When you’re dealing with an inherited property, understanding the tax implications can save you thousands of dollars. Inherited property comes with specific tax considerations that differ from regular home sales. There is typically no immediate tax due when you inherit property, but you may owe capital gains tax if you sell the property later for more than its value at the time of inheritance. This financial aspect often creates confusion during an already emotional time.
In this blog, we’ll explore how capital gains tax works for inherited property in Kentucky, including the concept of “stepped-up basis” that can significantly reduce your tax burden. We’ll also cover strategies to minimize taxes when selling inherited real estate and provide clear guidance on what Kentucky homeowners need to know about their potential tax liability.
What Is Capital Gains Tax on Inherited Property?
Capital gains tax is a tax on the profit realized when you sell an asset for more than its purchase price. When it comes to inherited property, special rules apply to how this tax is calculated. The most beneficial aspect is what’s known as the “stepped-up basis.”
In Kentucky, as in all states, the federal government applies a stepped-up basis to inherited assets. This means the cost basis of the property is adjusted to its fair market value on the date of the previous owner’s death, not the original purchase price.
For example, if your parents purchased a home in Kentucky for $100,000 years ago, and it was worth $300,000 when they passed away, your cost basis becomes $300,000. If you later sell the property for $320,000, you would only pay capital gains tax on the $20,000 difference.
This stepped-up basis is a significant tax advantage for heirs. Without it, you would owe taxes on the entire appreciation since the original purchase.
Kentucky Tax Rules for Inherited Property
Kentucky has specific tax rules that affect inherited property. Understanding these rules can help you plan your financial decisions more effectively after receiving an inheritance.
Kentucky does not have a state inheritance tax for close relatives. According to the Kentucky tax overview, the state has a flat income tax rate of 4.00%, which applies to all capital gains as ordinary income. Unlike the federal government, Kentucky makes no distinction between short-term and long-term capital gains.
When selling an inherited property in Kentucky, you’ll need to consider both federal and state taxes. The federal capital gains tax rates (0%, 15%, or 20%) will apply based on your overall taxable income. Then, Kentucky will tax any gains at the flat 4.00% rate.
For most Kentucky homeowners, the combination of the stepped-up basis and current exemptions means they may pay little to no tax on inherited homes they sell shortly after inheritance.
How Stepped-Up Basis Works in Practice
The stepped-up basis is the cornerstone of tax planning for inherited property. This provision dramatically reduces the capital gains tax you might owe when selling inherited real estate.
Here’s how the stepped-up basis works in practice:
- The property’s tax basis is reset to its fair market value at the date of death
- Any appreciation that occurred during the deceased’s ownership becomes tax-free
- You only pay capital gains tax on appreciation that occurs after you inherit
For example, let’s say your grandparent bought their Kentucky home for $50,000 in 1980. By the time of their death in 2024, the home is worth $250,000. You inherit the house and sell it one year later for $270,000.
Without the stepped-up basis, you would owe capital gains tax on $220,000 (the $270,000 sale price minus the $50,000 original cost). With the stepped-up basis, you only owe tax on $20,000 (the $270,000 sale price minus the $250,000 stepped-up value).
This can save heirs tens of thousands of dollars in taxes, particularly for properties that have appreciated significantly over time.
Federal vs. State Tax Considerations
When dealing with an inherited property in Kentucky, you’ll need to navigate both federal and state tax systems. Each has different rates and rules that apply to capital gains.
At the federal level, the tax rate on capital gains depends on your overall income and how long you’ve owned the asset. For assets held over one year, long-term capital gains tax rates of 0%, 15%, or 20% apply based on your income bracket. The 2025 federal thresholds for single filers are:
- 0% for income up to $48,350
- 15% for income between $48,350 and $533,400
- 20% for income above $533,400
Additionally, there’s a 3.8% Net Investment Income Tax for individuals with modified adjusted gross income exceeding $200,000 ($250,000 for married couples filing jointly).
At the state level, Kentucky taxes capital gains as ordinary income at the flat rate of 4.00%, regardless of how long you’ve owned the asset.
Another key difference: Kentucky does not have a state estate tax, but the federal estate tax applies to estates exceeding $13.99 million in 2025 (up from $13.61 million in 2024).
Do You Need to Pay Tax When You Inherit Property?
Generally, you don’t need to pay tax simply for inheriting property. Inheritance itself is not considered taxable income at the federal level or in Kentucky.
The inheritance only becomes subject to taxation when you sell the property and realize a gain. Even then, thanks to the stepped-up basis, you’ll only be taxed on the appreciation that occurs after you inherit the property.
Kentucky does not have an inheritance tax for close relatives including spouses, parents, children, grandchildren, and siblings. This means most Kentucky residents who inherit from family members won’t face any immediate tax consequences.
However, more distant relatives or non-relatives might face Kentucky inheritance tax rates between 0% and 16%, depending on their relationship to the deceased and the value of what they inherit.
It’s important to note that if you keep the inherited property and use it as a rental, any rental income would be subject to ordinary income tax rates at both federal and state levels.
Short-Term vs. Long-Term Capital Gains on Inherited Property
When selling inherited property, the distinction between short-term and long-term capital gains has important tax implications at the federal level.
Normally, to qualify for the lower long-term capital gains tax rates, you must own an asset for more than one year. However, inherited property receives special treatment. The IRS automatically considers the sale of inherited property as a long-term capital gain, regardless of how long you actually owned it before selling.
This means even if you sell an inherited house just a month after receiving it, you’ll still qualify for the preferential long-term capital gains tax rates of 0%, 15%, or 20% at the federal level, rather than the higher ordinary income tax rates that apply to short-term gains.
For example, if your taxable income places you in the 15% federal capital gains bracket and you sell an inherited property with a $50,000 gain, you’ll owe $7,500 in federal capital gains tax (15% of $50,000), plus Kentucky’s 4.00% tax of $2,000, for a total of $9,500.
Remember that Kentucky taxes all capital gains at 4.00% regardless of how long you held the asset, so this benefit only applies to your federal tax calculation.
Tax Strategies to Minimize Capital Gains
There are several effective strategies to reduce or eliminate capital gains tax when selling inherited property in Kentucky. With proper planning, you can significantly lower your tax burden.
One of the most powerful strategies is to use the property as your primary residence before selling. The IRS allows an exclusion of up to $250,000 in capital gains ($500,000 for married couples filing jointly) when selling your primary residence, if you’ve lived there for at least two of the five years preceding the sale.
Other effective tax planning strategies include:
- Timing the sale strategically to manage your overall taxable income level
- Offsetting capital gains with capital losses from other investments
- Using a 1031 exchange to defer capital gains by reinvesting in similar property
- Creating an installment sale to spread the capital gain over multiple years
For larger estates, more sophisticated approaches might include:
- Setting up a Charitable Remainder Trust to defer capital gains
- Investing in renewable energy projects that provide tax credits
- Working with an estate planning attorney to structure asset transfers effectively
Remember that improvements you make to the property while you own it can increase your cost basis, thereby reducing your taxable gain when you sell.
Selling Inherited Property vs. Gifted Property
There’s a significant difference in tax treatment between selling inherited property and selling gifted property. Understanding these differences can help you make better financial decisions.
When you inherit property, you receive a stepped-up basis to the property’s fair market value at the date of the previous owner’s death. This often results in minimal or no capital gains tax when selling soon after inheritance.
In contrast, gifted property does not receive a stepped-up basis. Instead, you generally take on the donor’s original cost basis. This means if the property has significantly appreciated since the original purchase, you could face substantial capital gains taxes when selling.
For example, if someone gives you a house they bought for $100,000 that’s now worth $300,000, and you later sell it for $320,000, you would pay capital gains tax on $220,000 ($320,000 minus $100,000). If you had inherited the same property at the $300,000 value, you’d only pay tax on $20,000.
This distinction makes inheritance generally more tax-advantageous than gifting for appreciated property. However, gifting can have other benefits as part of a comprehensive estate planning strategy.
Common Questions About Inherited Property Taxes
Many Kentucky homeowners have questions about the tax implications of inherited property. Here are answers to some of the most common concerns.
Do I need to report an inheritance on my tax return? No, inherited property is not considered taxable income. You don’t need to report the inheritance itself on your federal or Kentucky tax returns. However, if the property generates income (like rental income), you must report that.
How do I determine the property’s fair market value for tax purposes? You can establish the fair market value through a professional appraisal, comparable sales analysis, or the property tax assessment at the time of death. A professional appraisal is usually the most accurate and defensible method.
What if I share inherited property with siblings? If multiple heirs inherit a property together, each receives a proportionate share of the stepped-up basis. If you sell the property, each owner would pay capital gains tax on their portion of any gain above their share of the stepped-up basis.
Can I avoid capital gains tax if I reinvest in another property? Unlike primary residences, inherited property doesn’t automatically qualify for 1031 exchanges. However, if you use the property as an investment property before selling, you might qualify to defer capital gains through a 1031 exchange into another investment property.
Will I owe federal estate tax on inherited property? Most people won’t owe federal estate tax as it only applies to estates exceeding $13.99 million in 2025. The tax is paid by the estate before distribution to heirs, not by the individual heirs.
How a Financial Advisor Can Help
Navigating the tax implications of inherited property can be complex. A qualified financial advisor can provide valuable guidance tailored to your specific situation.
A financial advisor specializing in estate planning can help you:
- Determine the accurate stepped-up basis of your inherited property
- Calculate potential capital gains tax under different selling scenarios
- Identify tax deductions and strategies to minimize your tax liability
- Coordinate with tax professionals to ensure proper reporting
- Develop a comprehensive plan for managing your inheritance
They can also advise on whether keeping or selling the property makes more financial sense based on your goals. If you decide to keep the property as a rental, they can help you understand the ongoing tax implications and reporting requirements.
For substantial inheritances, working with a team that includes a financial advisor, estate planning attorney, and tax professional can provide comprehensive support. They can help ensure you don’t miss important deadlines or opportunities to reduce your tax burden.
Conclusion
Understanding the capital gains tax implications of your inherited property in Kentucky doesn’t have to be overwhelming. With the benefit of the stepped-up basis, most heirs will pay significantly less in taxes than they might expect when selling inherited homes. Remember that you generally only pay tax on the appreciation that occurs after you inherit the property, not on all the appreciation since the original purchase.
If you’re dealing with an inherited property in Kentucky and feeling stressed about the financial and emotional complications, Kentucky Sell Now can help. We buy houses for cash, allowing you to skip the hassle of repairs, showings, and lengthy closing processes. You can avoid the uncertainty of traditional home sales and potential carrying costs while you wait for a buyer. Contact Kentucky Sell Now today for a fair cash offer on your inherited property and move forward with peace of mind.