Capital Gains Tax on Inherited Property: Joint Tenancy, Step-Up in Basis, and Tax Code Pitfalls

If your parent added you to the deed of their home as a Joint Tenant with Right of Survivorship, you may assume you’ve avoided probate—and taxes. But when it comes to capital gains tax, especially in New York, the rules are more complex.

A key example involves a family home in New York, and how joint tenancy affects the step-up in basis, capital gains, and how the IRS views partial gifts made during life versus inheritances received at death.

Example: New York Property With Partial Gift and Joint Tenancy

Suppose your mother bought a house some forty years ago for $80,000 and today that same property is worth $1.25 million. Your mother wants to add you as joint tenant with right of survivorship.

Here’s where things get tricky: what’s your cost basis, and how much capital gains tax would you owe if you sold the property after her passing?

What Is Cost Basis, and What is Capital Gain?

Cost Basis is the money put into an asset. When your mother bought the home for $80,000, that became her tax basis. If she later renovates the home with a $20,000 kitchen, the tax basis becomes $100,000.

Capital Gain is the difference between the net sales price and the cost basis. If a property sells for $1.25 million, but there’s $50,000 in closing costs (fees and commissions), the net sales price is $1.2 million. If the Basis is $100,000, then the Capital Gain is $1.1 million.

A Home Split in Two

When your mother added you to the deed as a joint tenant, she gifted you half of the property. From a tax perspective, the home consists of two halves, her half and your half.

Under IRS rules, gifts retain the donor’s basis—meaning you took over your mother’s basis in your half of the home.

Your half of the home: $50,000 basis
Her half of the home: $50,000 basis
Total basis: $100,000

You Sell the House While Your Mother Is Still Alive

If you sell the home now for $1.25 million, your combined capital gain would be:

Sale Price: $1.2 million

Closing Costs: $50,000
Tax Basis: $100,000
Capital Gain: $1.1 million

Each of you would recognize $550,000 in capital gains on your respective halves.

If you both qualify for the primary residence exclusion (having lived in the home for 2 out of the last 5 years), you each can exclude $250,000 of the gain. Here’s the breakdown:

Taxable Gain per Person: $550,000 – $250,000 = $300,000
Estimated Tax (at 25%): $75,000 per person, or $150,000 total

However, if you don’t live in the house, you won’t qualify for the homeowner’s exclusion, and your capital gains tax would be higher, 25% of $550,000 is —$137,500 for your half, or $212,500 total.

After Her Death: What Happens to the Capital Gains Tax?

Internal Revenue Code § 1014 generally allows for a step-up in basis for property acquired from a decedent.

A step-up in basis is a tax rule that adjusts the value of an inherited asset to its fair market value at the date of the owner’s death. This new value becomes the beneficiary’s cost basis, which is used to calculate capital gains when the asset is eventually sold.

If Mom died today owning the whole property, the tax basis would be set at the fair market value, and if the property is sold right away, there will be no capital gains tax.

Step-Up of Jointly Owned Property

Under § 1014(b)(9), jointly owned property will receive a step-up in basis if the property is acquired by reason of death, form of ownership, or other conditions—including joint tenancy.

IRC § 2040: A Common Mistake in Attribution

IRC § 2040(a) governs how property held as joint tenants is treated for estate tax purposes. Specifically, it states that for non-spousal joint tenants, any jointly owned interest that is gifted or partially gifted is included in the decedent’s gross estate.

Many people assume that because the gifted partial interest is included in the decedent’s estate, it will receive a step-up in basis. This is particularly because IRC § 1014(b)(9) states that the step-up will apply if “the property is required to be included [in] the decedent’s gross estate”.

However, IRC § 1014(b)(9) only apples to property acquired from the decedent by reason of death. It does not apply to property that was gifted before death, such as the half you received years earlier when your mother added you to the deed.

What Does That Mean?

When the house is sold, her half of the property qualifies for a step-up in basis under § 1014. But your half—which was gifted to you during her lifetime—does not receive any step-up. It retains the original basis of $50,000.

Her half of the home: gets a step-up in basis and has $0 Capital Gain
Your half of the home: $550,000 Gain
Total Tax: $75,000 if you qualify for the homeowner exclusion, $137,500 if you don’t

Conclusion: Don’t Let a Good Intent Trigger a Tax Nightmare

Adding a child to the deed of a home is often done with the best intentions. But without proper legal advice, it can lead to unexpected capital gains tax liability—especially in high-value markets like New York.

Understanding the tax rules is critical. The IRS draws a sharp line between what you inherit at death (eligible for a step-up in basis) and what you receive as a lifetime gift (not eligible). Avoiding this pitfall requires proactive estate planning.