Taxes are an unpleasant part of inheriting a house, farm, or brokerage account. But it’s critical to understand how capital gains rules apply, particularly in Illinois.
An experienced estate planning attorney can explain how capital gains rules apply to inherited property. It can be the difference between a manageable transition and an unexpected tax bill.
The Step-Up in Basis: A Built-In Tax Break
When property is inherited, the “cost basis” for tax purposes is reset to the fair market value on the date the original owner died, rather than what that person paid for it. This is called the “step-up in basis” which can erase decades of taxable appreciation.
An example is a home purchased decades ago for $80,000 that has appreciated to $400,000 at the time of the owner’s death. If the home is sold, capital gains taxes would be owed on the $320,000 of appreciation. But if the property is passed to heirs, the heirs’ new basis is $400,000, and if they sell it shortly thereafter, no capital gain is owed.
This rule applies to real estate, stocks, and most other appreciated assets, except for tax-deferred retirement accounts like traditional IRAs and 401(k)s, which have their own distribution rules.
This process does not apply if the property owner gives a family member property while they are still alive. A gift usually carries the owner’s cost basis, so the recipient may face a large capital gains tax bill. Holding appreciated assets until death is generally the more tax-advantaged option.
Illinois Estate Tax Adds a Layer That Families Often Overlook
Estate taxes, in addition to capital gains taxes, are a concern for Illinois families. Illinois imposes its own estate tax separately from federal estate tax. In 2026, the threshold for federal estate tax is $15 million per individual, but in Illinois the threshold is only $4 million. In addition, Illinois’ estate tax is called a “cliff tax” because it applies to the entire estate if the total valuation exceeds $4 million. The state tax can be as high as 16 percent, and the $4 million exemption is not portable between spouses. Using both $4 million exemptions is a key part of a comprehensive estate plan.
Illinois allows an unlimited marital deduction, meaning assets left outright to a surviving spouse pass free of Illinois estate tax regardless of value. This is why the lack of portability matters: without advance planning, the first spouse’s $4 million exemption is effectively wasted, leaving only one exemption available when the second spouse dies. It’s also worth noting that lifetime gifts reportable to the IRS are added back into the calculation when testing an estate against the $4 million threshold, so large gifts made during life don’t automatically sidestep Illinois estate tax exposure.
Planning Strategies to Discuss With an Attorney
There are several opportunities to reduce tax exposure through estate planning. Some options include:
- Lifetime gifting: using the maximum annual federal gift tax exclusion of $19,000 per recipient gradually reduces the taxable estate. Because gifts at or under this amount don’t need to be reported to the IRS, they are not added back into the Illinois estate calculation, unlike larger, reportable gifts.
- Credit shelter or marital trusts: avoid the issue of estate tax exemption portability by structuring a plan that uses both $4 million exemptions.
- Careful basis documentation: retaining appraisals and records of fair market value at death to protect heirs if the IRS questions the stepped-up basis.
- Charitable giving of appreciated assets: donating highly appreciated property can avoid capital gains tax entirely while supporting a valued cause.
Guidance for Accessing Valuable Yet Underused Planning Techniques
The stepped-up basis is one of the most valuable and least understood benefits of estate planning available to Illinois families. An attorney from Legacy & Life Law Firm can demonstrate applying the available tools to capitalize on estate tax exemptions available to Illinois residents, potentially saving families thousands of dollars. Call for a consultation today.