Heirs selling an inherited house or rental in the Louisville area are often relieved to find the capital gains tax on inherited property is much smaller than they feared, because of a rule called stepped-up basis. Instead of inheriting the original owner's low purchase price as the tax basis, the heir's basis generally resets to the property's fair market value on the date of death.
How Stepped-Up Basis Actually Works
If a parent bought a home in the Highlands decades ago for $60,000 and it's worth $340,000 at the time of their death, the heir's basis becomes roughly $340,000, not $60,000. If the heir sells shortly after for close to that value, the taxable gain can be minimal or even a small loss after selling costs, even though the original owner's paper gain over the decades was substantial.
Why the Sale Timeline Matters
The stepped-up basis is set at date of death, but a property's value can move before the estate is settled and the sale actually closes. An heir who sells within a matter of months usually has clear alignment between the appraised value and the sale price, keeping the taxable gain small. A property held for several years before selling, especially one that appreciates significantly or is used as a rental in the meantime, can generate a real gain, plus depreciation recapture if it was rented.
Multiple Heirs and Shared Ownership
When siblings inherit a property together, each heir typically gets their own proportional share of the stepped-up basis, and each is responsible for reporting their share of any gain or loss on their individual return once the property sells. Disagreements among heirs about whether to sell right away or hold the property longer can directly affect everyone's eventual tax outcome, since delay reopens the door to appreciation and, if rented, recapture.
Can an Heir Use a 1031 Exchange?
Yes, if the inherited property is held for investment or business use rather than as a personal residence, an heir can use a 1031 exchange to defer any gain that does accrue after the date of death, the same as any other investment property owner. This is most relevant for heirs who hold onto a rental for a while before deciding to sell, rather than those who sell immediately near the stepped-up value.
Estate and Probate Timing in Kentucky
A Louisville property typically has to pass through probate, or a simplified small-estate process for lower-value estates, before an heir has clear title to sell, and that process alone can take several months to a year depending on the county docket and whether the estate is contested. Heirs eager to sell quickly to capture the stepped-up basis before the market moves often underestimate how long the legal steps take before a listing can even go live.
Kentucky also imposes an inheritance tax separate from federal estate tax, though most immediate family members, including children and grandchildren, are exempt or taxed at reduced rates, while more distant relatives and unrelated heirs can owe a meaningful percentage. That liability is distinct from the capital gains tax discussed above and is worth confirming with the estate's attorney or accountant early in the process.
Common 1031 Exchange Questions
Does stepped-up basis apply to property held in a trust?
It depends on the trust structure. Property in a revocable living trust generally still receives a step-up at the grantor's death because it's treated as part of the estate, while certain irrevocable trusts may not qualify, so the specific trust terms need review.
What if the property was jointly owned with the deceased?
A surviving joint owner who wasn't a spouse typically only gets a step-up on the deceased's share of the property, not the whole thing. A surviving spouse in a community property state can sometimes receive a full step-up on the entire property, though Kentucky is not a community property state.
How do I establish the date-of-death value if there's no formal appraisal?
A retrospective appraisal, prepared by a qualified appraiser estimating value as of the date of death, is the standard way to establish this after the fact, and it's worth commissioning before a sale if one wasn't done during estate settlement.
Do I owe capital gains tax if I inherit and immediately move into the house?
Moving in doesn't trigger tax by itself. If the heir later sells after meeting the two-year ownership and use test as a primary residence, the Section 121 exclusion may also apply on top of the stepped-up basis.
