Capital Gains on an Inherited Texas House: How the Stepped-Up Basis Really Works

Under Internal Revenue Code Section 1014, the basis of property acquired from a decedent generally adjusts to its fair market value on the date of death — or to another value when a valid alternate-valuation or special-use election applies [1]. Although this Section 1014 adjustment is commonly called a "step-up," the adjustment can also be downward when the property's date-of-death value is lower than its previous adjusted basis.

Probate itself does not create the basis adjustment. Property may qualify under Section 1014 even when it passes outside probate, depending on how the property was owned, transferred, and included in the decedent's estate. Conversely, a lifetime gift generally receives carryover basis rather than a date-of-death adjustment.

The starting basis is generally the property's fair market value on the date of death. Federal law does not require every estate to obtain an appraisal meeting the technical "qualified appraisal" definition used for certain other tax purposes. Nevertheless, the best evidence for inherited real estate is usually a retrospective date-of-death appraisal prepared by a state-licensed or state-certified real estate appraiser.

The valuation should address:

• The property's physical condition on the date of death
• Comparable sales reasonably close to the valuation date
• Market conditions existing on that date
• Deferred maintenance, damage, occupancy, zoning, access, easements, or other property-specific issues
• A defensible allocation between land and improvements when depreciation may be relevant

A county appraisal-district value, online estimate, current listing price, or real estate agent's comparative market analysis may provide supplemental information, but these sources should not automatically be treated as conclusive federal tax evidence. When the date of death occurred months or years earlier, request a retrospective appraisal specifically effective as of the date of death.

When Form 706 requires a specific value for the property, the appraisal and other valuation records should reconcile with the value reported on the return [3]. A Form 706 filed solely to elect portability may use special estimated-value procedures for certain property qualifying for the marital or charitable deduction, so not every Form 706 reports an exact value for every asset. If no estate tax return is required, the executor should still obtain a well-supported retrospective appraisal from a state-licensed or state-certified real estate appraiser to substantiate the basis if it is questioned.

Important: The general date-of-death basis adjustment arises by operation of law; the beneficiary does not make a separate election to receive it. However, the seller must substantiate the basis, report the eventual sale when required, and comply with the consistent-basis rules when applicable. Alternate valuation and special-use valuation require elections by the executor, and Form 8971 reporting may apply to certain estates [1][8][13].

Some estates that are required to file Form 706 or Form 706-NA under Internal Revenue Code Section 6018 must also file Form 8971 and furnish the appropriate Schedule A to beneficiaries [13]. An estate filing Form 706 solely to elect portability, make certain generation-skipping transfer elections, or make a qualifying protective filing generally is not subject to the Form 8971 requirement. When the consistent-basis rules apply, a beneficiary generally may not use an initial basis greater than the value reported on that beneficiary's Schedule A, subject to permitted post-death adjustments. The executor files Form 8971 with the IRS and furnishes each beneficiary only that beneficiary's Schedule A; Form 8971 itself should not be furnished to any beneficiary. The estate should retain Form 706, Form 8971, all Schedules A, appraisals, and subsequent basis records. Each beneficiary should give the beneficiary's own Schedule A and related basis records to the beneficiary's tax adviser.

Texas community-property ownership can produce a particularly valuable basis adjustment when the first spouse dies. Under Internal Revenue Code Section 1014(b)(6), both the deceased spouse's interest and the surviving spouse's interest in qualifying community property generally receive a date-of-death basis adjustment, provided at least one-half of the community interest is included in the deceased spouse's gross estate [7][14].

Example: Assume a married Boerne couple bought a home for $80,000, the property remained qualifying community property, and the home was worth $450,000 when the first spouse died. The aggregate basis in the property generally becomes $450,000. In a non-community-property situation in which only the deceased spouse's one-half interest receives an adjustment, the aggregate basis might instead be $265,000: the survivor's unchanged $40,000 adjusted basis in the retained one-half interest plus a $225,000 date-of-death basis in the inherited one-half interest.

Because the adjustment can increase or decrease basis, "basis adjustment" is more precise than "step-up" when describing the general rule.

Title alone does not always determine whether Texas property is community or separate property. The acquisition date, source of funds, marital agreements, gifts, inheritances, refinancing history, and later transactions may affect characterization. Separate property does not receive a full community-property adjustment merely because both spouses signed a deed or mortgage. A Texas estate attorney and CPA should confirm the property's character before the basis is reported.

After someone dies, the estate may make improvements to the property before selling it. These improvements can affect the basis in ways that are not always intuitive.

Capital Improvements Generally Increase Adjusted Basis

Amounts properly capitalized after death generally increase the estate's or heir's adjusted basis. The tax classification depends on what the work accomplishes — not merely on the contractor's description. Work that materially betters the property, restores it, or adapts it to a new use may need to be capitalized. Examples can include a complete roof replacement, a new HVAC system, a substantial kitchen renovation, an addition, or major structural work [4].

Example: A house has a $450,000 date-of-death basis. The estate makes a properly capitalized $25,000 improvement before selling. The adjusted basis becomes $475,000. If the amount realized after selling expenses is $480,000, the resulting gain is $5,000.

If the property is placed in service as a rental, a capital improvement may need to be depreciated separately instead of being recovered immediately. The executor should retain the contract, invoice, proof of payment, completion date, photographs, permits, and a description of the work.

Repairs Generally Do Not Increase Basis

Routine work that merely keeps the property in ordinarily efficient operating condition generally does not increase basis. Examples may include minor touch-up painting, carpet cleaning, repairing a small leak, or patching limited drywall damage. However, work performed as part of a larger renovation may have to be capitalized even if the same work would have been deductible when performed separately.

Repair and maintenance costs are not automatically deductible merely because an estate paid them. Deductibility depends on who owns the property, how it is held or used, why the expense was incurred, whether the property produces income, and whether the expense is claimed for estate-tax or income-tax purposes. The CPA must also prevent the same expense from being deducted twice.

The Practical Problem

Estates often spend money on the property without carefully tracking which costs are capital improvements versus repairs. When the property sells, the executor may not have clear records of what was spent and why.

That lack of clear records is one reason to maintain detailed records from the moment the estate takes possession of the property. Every contractor invoice, every receipt, every payment should be documented and categorized.

Property taxes, insurance, utilities, security, lawn care, mortgage interest, and similar post-death carrying costs generally do not increase the inherited basis simply because the estate paid them. Their treatment depends on the property's use and the taxpayer paying them.

If the estate holds the property for rental or investment, some costs may be deductible on Form 1041 or treated as estate-administration expenses. If an heir receives the property and uses it personally, many carrying costs may be personal and nondeductible, although separately applicable rules may allow certain mortgage-interest or property-tax deductions. Internal Revenue Code Section 266 also permits limited capitalization elections for certain taxes and carrying charges in qualifying circumstances.

Because the treatment varies by expense and circumstances, the executor should maintain a separate ledger for:

• Property taxes
• Insurance
• Utilities
• Security and monitoring
• Lawn and pool service
• Repairs
• Capital improvements
• Mortgage interest
• Legal and accounting expenses
• Selling expenses

The CPA should classify each item rather than relying on the description appearing on the invoice.

When the estate sells the property, certain selling expenses are deducted from the sale price to determine the amount realized [5]. These include:

• Real estate agent commissions
• Seller-paid owner's title insurance premiums directly attributable to the sale
• Applicable transfer or stamp taxes, if actually imposed
• Legal fees related to the sale
• Advertising costs
• Seller-paid escrow and closing fees directly attributable to the sale

The amount realized is compared with the property's adjusted basis — not merely its original date-of-death basis — to determine the gain or loss.

Example: The property sells for $480,000. Documented seller-paid commissions and other qualifying selling expenses total $28,800. The amount realized is $451,200. If the adjusted basis is $450,000, the resulting gain is $1,200.

Only expenses attributable to the sale reduce the amount realized. Mortgage principal paid at closing reduces the seller's cash proceeds but does not reduce taxable gain. Property-tax prorations, repair credits, lien payments, security-deposit transfers, and other closing entries may receive different treatment. Texas does not impose a general state real estate transfer tax; a transfer or stamp tax would therefore be relevant only if another jurisdiction actually imposed one on the transaction. Preserve the final settlement statement and any sale-related invoices paid outside closing, and let the CPA determine the treatment of each entry.

Inherited capital assets are generally treated as held for more than one year, regardless of the actual post-death holding period [9]. The applicable rate depends on the taxpayer reporting the gain and that taxpayer's overall taxable income [12].

The following figures are taxable-income thresholds, not amounts of capital gain considered in isolation. For individual taxpayers in 2026, the maximum zero-rate and maximum 15% rate amounts are:

• Married filing jointly or qualifying surviving spouse: 0% through $98,900; 15% above $98,900 through $613,700; 20% above $613,700
• Married filing separately: 0% through $49,450; 15% above $49,450 through $306,850; 20% above $306,850
• Head of household: 0% through $66,200; 15% above $66,200 through $579,600; 20% above $579,600
• Other individual filers, including single filers: 0% through $49,450; 15% above $49,450 through $545,500; 20% above $545,500

Capital gain is layered on top of the taxpayer's other taxable income. Therefore, one sale can have portions taxed at different rates. The thresholds do not mean that the entire gain is taxed at a single rate.

Estates and trusts have much more compressed 2026 brackets:

• 0% maximum rate amount: $3,300
• 15% maximum rate amount: $16,250
• Amounts above $16,250 can enter the 20% capital-gains bracket

This estate-versus-individual distinction is critical. A sale reported by an estate may reach the 20% bracket at a much lower income level than a sale reported by individual heirs. Whether the gain remains taxable to the estate or can be carried out to beneficiaries depends on fiduciary-income-tax rules, the governing instrument, applicable law, and how the transaction and distributions are handled.

Texas does not levy an individual income tax, so an individual's capital gain is not taxed through a Texas personal-income-tax system [18]. However, the seller's residence, an estate's tax residence, a trust's fiduciaries and beneficiaries, and the property's prior tax history can create filing or tax obligations in another state. Entity ownership can also create separate Texas franchise-tax or other tax considerations. Accordingly, federal tax may not be the seller's only potential tax exposure.

A sale may still have to be reported when no tax is due. Form 1099-S reports gross proceeds, not the seller's complete adjusted basis. An individual who receives Form 1099-S for a home sale generally must report the sale even when no gain is taxable. An individual generally need not report a main-home sale only when all gain is excludable under Section 121, no Form 1099-S was received, and no other reporting rule applies. Estate, investment, rental, and business-property sales generally require reporting on the applicable return. The seller's CPA should determine the correct forms [2][5].

The 3.8% Net Investment Income Tax may apply in addition to regular capital-gains tax [11].

For individuals, the NIIT generally applies to the lesser of net investment income or the excess of modified adjusted gross income over:

• $200,000 for single or head-of-household filers
• $250,000 for married couples filing jointly and qualifying surviving spouses
• $125,000 for married taxpayers filing separately

These individual thresholds are not indexed annually for inflation.

The NIIT can also apply to estates and nongrantor trusts. For 2026, the relevant estate-and-trust threshold is $16,000 because that is where the highest ordinary-income-tax bracket begins. The estate calculation generally applies 3.8% to the lesser of undistributed net investment income or adjusted gross income exceeding the applicable threshold [11][12].

That estate threshold is an important reason to compare a sale during estate administration with a sale after distribution. NIIT is not solely a concern for higher-income heirs; an estate can encounter the tax at a much lower income threshold.

Inherited rental property requires separate calculations for basis, land, depreciable improvements, post-death depreciation, and the eventual sale.

How the Date-of-Death Adjustment Affects Prior Depreciation

For an inherited ownership interest that receives a Section 1014 basis adjustment, the decedent's adjusted basis — including reductions for depreciation allowed or allowable before death — is generally replaced by the applicable date-of-death or alternate-valuation value [1][7]. The beneficiary ordinarily does not recapture the decedent's pre-death depreciation merely because the beneficiary later sells the inherited property.

The tax benefit the decedent previously received is not reversed on the decedent's old returns. Instead, the beneficiary starts with the newly determined inherited basis. Different rules may apply to a surviving co-owner's retained interest if only part of the property receives an adjustment. Texas community-property treatment may produce a full adjustment when its requirements are met.

Starting a New Depreciation Schedule

Land cannot be depreciated. The inherited basis must be reasonably allocated between land and depreciable buildings or improvements.

If the estate or beneficiary continues to hold the property as a residential rental, the inherited depreciable building basis generally begins a new MACRS schedule. Residential rental buildings under the General Depreciation System are generally depreciated using the straight-line method over 27.5 years with the mid-month convention. Depreciation begins when the property is placed in service — meaning it is ready and available for rent — not merely when the beneficiary decides that renting might be an option [6].

The inherited owner does not simply continue the decedent's remaining 27.5-year schedule for the inherited basis. Jointly owned property may require separate schedules for the survivor's original interest and the newly inherited interest.

Post-Death Depreciation and the Later Sale

Depreciation allowed or allowable after death reduces the estate's or beneficiary's adjusted basis. When the rental property is sold, gain attributable to post-death depreciation may be treated as unrecaptured Section 1250 gain subject to a maximum 25% federal rate. Other portions of the gain may be subject to the regular 0%, 15%, or 20% long-term capital-gains rates [6][16].

A CPA should review:

• The date-of-death appraisal
• Allocation between land and improvements
• Community, separate, or joint ownership
• The decedent's final depreciation schedule
• The estate's and beneficiary's post-death depreciation
• The property's placed-in-service date
• Capital improvements made after death
• Form 4562
• Form 4797
• The Unrecaptured Section 1250 Gain Worksheet
• The final settlement statement

Internal Revenue Code Section 2032 permits an executor to elect alternate valuation only when the election decreases both:

• The value of the gross estate; and
• The combined federal estate tax and applicable generation-skipping transfer tax, after allowable credits [8].

An estate that owes no applicable federal transfer tax generally cannot make the election merely to obtain a more favorable income-tax basis.

Which Valuation Date Applies?

If property is distributed, sold, exchanged, or otherwise disposed of within six months after death, that property is generally valued on the date of the disposition. Property still held six months after death is generally valued on the date six months after death. Therefore, it is inaccurate to state that every asset automatically receives a value from the six-month date.

How the Election Affects Basis

When a valid alternate-valuation election applies, the alternate value generally becomes the basis used under Section 1014.

A lower alternate basis produces more taxable gain — or a smaller loss — when the property is later sold.

An individual asset could increase in value even though the estate as a whole declines sufficiently to qualify for the election. The executor cannot select the alternate date only for the house; the election applies across the gross estate under the statutory rules.

The 2026 Estate-Tax Exclusion

For decedents dying in 2026, the federal basic exclusion amount is $15 million per individual. A married couple does not automatically have a combined $30 million exclusion. A surviving spouse may be able to use a deceased spouse's unused exclusion only when portability is properly elected on Form 706 or other applicable planning has been completed.

Public Law 119-21 established the $15 million amount for 2026 and provides inflation adjustments beginning in 2027. The $15 million basic exclusion amount has no scheduled sunset, although a future Congress can amend the law [12].

The Section 2032 election is irrevocable once validly made. The executor should obtain tax advice before filing Form 706 because reducing estate tax can also reduce the beneficiaries' income-tax basis.

A sale can produce a loss when the amount realized after selling expenses is less than the property's adjusted inherited basis. A market decline is not the only possible cause; commissions and other qualifying selling expenses can create or increase the loss.

Inherited property that is a capital asset is generally treated as held for more than one year, regardless of the actual post-death holding period [9]. However, a separately purchased interest — such as a sibling's share acquired in a later buyout — has its own cost basis and holding period.

Whether the Loss Is Deductible

A loss on personal-use property is generally nondeductible. If an heir occupies the inherited house as a residence or holds it primarily for personal use, the loss may be disallowed.

If the estate is the legal owner of the decedent's residence and the executor intends to realize its value through sale during administration, IRS Publication 559 explains that the property may be treated as an investment capital asset [17]. Evidence can include an early decision to sell, a listing agreement, efforts to market the property, and the absence of personal use.

For an individual heir, intent and actual use matter. Listing the property for sale, offering it for rent, maintaining businesslike records, and avoiding personal occupancy can support investment treatment, but no single action automatically guarantees deductibility. If an heir first holds the house for personal use and later converts it to rental or other income-producing use, a special basis limitation applies. The depreciation basis is the lesser of the property's fair market value or adjusted basis on the conversion date. If the converted property is later sold at a loss, the loss basis also starts with the lesser of those two amounts and is then adjusted for post-conversion events. The basis used to calculate a gain follows the normal adjusted-basis rules. These dual-basis rules can produce a sale with neither a recognized gain nor a deductible loss [1][6].

Who Receives the Loss?

If the estate sells the property, the capital loss generally belongs to the estate. The loss does not automatically pass through to heirs in the year of sale. An unused capital-loss carryover may pass to successor beneficiaries when the estate terminates under Internal Revenue Code Section 642(h), subject to the applicable rules.

If an individual heir sells after distribution, that heir reports the gain or loss attributable to that heir's ownership interest. Capital losses first offset capital gains. Subject to the applicable limitations, an individual may generally deduct up to $3,000 of excess net capital loss against ordinary income each year, or $1,500 if married filing separately, and carry the unused remainder forward [5].

Documenting the Loss

To support a claimed loss, retain the records needed to establish the applicable valuation, adjusted basis, amount realized, ownership share, and investment, rental, or business character of the property. Depending on the facts, those records may include [1][5][6][17]:

• An appraisal effective as of the applicable valuation date — usually the date of death, but potentially a disposition date or six-month date when alternate valuation applies
• Form 706 and alternate- or special-use valuation election records, when applicable
• The beneficiary's Schedule A from Form 8971, when applicable
• The final settlement statement and invoices for selling expenses paid outside closing
• Records of capital improvements, depreciation allowed or allowable, casualty adjustments, credits, and other basis changes
• An appraisal or other defensible evidence of fair market value on the date personal-use property was converted to rental or other income-producing use
• Listing agreements, rental records, occupancy records, correspondence, and other evidence supporting investment, rental, or business treatment
• Records showing whether an heir or beneficiary occupied the property, used it personally, or was permitted to live there rent-free
• Documents establishing each seller's ownership percentage and basis allocation
• Records of any separately purchased interest or co-heir buyout

No single document establishes every element of a deductible loss. The taxpayer's CPA should review the complete file before the loss is reported.

When several heirs inherit a house, the property's adjusted inherited basis is generally allocated among them according to their ownership interests.

Example: A house has a $450,000 date-of-death basis and passes equally to three heirs. Each heir generally begins with a $150,000 share of the basis. If one heir later purchases the other two interests for $150,000 each, the purchasing heir generally has:

• $150,000 of inherited basis in the original one-third interest; and
• $300,000 of cost basis in the two purchased interests, plus any properly capitalized acquisition costs.

The purchased interests have their own acquisition dates and holding periods. The selling heirs separately compare their amounts realized with their allocated bases.

A fractional-interest valuation issue may arise when the decedent owned only an undivided partial interest at death or when an actual partial interest must be valued for estate, gift, or transaction purposes. Any discount must be supported by the specific ownership rights, marketability, partition risk, restrictions, and a defensible appraisal. Co-inheritance alone does not create an automatic discount.

A below-market family buyout can create gift-tax, fiduciary-duty, self-dealing, and beneficiary-consent issues. Obtain an appraisal and advice from the estate attorney and CPA before completing the transaction.

Sale During Probate

When the estate owns and sells the property during administration, the transaction is generally reported on the estate's Form 1041. A capital-asset sale commonly requires Form 8949 and Schedule D (Form 1041). A sale of rental or business property may also require Form 4797 [10].

The settlement statement reports the transaction's proceeds and closing charges but does not establish the property's tax basis. Basis must be supported separately with the appraisal, Form 8971 materials when applicable, post-death improvement records, depreciation schedules, and other adjustments.

Capital gain is ordinarily retained and taxed by the estate, but fiduciary accounting, the governing instrument, local law, distributions, and federal distributable-net-income rules can affect the result.

Sale After Distribution

When property is distributed and the heirs later sell it, each heir generally reports the transaction based on that heir's ownership share and the estate's adjusted basis immediately before distribution, subject to applicable distribution rules and adjustments.

A sale of investment property is generally reported on Form 8949 and Schedule D. Rental or business property may require Form 4797. The inherited portion is generally treated as long-term regardless of the actual holding period. Any separately purchased interest must be tracked independently.

Which Approach Is Better?

The analysis should consider:

• The estate's compressed income-tax and NIIT thresholds
• Whether capital gain can or will be allocated to beneficiaries
• Each heir's tax residence and income level
• Court authority and creditor claims
• Title and insurability
• The number of required sellers and signers
• Potential disagreements among heirs
• Basis allocation and recordkeeping
• The risk of distributing property before estate obligations are resolved

Do not distribute the property solely to attempt to change the taxpayer without advice from the estate attorney and CPA.

The decedent's old purchase price and improvement history are often replaced by a full Section 1014 adjustment, but those records remain important when only part of the property receives an adjustment or an exception applies.

Keep basis records throughout the ownership period and until the limitations period has expired for the return reporting the sale. As a conservative administrative practice, many families retain the complete tax file for at least seven years after the sale and filing of the final related returns. Title, probate, trust, and fiduciary records may need to be retained longer. Follow the estate attorney's and CPA's written retention instructions.

If the reported basis is challenged, the taxpayer bears the practical burden of supporting the valuation and subsequent adjustments. Weak or missing records can result in additional tax, interest, penalties, and professional fees.

Some inherited-property situations are straightforward enough that the executor can handle the basic tax reporting. But several situations require professional CPA guidance:

Always Consult a CPA When:

• The property was used as a rental and depreciation was claimed or was allowable, even if no depreciation deduction was actually claimed
• Form 706 is required or being considered, including for portability, or the estate may owe federal estate or generation-skipping transfer tax
• The executor is considering the alternate valuation date
• Multiple heirs own undivided interests in the property
• The property was transferred to a trust during the decedent's lifetime
• Capital improvements were made by the estate before the sale
• The property is sold at a loss and the heir wants to deduct it
• The property is in a different state than the heir's residence (multi-state tax issues)
• The heir, estate, trust, fiduciary, or beneficiary is a resident of another state, or the transaction involves property or deferred gain previously sourced to another state.

A prior California "connection" by itself does not make the sale of Texas real estate taxable in California. California generally taxes its residents on worldwide income and taxes nonresidents on California-source income. Gain from real property is generally sourced to the state where the property is located. A California resident selling inherited Texas property may therefore have California tax exposure, while a Texas resident selling Texas property generally does not become subject to California tax merely because the decedent once lived there. Estates, trusts, part-year residency, installment sales, and prior California-source deferrals require separate analysis [15].

What a CPA Can Do

A qualified CPA can:

• Review the basis calculation using the applicable valuation, ownership characterization, Form 706 and Form 8971 materials when relevant, and all post-death adjustments
• Calculate the gain or loss on the sale, accounting for selling expenses
• Analyze depreciation allowed or allowable after death and determine any Section 1231, unrecaptured Section 1250, or depreciation-recapture consequences
• Prepare or review the estate's income tax return (Form 1041)
• Prepare the heir's individual tax return reporting the sale
• Identify any multi-state tax obligations
• Review whether the available documentation supports the positions taken on the returns and identify any material gaps

Professional fees vary, but a review can reduce the risk of reporting an unsupported basis or misclassifying gain, loss, depreciation, or multistate tax. Complex cases should be reviewed by a CPA and, when legal, fiduciary, ownership, or title issues are involved, a qualified attorney.