster Declarations and How They Impact Your Property Taxes

Frequently Asked Questions About How to Avoid Paying Capital Gains Tax on Inherited Property

What is the difference between long-term and short-term capital gains on inherited property?

Long-term and short-term capital gains typically refer to how long you’ve held an asset before selling. Inherited property gets special treatment: for tax purposes, no matter how soon after inheritance you sell, it’s treated as a long-term asset. This means you benefit from the lower long-term capital gains tax rates, even if you sell the home immediately upon inheriting it.

What is the step-up in basis for inherited property?

The “step-up in basis” is a tax rule that can lead to major savings. When you inherit a property, the property’s basis (its value for tax purposes) is usually bumped up to the fair market value at the time the previous owner passed away. If you sell the home soon after inheriting it, your potential capital gain could be minimal—or even zero—because the sale price is close to this new stepped-up basis.

Can improvements to inherited property affect capital gains taxes?

Yes! Investments you make in the property can further adjust what you might owe. Any qualified improvements (such as a new roof, renovated kitchen, or upgraded HVAC) made after you inherit the property increase your adjusted basis. If you later sell, you’ll subtract this higher basis from your sale price, reducing your taxable gain and possibly trimming your tax bill.

Are there any special rules for selling an inherited home that was a rental property?

Inherited rental properties are also eligible for the step-up in basis. However, if the property was used as a rental by the heir after inheritance, depreciation taken during the rental period must be recaptured and taxed upon sale. This adds complexity, so careful record-keeping and consultation with a tax professional are crucial to determine your specific liability.

Are there any state-level taxes on inherited property sales?

Texas does not impose a state-level capital gains tax, so you only need to consider federal capital gains tax rules when selling an inherited property in the Lone Star State. Local property taxes still apply, but they’re separate from federal capital gains.

Could my inherited property be subject to both estate and capital gains taxes?

It’s possible, but rare for most homeowners. Estate taxes apply to very large estates (valued at millions of dollars), while capital gains taxes concern profits when you sell the property. The good news: The step-up in basis often minimizes or eliminates capital gains on sales following inheritance, reducing the overlap between estate and capital gains taxation for most families. 

Sources:

1. Internal Revenue Service. (n.d.). Gifts & inheritances. U.S. Department of the Treasury. Retrieved June 10, 2025, from https://www.irs.gov/faqs/interest-dividends-other-types-of-income/gifts-inheritances/gifts-inheritances
2. Internal Revenue Service. (n.d.). Gift tax. U.S. Department of the Treasury. Retrieved June 10, 2025, from https://www.irs.gov/businesses/small-businesses-self-employed/gift-tax