Is an Inheritance Taxable?
Someone inherits a house, investment account, or sum of money and immediately asks: “How much tax will I owe?”
The answer is often less alarming than expected—but several different taxes can apply, and they are frequently confused with one another.
Inheritance tax and estate tax are not the same
An inheritance tax is imposed on the person who receives property. Whether tax is due may depend on the beneficiary’s relationship to the person who died and the law of the applicable state.
An estate tax is imposed on the estate itself, generally based on the value of the taxable estate. The estate ordinarily calculates and pays the tax before distributing the remaining property.
The federal government imposes an estate tax on estates exceeding the applicable federal exemption. It does not impose a general federal inheritance tax on each beneficiary.
State law varies. Some states impose an estate tax, some impose an inheritance tax, and a small number may impose both. Many states impose neither.
The relevant state may depend on where the deceased person lived, where the beneficiary lives, and where particular real or tangible property is located.
Is an inheritance considered income?
Generally, receiving inherited cash or property is not taxable income merely because it was inherited.
That does not mean every inherited asset is permanently tax-free. Tax may arise because of the type of asset received or what happens after the inheritance.
Examples include:
Interest or dividends earned after death;
Rent collected from inherited real estate;
Capital gain when inherited property is sold;
Distributions from a traditional individual retirement account or retirement plan;
Deferred compensation or other income earned before death but paid afterward; and
Income accumulated by an estate or trust before distribution.
The tax result can therefore be very different depending on whether someone inherits cash, real estate, stock, a business, or a retirement account.
What happens to the tax basis of inherited property?
Many inherited capital assets receive an adjusted income-tax basis based on their fair market value at the owner’s death.
For example, if a parent purchased stock for $50,000 and it was worth $200,000 at death, the beneficiary’s basis may generally be adjusted to $200,000. If the beneficiary promptly sells it for that amount, there may be little or no capital gain.
This adjustment does not apply in the same way to every asset. Traditional retirement accounts, deferred compensation, and other items representing untaxed income generally retain their income-tax character.
Retirement accounts require separate planning
An inherited retirement account is not treated like inherited cash.
Distributions from a traditional individual retirement account or employer retirement plan are generally subject to income tax when withdrawn. Federal law may also require the beneficiary to withdraw the account within a particular period.
The applicable rules depend on several factors, including:
Whether the beneficiary is a surviving spouse;
Whether the beneficiary is an individual, trust, estate, or charity;
The beneficiary’s age or disability;
The age of the account owner at death; and
The language of any trust named as beneficiary.
Beneficiary designations should therefore be coordinated with the estate plan rather than completed in isolation.
Selling inherited property can create tax
Even when receiving property is not taxable, selling it may be.
The gain or loss is generally measured by comparing the sale price with the beneficiary’s adjusted tax basis. A reliable date-of-death appraisal can be essential, particularly for real estate, closely held businesses, artwork, and other property without a readily available market value.
Who pays any estate tax?
The governing documents and applicable law determine how estate tax is allocated among beneficiaries.
A will or trust may direct that tax be paid from the residuary estate, apportioned among the beneficiaries whose property generated the tax, or allocated in another manner. That language can substantially change what each beneficiary ultimately receives.
A beneficiary receiving an asset outside probate—such as life insurance, a retirement account, or jointly owned property—may still be affected by estate-tax apportionment.
The practical takeaway
Most beneficiaries will not owe tax simply because they received an inheritance. But the complete analysis requires asking:
Is there a federal or state estate tax?
Does any state impose an inheritance tax?
Will the inherited asset generate taxable income?
What is the beneficiary’s tax basis?
Does the asset have special rules, as retirement accounts do?
Who must bear any tax under the will, trust, beneficiary designation, and applicable law?
Estate planning should address more than who receives each asset. It should also consider how the asset will pass, how it will be taxed, and whether the beneficiary will have the information and liquidity needed to manage it.
This article provides general information and is not legal or tax advice. Tax laws, exemptions, and filing requirements change, and the result depends on the parties, assets, governing documents, and jurisdictions involved.
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