How to Calculate Capital Gains on Sale of Inherited Property

Is it a gift or a challenge? Well, inheriting a home from a loved one can feel like both. While this might seem like a gift, it can quickly become overwhelming when you realize the legal and tax implications are also involved. So, what comes next?

To put it simply, Probate is the legal process of handling a deceased person’s estate which must be completed before the property officially passes to you. This means legal paperwork, potential waiting periods, and, most importantly, taxes. The responsibility for overseeing this typically falls on the personal representative named in the will.

But here’s the thing- understanding probate property taxes is crucial at the same time. Inheriting a home can come with financial obligations such as capital gains tax, stamp duty land tax, and, most significantly, inheritance tax. 

Our previous blog covered the topic if you can sell your house before Probate. Now, let’s focus on the next step- how these taxes affect those who inherit and later sell a probate property.

Immediate Taxes When Inheriting a Probate Property

If you inherit property, you might not have to pay taxes right away. However, understanding potential tax obligations is important. There are types of taxes may apply to inherited assets:

Capital Gains Tax 

Capital gains tax is a tax on the profit made when selling an asset that has increased in value. However, when someone inherits a property, CGT does not apply immediately because transfers due to death are not considered taxable events. The tax may become relevant later when the property is sold.

Stamp Duty Land Tax

If a property is inherited through a deceased person’s will, no Stamp Duty Land Tax is charged, even when the mortgage is transferred to the beneficiary. However, if the property is sold by the executor or personal representative of the estate, SDLT will apply to the purchaser. Certain reliefs may reduce or eliminate this tax liability, depending on the buyer's circumstances. 

For example, if a company or a partnership with corporate partners purchases a property that was the deceased's primary residence in the last two years, they may qualify for full SDLT relief.

Inheritance Tax (IHT)

Inheritance tax is a tax paid on the total value of the deceased’s estate, including property, cash, and investments. Unlike CGT and SDLT, there are no exemptions from IHT. It is usually charged at 40% on the estate's value above the tax-free threshold, known as the nil rate band (NRB), which is currently set at $325,000.

If the deceased gifted assets within seven years before passing away, the NRB may be reduced, leading to a higher IHT liability. However, if a residential property is inherited by direct descendants (such as children or grandchildren), an additional tax-free allowance, called the residential nil rate band (RNRB), may apply. But RNRB cannot exceed the value of the home after subtracting any outstanding mortgage.

Tax Considerations for the Sale of an Inherited Property 

If an inherited property is sold later, CGT applies if its value has increased since the time of inheritance. The taxable capital gain is the difference between the selling price and the probate value (the market value at the time of inheritance, which was used for IHT purposes).

It is important to note that CGT liability cannot be avoided by gifting the property or selling it below market value. 

Let’s try to understand this with the help of an example- Sarah purchased a house for $120,000 in 1995. When she passed away in 2019, her daughter, Emily, inherited the house, which had a market value of $450,000 at the time. Since inheritance is not a taxable event for CGT, no tax was due immediately.
In 2025, Emily decided to sell the house for $600,000. 

The capital gain is calculated as follows:

Assuming Emily is a higher-rate taxpayer and never lived in the property, she would be taxed at a CGT rate of 24%, resulting in a tax bill of $35,280 ($147,000 x 24%).

How the Stepped-Up Basis Works 

How are capital gains taxed on a stepped-up basis? How does it work? The stepped-up basis is a tax rule that applies to inherited assets. When you inherit an asset such as a house, stocks, or a business- the IRS resets the original purchase price (cost basis) to the asset’s fair market value on the date of inheritance. This adjustment prevents heirs from paying capital gains taxes on the appreciation that occurred during the original owner’s lifetime.

Without the stepped-up basis, heirs could face massive tax bills when selling inherited property. Instead, this rule ensures that capital gains taxes apply only to appreciation after the inheritance, not before.

Let’s have a look at one more example to help you understand it even better: Suppose your parents purchased a home many years ago for $100,000. Over time, the property increased in value, and when they passed away, it’s worth $500,000.

How the Stepped-Up Basis Applies:

• Before your parents passed, their original cost basis was $100,000.
• When you inherit the house, the IRS resets your cost basis to the current fair market value of $500,000.
• If you sell the house immediately for $500,000, your capital gains tax is calculated as follows:
  Sale price ($500,000) - Stepped-up basis ($500,000) = $0 taxable gain
  Since there is no gain, you owe no capital gains tax.

What Happens If You Wait to Sell?

• Suppose you hold onto the house for a year and the real estate market rises, increasing the home's value to $550,000.
• Now, if you sell, your capital gains tax is based on the increase in value after inheritance:
  Sale price ($550,000) - Stepped-up basis ($500,000) = $50,000 taxable gain
• In this case, you would owe capital gains taxes on $50,000, rather than on the full appreciation from when your parents originally purchased it.

Why This Matters:
Without the stepped-up basis, you would have inherited your parents’ original cost basis ($100,000). If you then sold the house for $550,000, the taxable gain would be:

Sale price ($550,000) - Original purchase price ($100,000) = $450,000 taxable gain

That means you could owe capital gains taxes on $450,000—a significant tax burden. But thanks to the stepped-up basis, you only owe taxes on the increase after inheritance ($50,000 instead of $450,000).

How Can We Help?

You shouldn’t have to deal with unnecessary stress or uncertainty- that’s why we’re here at The District Phx, our goal is to simplify every step and provide you with a stress-free experience from start to finish, knowing you’ve made the right choice.

Contact us if you are struggling with the same and need our help to get this sorted.