Inheriting Money: Tax Guide
A guide by Taxstra Tax & Accounting — CPA-led tax strategy for business owners
Income Tax on Inheritance
What taxes you owe when you inherit money or property
Inheritance itself is not subject to federal income tax. You do not report inherited money, property, or assets as income on your tax return (Form 1040). This is a fundamental principle of tax law: inherited assets pass to beneficiaries free of income tax liability.
Key Rule: No Income Tax on Inheritance
Inherited assets are not income. You receive cash, stocks, real estate, retirement accounts—all tax-free. You do not file Form 1040 reporting inheritance as income. This applies whether you inherit $10k or $1M.
However, post-inheritance income is taxable. Example: you inherit a rental property valued at $500k. The inheritance itself is not taxed. But rental income ($3k/month) is taxable. Interest income on inherited cash is taxable. Dividends on inherited stock are taxable. The inherited asset is not taxed; income from it is.
Estate Tax vs Income Tax
Estate tax (paid by the estate, not the beneficiary) applies only to estates over $13.61M (2026 exemption). Beneficiaries do not pay estate tax. However, the estate itself may owe estate tax before assets pass to you. Confirm with the estate executor/attorney whether estate tax applies to your inheritance.
The decedent's final tax return (filed by the executor) reports any income earned by the decedent through their date of death. You, the beneficiary, are not liable for that tax (the estate pays from its assets). After you inherit, you are only responsible for income tax on income you generate, not on the inheritance itself.
Step-Up in Basis
The single biggest tax benefit of inheritance
Step-up in basis (IRC Section 1014) is a massive tax advantage for inherited assets. Your basis in inherited property is stepped up to its fair market value on the decedent's date of death. This eliminates all unrealized capital gains.
Step-Up Basis Example: Stock
Parent bought stock in 1990 at $10/share. At death in 2026, it's worth $250/share. Your basis is $250/share (not $10). If you sell immediately at $250/share, zero capital gains tax. You inherit the full appreciation ($240/share) entirely tax-free. If parent had sold before death, they would owe capital gains tax on $240/share.
Real Estate Step-Up Impact
Parent bought rental property at $200k in 1990. It's worth $800k in 2026 (unrealized gain: $600k). Parent dies; you inherit. Your basis: $800k. If you sell for $800k, no capital gains. If parent had sold before death, capital gains tax: 15% × $600k = $90k. Step-up saves $90k in taxes. Keep inherited property if step-up benefit is large.
Step-up applies to most inherited assets: stocks, bonds, real estate, mutual funds, business interests. There are exceptions: inherited IRAs do not receive step-up (they are income in respect of a decedent, IRD). Inherited annuities: step-up applies to cost basis, but accumulated earnings are taxed to beneficiary.
Step-Up Timing: Date of Death Valuation
Step-up basis is set on the decedent's date of death (or alternate valuation date, 6 months later, if elected by estate). Assets must be valued at FMV on that date. If stock worth $100 at death, $150 when you receive it, your basis is $100 (death date), not $150. Professional appraisals required for real estate, art, business interests.
Depreciation Recapture on Rental Property
Inherited rental property receives step-up in basis. However, the executor calculates the depreciation recapture tax (unrecaptured Section 1250 gains) on the decedent's final return. You do not inherit the depreciation tax liability—it's paid by the estate. Your depreciation schedule resets on the stepped-up basis, and future depreciation is deductible to you.
Estate Tax Thresholds
Federal and state exemptions for inherited assets
Federal estate tax applies only to estates exceeding the exemption amount. In 2026, the federal exemption is $13.61M per individual ($27.22M for married couples). Estates at or below the exemption owe zero federal estate tax. Estates above the exemption pay 40% tax on the excess.
2026 Federal Estate Tax Exemption: $13.61M
If deceased's taxable estate (assets minus liabilities, minus charitable deductions) is under $13.61M, no federal estate tax. Estate value: $10M? No tax. Estate: $15M? Tax on $1.39M at 40% = $556k. Exemption indexed annually. Note: exemption sunsets to ~$7M per person in 2026 if Congress doesn't extend it.
However, most estates are well below the exemption. Median U.S. estate value: ~$250k. Only approximately 0.1% of estates owe federal estate tax. If the deceased was not extremely wealthy (multimillionaire+), estate tax likely does not apply.
Portability for Married Couples
Married couples can combine exemptions via portability election (Form 706, filed within 9 months of death). Surviving spouse inherits unused exemption of deceased spouse. Example: spouse dies with $13.61M exemption unused. Surviving spouse now has $27.22M exemption for their own estate. Requires timely Form 706 election.
State Estate and Inheritance Taxes
12 states and D.C. impose estate tax (exemptions: $1M-$6.94M). Six states impose inheritance tax (0%-18% on beneficiaries). Some states have both. If deceased lived in or owned real estate in these states, check state rules. Examples: New York estate tax exemption: $6.94M (40% above). California: no estate or inheritance tax (2026). New Jersey: inheritance tax on unrelated beneficiaries at 15-18%.
As a beneficiary, you typically do not directly pay federal estate tax (the estate pays before distribution). However, if you inherit property subject to a mortgage or other debt, you may assume that debt. Check the estate settlement documents to understand whether any tax or debt liability passes to you.
Inherited IRAs & SECURE Act 10-Year Rule
Distribution rules for inherited retirement accounts
Inherited IRAs (Traditional and Roth) are subject to SECURE Act 2.0 rules. Non-spouse beneficiaries must fully distribute (withdraw) the inherited IRA balance within 10 calendar years following the year of the original owner's death. There are no annual required minimum distributions (RMDs) during the 10-year period, but the entire balance must be withdrawn by December 31 of year 10.
10-Year Distribution Rule (SECURE Act 2.0)
Original owner dies in 2025. Beneficiary (non-spouse, e.g., adult child) inherits $500k IRA. Deadline: December 31, 2035 (10 years after death). Beneficiary can take $0 in years 1-9, then $500k in year 10. Or $50k/year for 10 years. Or any combination. Flexibility on timing within 10 years, but all out by year 10.
Exception: spouse beneficiaries have different rules. Surviving spouses can roll the IRA into their own name (continue as their IRA), treating inherited assets as their own retirement account. Spouses can defer RMDs until their own RMD age. Most advantageous option for spouses.
Tax on Inherited IRA Distributions
Distributions from inherited Traditional IRAs are taxed as ordinary income at full rate (not capital gains rates). Example: inherit $300k Traditional IRA, take full distribution in year 10, all $300k is ordinary income (taxed at 37% top rate = $111k tax). Minimize tax by spacing distributions over 10 years, but all must be out by year 10.
Roth IRA Inheritance Advantage
Inherited Roth IRA: distributions are tax-free (if Roth held over 5 years by deceased). Example: inherit $300k Roth IRA, withdraw $300k tax-free (0% tax). Most tax-efficient inheritance. If deceased held Roth less than 5 years, earnings are taxed, but contributions are tax-free. Request conduit trust setup if inherited from employer plan (401k, 403b) to stretch distributions over 10 years.
Important: inherited IRAs do not receive step-up in basis. The entire balance is ordinary income (Traditional IRA) or tax-free (Roth IRA) regardless of cost basis or FMV at death. If inherited asset is highly appreciated, prefer non-IRA assets (stocks, real estate) to capture step-up benefit instead.
Disclaiming Inherited Property
Refuse inheritance to redirect to other beneficiaries
A qualified disclaimer (IRC Section 2518) allows you to refuse inherited property and have it pass to the next beneficiary as if you never inherited. This is a powerful planning tool to redirect wealth without incurring gift tax.
Qualified Disclaimer Rules
To disclaim inherited property: (1) written disclaimer filed with estate executor within 9 months of decedent's death, (2) you cannot have accepted benefit from property (spent money, taken rent, etc.), (3) property must pass to someone else (not your choice who), (4) cannot accept benefit if you receive other property. No gift tax on disclaimer.
Disclaimer Strategy: Tax Bracket Planning
You inherit $500k. You're in high tax bracket; your child is in lower bracket. Disclaim in favor of your child. Your child receives property with same basis (stepped-up). If property generates income, taxed to your child at lower rate. Tax savings: significant. Disclaimer is effective tax planning tool, no gift tax consequence.
Common scenarios: inheriting IRA or retirement account when you don't need the income. Disclaim in favor of grandchild (more time to grow tax-free within 10-year window). Inheriting large estate when you want charitable giving. Disclaim portion to charitable remainder trust (CRT), receive income stream without estate tax consequences.
Disclaimer Timing is Critical
9-month deadline (from date of death, not date you become aware of inheritance) is strict. Miss the deadline and you're stuck with the property; you can't refuse it later. If inheritance is complex, consult estate attorney immediately after death to plan disclaimer timing.
Inherited Property Planning
Tax strategies for the first year after inheritance
After inheriting property, you have several strategic choices to optimize tax outcomes. Do not rush to sell or transfer inherited assets—the first year offers significant planning opportunities.
Hold Period Strategy
If you inherit appreciated stock or real estate, hold for at least 1 year if possible. Your basis is stepped-up (FMV at death). If asset increases further in value after death, you only owe tax on gains after inheritance date. Example: inherit stock at $100 FMV, sell at $105 after 1 year, $5 capital gains (15% LTCG = $0.75 tax). If asset declines to $95, you have $5 loss (deductible, subject to limitations).
Inherited Rental Property: Depreciation Reset
If inherited rental property, reset depreciation schedule on stepped-up basis. If property stepped-up to $500k and building is 80% of value, depreciable basis: $400k. Take straight-line depreciation over 27.5 years (~$14.5k/year deductible). This is a new depreciation schedule; old schedule does not carry over from deceased.
For inherited homes: if you plan to live in it (principal residence), you're eligible for Section 121 exclusion ($250k/$500k if married) after owning and occupying for 2 of the last 5 years. If inherited home increases in value and you sell, capital gains up to the exclusion are tax-free (your basis is stepped-up, so gains are typically minimal unless property appreciates significantly post-inheritance).
Inherited IRD (Income in Respect of Decedent)
Some inherited property is IRD (unpaid interest, dividends, compensation due at death). IRD does not receive step-up in basis—it's ordinary income to beneficiary and subject to income tax. Example: decedent owned Series I bonds with $10k accrued interest. That $10k is IRD (taxed to estate or beneficiary as ordinary income). Bonds themselves get step-up, but accrued interest does not.
State Inheritance Tax
Which states tax inherited property
Six states impose inheritance tax (tax on beneficiaries). This is separate from federal estate tax. Inheritance tax rates range from 0% to 18% depending on state and relationship to deceased. Spouses are often exempted; children taxed at lower rates; unrelated beneficiaries at highest rates.
Six States with Inheritance Tax
Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania. Tax varies by relationship: spouse often exempt (0%), lineal descendants (children): 1%-15%, siblings: 5%-15%, unrelated: 15%-18%. Example: inherit $100k in New Jersey from non-spouse, non-child: ~$18k tax. California, Florida, Texas: no inheritance tax.
Additionally, 12 states and D.C. impose estate tax (tax on the estate, not the beneficiary). Estate tax exemptions range from $1M-$6.94M (far lower than federal $13.61M). If decedent lived in or owned real estate in these states, check state rules. New York, Illinois, Connecticut, Hawaii, Massachusetts, Maine, Minnesota, Mississippi, Missouri, Oregon, Rhode Island, Tennessee, Vermont, Washington, D.C.
Planning for State Inheritance Tax
If decedent was domiciled in an inheritance tax state and you live elsewhere, consult estate attorney. Inherited property may be subject to that state's tax based on location (real estate) or decedent's residence. Example: decedent in New Jersey, you inherit NJ property, NJ inheritance tax applies. Inherited property in California (no tax), but decedent was NJ resident, estate may still owe tax based on domicile.
Credit for Taxes Paid
If inherited property is subject to both federal estate tax (if applicable) and state inheritance tax, you may be eligible for credit on state return for portion of federal tax paid. Conversely, federal return may provide credit for state estate/inheritance taxes paid. Consult CPA or estate attorney to maximize credits and reduce double taxation.
| Asset Type | Income Tax Treatment | Estate/Inheritance Tax | Planning Considerations |
|---|---|---|---|
| Cash | No income tax. Step-up not applicable (already $1 = $1). Receive cash tax-free. | Subject to federal estate tax if estate over $13.61M | No planning needed. Direct inheritance. |
| Stock (appreciated) | No income tax on inheritance. Basis stepped up to FMV at death. Sell immediately with no capital gains tax. | Subject to federal estate tax at FMV at death | Receive step-up benefit ($1 for each $1 inherited). Significant tax savings if original cost basis low. |
| Real Estate (home, rental) | No income tax. Basis stepped up to FMV. If sale within one year, no capital gains (stepped-up basis). Rental property: basis stepped up, but depreciation starts fresh (no recapture of depreciation taken by deceased). | Subject to federal estate tax at FMV | Major planning tool. Deceased's depreciation recapture not taxed to beneficiary. Rental: reset depreciation clock. |
| Traditional IRA | No income tax on inheritance (beneficiary liable for distributions). Must distribute within 10 years (SECURE Act). Distributions taxed as ordinary income at full rate. | Subject to federal estate tax (included in estate value) | Consider disclaim if other beneficiary in lower bracket. Plan 10-year withdrawal strategy. Avoid bunching distributions (pushes into high bracket). |
| Roth IRA | No income tax on inheritance or distributions (Roth grows tax-free). Must distribute within 10 years (SECURE Act). Distributions are tax-free (if Roth held over 5 years by deceased). | Subject to federal estate tax (included in estate value) | Highly tax-efficient. Stretch over 10 years, receive tax-free growth. Best asset to inherit. |
| Life Insurance Proceeds | Not subject to income tax (IRC 101(a)). Entirely tax-free to beneficiary. No step-up needed. | Included in estate if deceased owned policy. Excluded if irrevocable trust or 3rd party owns policy. | If deceased owned policy, estate tax applies. Consider ILIT (irrevocable life insurance trust) to remove from estate (requires 3-year lookback). |
| Retirement Account (401k, 403b) | No income tax on inheritance. Must distribute within 10 years. Distributions taxed as ordinary income. | Subject to federal estate tax | Check if employer allows conduit trust (stretches distributions). Most plans: lump sum or 10-year option. |
| Bonds, Treasury Securities | Step-up in basis to FMV at death. No income tax on inheritance. Any accrued interest on bonds is taxable to estate (not beneficiary). | Subject to federal estate tax at FMV | Accrued interest taxed to estate on final return. Beneficiary receives step-up benefit. |
| Annuity | Step-up in basis only to cost basis (not accumulated earnings). Inherited annuity: beneficiary receives step-up, but deferred gains are taxed when distributed (ordinary income). | Subject to federal estate tax | Least tax-efficient. Deferred gains taxed to beneficiary. Roth IRA or life insurance preferable. |
| S-Corp or Partnership Interests | Basis stepped up to FMV at death. Depreciation and income recapture carry over. Beneficiary inherits interest with stepped-up basis. | Subject to federal estate tax. Value often discounted (minority interest, lack of control, lack of marketability). | Use valuation discounts (20%-40%) to reduce estate tax. Consider buy-sell agreement with other owners. |
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