# What Happens With Taxes When You Inherit a House
Inheriting a house triggers complex tax consequences that most heirs overlook until after probate closes. The rules vary by state and depend on whether you keep, sell, or rent the property. Getting these details right saves thousands in unnecessary taxes.
The federal tax system treats inherited property with a major advantage called a stepped-up basis. When someone dies, the IRS resets the property's value to its fair market value on the date of death. This matters enormously for capital gains taxes.
Here's how it works in practice. Suppose your parent bought a house for $200,000 in 1985 and it's worth $600,000 when they die in 2024. You inherit it. Your new cost basis becomes $600,000, not $200,000. If you sell the house for $610,000 six months later, you owe capital gains tax on only $10,000, not $410,000. Without the stepped-up basis, that inherited property would trigger a massive tax bill.
The stepped-up basis applies to all property types. Real estate, stocks, bonds, and other assets receive this reset. It applies whether the estate pays estate taxes or not. This rule exists at the federal level and applies equally across all states.
State inheritance taxes complicate the picture. Most states don't tax inheritance, but a few do. Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania impose inheritance taxes on heirs. The rates and exemptions vary. New Jersey charges 11 to 16 percent on non-lineal heirs like cousins but often exempts spouses and children. Kentucky charges 4 to 16 percent depending on the relationship. These state taxes hit when you inherit, separate from federal rules.
Illinois, Maine, Maryland, Massachusetts, Minnesota, Mississippi, New York, Oregon, Rhode Island, Vermont, and Washington impose estate taxes, not inheritance taxes. The distinction matters. Estate taxes reduce what the estate can distribute before heirs receive anything. Inheritance taxes hit heirs directly after they receive property. Both reduce what you ultimately keep.
If you sell an inherited house within a year, you likely avoid capital gains tax entirely because your basis resets to the death date value. Holding it longer still works in your favor. Long-term capital gains rates apply to appreciation after the date of death. Federal rates run 0, 15, or 20 percent depending on income. State capital gains taxes add more in states like California, which taxes all investment income, or Washington, which taxes capital gains above $250,000 at 7 percent.
Rental property creates additional tax obligations. If you inherit a house and rent it out, you must report rental income and can deduct depreciation. Depreciation reduces your taxable rental income but creates depreciation recapture when you sell. You'll owe 25 percent recapture tax on the depreciation you deducted, separate from capital gains tax.
Primary residence status offers relief. If you inherit your parent's primary residence and it was their main home, you don't lose the principal residence exemption. You can claim it when you sell if you lived there as your main home for two of the five years before sale.
Talk to a tax professional before making any decisions. The difference between keeping a house one year versus two years, or between renting it out versus leaving it vacant, carries real tax consequences. A CPA or tax attorney can model your specific situation and identify which state rules apply to your inheritance.