How the IRS Values (and Audits) an Inherited Home

# How the IRS Values (and Audits) an Inherited Home

When you inherit a home, the IRS doesn't use the price your parent paid decades ago. Instead, the agency applies what's called a "step-up in basis" to reset the property's value on your tax record. Understanding this rule can mean the difference between a tax-free inheritance and a hefty capital gains bill.

Here's how it works. Your parent bought a house in 1985 for $80,000. It's now worth $400,000. When they pass away, the IRS resets your "basis" (the value used to calculate taxes) to the fair market value on the date of death. That means your inherited basis is $400,000, not $80,000. If you sell the home immediately after inheriting it, you owe no capital gains tax because you haven't made any profit.

This step-up in basis is one of the largest tax breaks available to heirs. The IRS doesn't tax the appreciation that happened during your parent's lifetime. However, any increase in value after you inherit the property does count as taxable gain. If you sell the home for $425,000 six months after inheriting it, you owe capital gains tax on only the $25,000 gain, not the original $320,000 increase.

The valuation matters enormously. The IRS bases the step-up on the home's fair market value as of the date of death. This is where audits happen. The agency doesn't accept guesses. They want appraisals, comparable sales data, and documentation.

If the IRS questions the valuation you used on your inheritance tax return (Form 706, filed for estates over $12.92 million in 2023, or $13.61 million in 2024), they have multiple tools to challenge it. The most common approach: hiring their own appraiser to compare your property against recently sold homes in the same area. If their appraiser values the home higher than you claimed, you'll owe additional taxes plus interest and penalties.

Getting the valuation right from the start protects you. Hire a professional appraiser immediately after the death occurs. Do not rely on Zillow estimates or the recent property tax assessment. Those numbers carry no weight with the IRS. A formal appraisal typically costs $300 to $600 but saves thousands in potential audit exposure.

Document everything. Keep the appraisal report, the appraiser's credentials, and photos of the property condition at the time of inheritance. If the home needed repairs, note that. If the market was depressed in your area, document comparable sales prices from that period.

This matters for your children too. Parents who communicate openly about inherited property values help their heirs avoid surprises. A parent nearing the end of life can have a professional appraisal done in advance. Share that document with your executor and heirs. Include it with your will or in a letter explaining your estate plan.

When you eventually sell the inherited home, you'll need records showing what you paid for it (the stepped-up basis) versus what you sold it for. The IRS expects a clear paper trail. Without it, auditors assume the worst and make their own calculations.