Do I owe capital gains tax if I sell an inherited house after 2 years in 2025?

When you inherit a house, you receive a stepped-up basis equal to the fair market value (FMV) of the property on the date of the decedent's death (or the alternate valuation date if the estate elected it). This is one of the most significant tax benefits in the U.S. tax code.

Here's how it works in practice:

Suppose your parent bought a house for $100,000 in 1990, and it was worth $400,000 when they passed away. Your cost basis is $400,000 — not $100,000. If you sell it for $420,000 after holding it for two years, your taxable gain is only $20,000, not $320,000.

Can you exclude the gain? The Section 121 exclusion ($250,000 single / $500,000 married) requires that you used the home as your primary residence for at least 2 of the 5 years before the sale. If you moved into the inherited house and lived there for 2+ years before selling, you could potentially exclude up to $250,000 (or $500,000 if married filing jointly) of any gain above the stepped-up basis.

If you did NOT live in the home, you'll owe capital gains tax on the difference between the sale price and your stepped-up basis. If you held the property for more than one year, it qualifies for long-term capital gains rates (0%, 15%, or 20% depending on your income). You'll also need to account for selling costs, which reduce your gain. Report the sale on Schedule D and Form 8949.