Option 1: Sell the property
Selling shortly after inheriting usually produces little or no capital gains tax, because your basis is the FMV at the date of death. If the property has not appreciated since then, the gain is near zero. Any gain is taxed at long-term capital gains rates regardless of how long you held it — inherited property automatically qualifies for long-term treatment.
If the estate paid estate tax on the property, you may get a basis increase under IRC 1016 for the estate tax attributable to the property, further reducing your taxable gain.
Option 2: Continue renting it
If you keep the property as a rental, you inherit it at stepped-up basis and begin a new depreciation schedule. Divide the FMV between land and building, and depreciate the building portion over 27.5 years (residential). This can produce a significant ongoing depreciation deduction from the new, higher basis.
You report rental income and expenses on Schedule E. The property's gain clock starts fresh from the date of death, and any appreciation in your hands is your capital gain when you eventually sell — not the decedent's.
Option 3: Move in as a primary residence
If you move into the inherited rental and use it as your primary residence for at least two of the five years before sale, you may qualify for the Section 121 exclusion — $250,000 ($500,000 married filing jointly) of capital gains excluded from tax.
However, because you inherited the property (not purchased it), your holding period is deemed long-term regardless. Note that any depreciation you claim while renting it after inheriting — but before moving in — creates recapture exposure that is not sheltered by the Section 121 exclusion.
Frequently asked questions
Is gain on an inherited property long-term?
Yes. Inherited property automatically qualifies for long-term capital gains rates regardless of how long you hold it.
Do I get new depreciation on an inherited rental?
Yes. Your depreciable basis is the property's FMV at the date of death (the land portion excluded). You start a fresh 27.5-year depreciation schedule.
Can I avoid all tax by moving into an inherited rental?
The Section 121 exclusion can shelter up to $250,000 ($500,000 MFJ) of gain, but depreciation claimed after inheriting is still subject to recapture. Move-in strategies require careful planning.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.