Tax Questions to Ask Before Selling an Inherited House

Step 1: Establish the Stepped-Up Basis

Basis is the starting number for measuring gain or loss when property is sold. For inherited property, it is set by 26 U.S.C. § 1014(a), which generally makes the basis the fair market value of the property at the date of the decedent's death. The statute gives alternatives: the value at an alternate valuation date if the estate makes that election, a value determined under a special valuation election, or, to the extent a particular estate tax exclusion applies, the basis the decedent had.

In plain terms, if a parent bought the house decades ago for far less than it was worth when they died, the heir's basis is generally the higher date-of-death value, not the old purchase price. That is the "step up." If the house was worth less at death than the parent paid, the basis steps down to that lower value. Basis is fixed by reference to the date-of-death value (or an alternative the statute allows); a rise or fall in the market afterward does not change that starting figure.

Community property. The IRS's Publication 551 says that in community property states, including California, when either spouse dies, the total value of the community property, even the part belonging to the surviving spouse, generally becomes the basis of the entire property, if at least half the value of the community interest is includible in the decedent's gross estate. Whether that applies depends on how the couple held title.

Showing the value. An appraisal as of the date of death is a common way to document fair market value. In probate, the personal representative files an inventory and appraisal with the court, and under Probate Code section 8902, a court-designated probate referee generally appraises the property the personal representative does not. A CPA, enrolled agent or tax attorney can say how that appraisal is used on a return. The IRS FAQ adds that a beneficiary can contact the executor for the date-of-death value.

Step 2: Understand How Capital Gains Are Calculated on the Sale

The basic arithmetic is the sale price, less selling costs, less the basis from Step 1. Selling costs generally include items such as commissions and closing costs, and improvements made after the inheritance can affect the figure; a tax preparer decides what counts.

Hypothetical: if a house's date-of-death value was documented at a certain figure and the house later sold for that same amount before costs, the costs of sale would leave no gain on paper, and might produce a loss. The IRS FAQ on inherited property puts it plainly: "If you sell the property for more than your basis, you have a taxable gain." A sale below basis produces a capital loss, and whether that loss is usable depends on how the property was held and used, which the IRS's Publication 559 discusses for a residence the estate sells.

Long-term treatment. Under 26 U.S.C. § 1223, a person who acquires property from a decedent, with basis set under 26 U.S.C. § 1014, and sells it within one year after the death is treated as having held it more than one year. The IRS's Publication 559 says the gain or loss on inherited capital-asset property "is considered long term, regardless of how long you held the property."

Reporting. The IRS FAQ says gross proceeds from selling inherited property count when deciding whether a return must be filed, and if there is a filing requirement, the sale is reported on Schedule D and/or Form 8949. If the estate or trust is the seller, California's Franchise Tax Board says on its estates and trusts page that a fiduciary return, Form 541, may be required, for example when the estate has income from a California source. The FTB publishes current California rates and forms. A CPA, an enrolled agent or a tax attorney reviews the calculation and prepares the returns.

Step 3: Check Whether California Withholding Applies at Closing

Withholding means the buyer, through escrow, holds back part of the sale price and sends it to the Franchise Tax Board. Under Rev. & Tax. Code section 18662, this generally applies when a California real property interest is sold by any person other than a corporation or partnership, with exceptions for some of those entities. The FTB publishes the current withholding percentage and forms.

The statute sets limits on when withholding is required. No withholding is required unless the sales price exceeds $100,000, and, except for an exchange accommodator, none is required unless the real estate escrow person has given written notice of the withholding requirements. A seller can also elect to have a smaller, certified amount withheld, based on the gain.

A buyer acting in good faith may also skip withholding by relying on the seller's written certificate, signed under penalty of perjury, stating one of several conditions, including that:

• the property is the seller's or decedent's principal residence under the federal principal-residence rules;
• the property was last used as the seller's principal residence;
• the sale will result in a net loss or a gain not recognized for California tax.

The statute lists other conditions too, such as certain exchanges and involuntary conversions. The FTB's certification form must say that "Title and escrow persons and exchange accommodators are not authorized to provide legal or accounting advice for purposes of determining withholding amounts." Escrow handles the mechanics; a CPA or tax attorney reviews which certificate, if any, fits before closing. Under the same section, escrow generally may not charge for complying unless it provides "assistance," and then the fee may not exceed $45.

Step 4: Understand the Property Tax Reassessment Rules Under Proposition 19

A buyer's property tax is not the heir's tax, but this step matters while the family holds the house and in deciding whether one heir keeps it. Under Rev. & Tax. Code section 60, a change in ownership is a transfer of a present interest in real property worth substantially the value of the whole. The State Board of Equalization's Change in Ownership FAQ says transfers that constitute a change in ownership may occur by inheritance, and that once the county assessor has determined a change in ownership has occurred, Proposition 13 requires the assessor to reassess the property to its current fair market value as of the date ownership changed.

Filing a change in ownership statement. Under Rev. & Tax. Code section 480, for property in probate, the personal representative files the statement with the county recorder or assessor before or at the time the inventory and appraisal is filed with the court. For other transfers at death, including through a trust, the trustee or the transferee files within 150 days after the date of death. Probate Code section 8800 has the inventory and appraisal filed within four months after letters are first issued to a general personal representative, or within further time the court allows.

The parent-child exclusion. For transfers on or after February 16, 2021, Rev. & Tax. Code section 63.2 lets a transfer between parents and children escape reassessment, in whole or in part, when a claim is filed, the home was the parent's principal residence, and it becomes the child's principal residence within one year. The child must also file for the homeowners' or disabled veterans' exemption within a year. The statute sets a value limit, measured against the prior taxable value plus a fixed dollar amount; value above that limit is added to the assessment. That figure is adjusted over time, so the county assessor or the State Board of Equalization is the source for the current amount. A separate exclusion covers family farms.

Grandchildren. A grandparent-grandchild transfer qualifies only if all the grandchild's parents, other than stepparents, who are children of the grandparents, are deceased as of the date of transfer.

The claim deadline. The claim is filed with the assessor within three years after the transfer, or before the property is transferred to a third party, or before an eligible transferee no longer occupies the home, whichever is earlier. A claim is also timely within six months after the mailing of a supplemental or escape assessment notice. If the property has not gone to a third party, a late claim may still be considered, but it applies starting with the lien date of the year it is filed.

If the family sells the house rather than an heir moving in, the exclusion's occupancy condition is not met. The county assessor's office answers questions about a specific property.

Step 5: Ask About the Federal Estate Tax and Its Effect on Basis

The federal estate tax is a tax on the estate itself, separate from any income tax on a sale. The IRS's estate tax FAQ says a return, Form 706, must be filed if the gross estate, increased by adjusted taxable gifts and the specific gift tax exemption, is above the filing threshold for the year of death. It is due nine months after the date of death, and an automatic six-month extension is available by filing Form 4768 by the due date. Whether a given estate must file depends on its value; the IRS publishes the threshold, and the estate's attorney or CPA confirms it.

The return matters to a seller because it can fix the basis. Under 26 U.S.C. § 1014, where a property's final value has been determined for estate tax purposes, or a value has been furnished in a required statement, the basis generally cannot exceed that value, when the property's inclusion increased the estate tax owed. The IRS's Publication 551 says beneficiaries of an estate that files Form 706 generally receive a Schedule A to Form 8971 reporting that value. The IRS FAQ warns that an accuracy-related penalty may apply if a seller uses a basis higher than the final estate tax value.

The same FAQ observes that because basis is the date-of-death value, "there is usually little or no gain to account for if the sale occurs soon after the date of death."

Step 6: Know What to Bring to Your CPA or Tax Attorney

Many families meet with three professionals before a sale. This list gathers what each one usually asks for.

Documents:

• Death certificate and deed. They prove the death and how title was held.
• Will or trust. It shows who acts and who inherits.
• Earlier exclusion claims. Any Proposition 58, 193 or 19 filings.
• Latest property-tax bill. It shows the assessed value.
• Date-of-death appraisal. It supports the basis; in probate, the inventory and appraisal.

For the CPA or enrolled agent:

• What is the basis for this property?
• Is withholding required at closing, and does a certificate apply?
• How is the gain or loss reported on the federal and California returns?

For the county assessor's office:

• Has the property been reassessed since the death?
• Is an exclusion claim pending or still available?

For the estate's or trust's attorney:

• Who has authority to sign the sale documents?
• Does the sale need court confirmation or a notice of proposed action?

Comparing ways to sell. A listing with a licensed agent, a sale by the owner without an agent, and a direct sale to a cash buyer carry different costs. A direct offer is often below what the open market would pay, because that buyer absorbs the repairs, the risk and the expense of reselling; in return, the seller does less preparation, has fewer showings and depends less on a buyer's loan. The tax rules and the estate's legal steps are the same whoever buys. Comparing written offers and estimated net proceeds, meaning the price less commissions, repairs, carrying costs, loan payoffs and closing costs, is how a family sees which fits. Cash offer vs. listing lays out those tradeoffs, and a house in rough shape raises its own questions in selling a house that needs repairs.

Typical timeline

The tax questions follow the estate's calendar rather than a fixed schedule. Basis is set as of the date of death. A change in ownership statement is due within 150 days after the death, or with the inventory and appraisal in probate. An estate tax return, if required, is due nine months after the death, subject to extension. Withholding is handled at closing. The exclusion claim window in Step 4 can close at the sale itself, and the sale is reported on the return for the year it closes.

When the process gets complicated

The appraisal is missing

Families sometimes discover no one documented the value at death. A CPA can explain how a value is established after the fact; the IRS FAQ points to the executor as the source of date-of-death value.

One heir wants to keep the house

If a child moves in and claims the exclusion while siblings want to sell, the property-tax and ownership questions overlap. When heirs disagree about the sale itself, that is a contested matter for an attorney who litigates trust and probate cases.

The house is outside your home county

The county where the property sits handles reassessment, so the assessor there is the contact. For a local example, see selling inherited property in San Diego County.

An heir lives in another state

California withholding and reporting rules apply to the California property; that heir's home state may have its own rules, which a tax professional there can address.