Thanks to tagteam and Critter-3 for your answers to my questions. Following up on your answers, I did some further research on the topic of taxes on an inherited house. In my case, the house was held in a revocable trust. I will summarize my understanding of taxes on an inherited house related to my original questions:
1) The first issue is the step-up in cost basis of the house when the owner dies. Under IRC Section 1014 assets received from a decedent are afforded a basis step-up to the fair market value (FMV) of the property at the date of the decedent's death (irrevocable grantor trusts are excluded under ruling 2023-02). How FMV is determined has been interpreted in different ways. As tagteam has mentioned, the IRS will accept an appraisal of the property on the date of death by a licensed real estate appraiser as FMV. A second possible determination of FMV is to sell the house immediately after the date of death. The IRS may accept the sale price as the cost basis depending on how much time has passed between the sale and date of death. A third way of determining FMV is to use a supplemental property tax bill sent by the county stating the assessed value on the date of death.
There are disadvantages of using all 3 methods. Getting a retroactive appraisal from an appraiser may not reflect the actual value of the property as it is only as good as the data used for the appraisal. Using the sale price for cost basis runs into the problem of how soon after the date of death the property is sold and how quickly the house has increased or decreased in value in that time. Using a supplemental property tax bill as FMV depends on the accuracy of the county assessor's valuation.
2) In selling an inherited house, capital gain or loss is calculated by subtracting the cost basis from the sale price reduced by deductible selling expenses. If a house is sold quickly after the date of death, it is likely that there will be a loss due to the nearly identical sale price and cost basis and deducting selling expenses. In the final year of Form 1041, any loss is passed on to the beneficiaries on the K-1's for their tax benefit.
3) The inheritor of a house will receive a supplemental property tax bill from the county for the period between the date of death and the closing date of the sale of the house. This tax bill is based on the newly assessed value of the house on the date of death. The amount of property tax can be used as a deduction to taxable income on Form 1041.
