Inheriting a rental property can feel like both a blessing and a burden. On paper, it’s an asset — but in reality, it often comes with tenants, deferred maintenance, tax questions, and pressure to make the “right” financial decision.
One of the biggest questions heirs ask is:
How do capital gains taxes work when selling an inherited rental property in California?
The good news is that inherited properties receive favorable tax treatment compared to properties you buy yourself. But when a property has been used as a rental — either before or after inheritance — the rules can get more complex.
This guide breaks down how capital gains apply, what the step-up in basis means for rental properties, and how to minimize taxes when selling.
For a broader overview of inherited home sales, see our main guide: Selling an Inherited Home in Los Angeles: What You Need to Know
What Is Capital Gains Tax?
Capital gains tax is the tax you pay on the profit from selling an asset, like real estate.
It’s calculated as:
Sale Price – Cost Basis = Capital Gain
For properties you purchase, the cost basis is usually what you paid plus improvements. But inherited properties follow a different (and often much more favorable) rule.
The Step-Up in Basis Explained (Why It Matters So Much)
When you inherit a property, the IRS generally allows a step-up in basis to the property’s fair market value on the date of the owner’s death.
This means:
- You are not taxed on decades of appreciation
- Capital gains are calculated only from the value after inheritance
The IRS explains the step-up in basis rule.
Example:
A parent bought a rental property for $200,000 in 1995. At the time of death, it was worth $850,000.
Your new tax basis becomes $850,000, not $200,000.
If you sell it shortly after inheriting for $860,000, you may only owe capital gains on $10,000 — not $660,000.
How Rental Use Changes the Tax Picture
While the step-up in basis still applies, rental use introduces a few additional factors.
Depreciation After Inheritance
If you continue renting the property after inheriting it, you may take depreciation deductions.
Important to know:
- Depreciation starts fresh after inheritance
- Depreciation taken reduces your basis
- Depreciation is subject to recapture tax when you sell
The IRS explains depreciation recapture.
Depreciation Recapture Explained
When you sell a rental property, the IRS “recaptures” depreciation at a rate of up to 25%.
Example:
You inherit a rental, rent it for 3 years, and claim $30,000 in depreciation.
When you sell, that $30,000 is taxed separately as depreciation recapture — even if your capital gain is small.
This is one reason some heirs choose to sell sooner rather than operate the property long-term.
Short-Term vs Long-Term Capital Gains
Inherited property is automatically treated as long-term, regardless of how long you hold it.
This means:
- You qualify for long-term capital gains rates immediately
- No short-term (ordinary income) rates apply
IRS long-term capital gains rules are outlined.
This is another tax advantage of inherited real estate.
California Capital Gains Considerations
California does not offer special capital gains rates.
Instead:
- Capital gains are taxed as ordinary income at the state level
- Rates depend on your total income
This means:
- You’ll pay federal capital gains tax
- Plus California state income tax on the gain
Understanding this helps avoid surprises at tax time.
How to Reduce Taxes When Selling an Inherited Rental
There are several legal ways to minimize your tax burden.
1. Sell Soon After Inheriting
Selling shortly after inheritance often results in minimal capital gains because the sale price is close to the stepped-up value.
This is especially effective if:
- The property needs repairs
- You don’t want to manage tenants
- You want simplicity
2. Deduct Selling Expenses
Selling costs can reduce your taxable gain, including:
- Real estate commissions
- Escrow and title fees
- Transfer taxes
- Legal fees
These deductions can meaningfully reduce what you owe.
3. Consider a 1031 Exchange (Advanced Strategy)
If you keep the property as a rental and later sell, you may qualify for a 1031 exchange, which allows you to defer capital gains by reinvesting into another investment property.
The IRS 1031 Like-Kind Exchange Guide explains this strategy.
Important: This only applies to investment use, not personal residences.
4. Work With a Tax Professional
Inherited rental properties combine:
- Estate rules
- Rental income
- Depreciation
- Capital gains
- State tax issues
A CPA or estate-focused tax advisor can help you:
- Time the sale properly
- Avoid overpaying taxes
- Document basis correctly
When Selling As-Is Makes Sense for Inherited Rentals
Many inherited rentals:
- Need major repairs
- Have difficult tenants
- Require time and money heirs don’t have
Selling as-is can:
- Avoid repair expenses
- Speed up the sale
- Reduce holding costs
- Simplify tax planning
Example:
A family in Long Beach inherited a tenant-occupied rental with plumbing issues and back rent owed. Rather than invest $40,000 in repairs, they sold as-is to a cash buyer and closed in 21 days.
Common Misconceptions About Inherited Rental Taxes
❌ “I’ll owe taxes on what my parent paid.”
➡️ Not usually — the step-up resets the basis.
❌ “I have to keep renting it to avoid taxes.”
➡️ Renting may increase complexity and depreciation recapture.
❌ “Selling right away is a tax mistake.”
➡️ Often, selling sooner reduces taxes.
Final Thoughts
Selling an inherited rental property in California doesn’t have to be a tax nightmare — but understanding how capital gains, depreciation, and the step-up in basis work is essential.
For many heirs, selling sooner and keeping things simple results in lower taxes, fewer headaches, and faster closure. Others may choose to hold and invest — but that decision should be intentional, not default.
At Mrs. Property Solutions, we’ve helped many California families sell inherited rental properties as-is and on flexible timelines. If you’re weighing whether to sell now or later, we’re happy to talk through your options — even if selling to us isn’t the right choice.