To determine if the sale of inherited property is taxable, you must first determine your basis in the property. The basis of property inherited from a decedent is generally one of the following:

• The fair market value (FMV) of the property on the date of the decedent's death.
• The FMV of the property on the alternate valuation date if the executor of the estate chooses to use alternate valuation. See the Form 706 Instructions, United States Estate (and Generation-Skipping Transfer) Tax Return.

If you or your spouse gave the property to the decedent within one year before the decedent's death, see Publication 551, Basis of Assets.

Report the sale on Form 1040, Schedule D (PDF), Capital Gain and Losses:

• If you sell the property for more than your basis, you have a taxable gain.
• For information on how to report the sale on Schedule D, please see Publication 550, Investment Income and Expenses.

For estates of decedents who died in 2010, basis is generally determined as described above.  However, the executor of a decedent who died in 2010 may elect out of the estate tax rules for 2010 and use the modified carryover of basis rules. 

Under this special election, the basis of property inherited from a decedent who died during 2010 is generally the lesser of:

• The adjusted basis of the decedent, or
• The fair market value of the property at the date of the decedent’s death.

However, the executor of the decedent’s estate may increase the basis of certain property that beneficiaries acquire from a decedent by up to $1.3 million, but no more than the fair market value of the property at the date of the decedent’s death.  The executor may also increase the basis of certain property that the surviving spouse acquires from a decedent by up to $3 million, but no more than the fair market value of the property at the date of the decedent’s death.  The executor of the decedent’s estate is required to provide a statement to all heirs listing the decedent’s basis in the property, the fair market value of the property on the date of the decedent’s death, and the additional basis allocated to the property.

Report the sale on Form 1040, Schedule D (PDF), Capital Gain and Losses, as described above.