Who Pays Capital Gains Taxes When There Are Multiple Heirs?

Generally, the capital gains pass through to the heirs. The estate reports the gain on the estate income tax return, but then takes a deduction for the amount of the gain distributed to the heirs since this usually happens during the same tax year. Then the estate issues K-1s to the beneficiaries passing through the gain. Schedule K-1 (Form 1041) is an official IRS form that’s used to report a beneficiary’s share of income, deductions, and credits from an estate or trust.

All of that said, estates usually have little or nothing in capital gains to report due to the step-up in basis. When you inherit real estate, the property's tax basis is "stepped up," which means the value is re-adjusted to its current market value and often reduces or entirely eliminates the capital gains tax owed by the beneficiary.