Do I Pay Income Tax on an Inheritance?
Is your inheritance subject to income tax? Discover the nuances of what's taxed and what's not, beyond the initial inherited amount.
An inheritance represents assets, property, or money received from a deceased individual. The principal amount received as an inheritance is not considered taxable income at the federal level for the beneficiary.
Federal Income Tax on Inherited Assets
While the inherited principal is not subject to federal income tax, certain aspects of an inheritance can generate taxable income for the beneficiary. Income produced by inherited assets after you receive them is taxable.
Interest earned from inherited bank accounts or bonds becomes taxable income to the beneficiary. Similarly, dividends received from inherited stocks are considered taxable income. If you inherit rental property, the rental income collected after the inheritance is also subject to income tax.
When inherited assets like stocks or real estate are sold, any capital gain realized from the sale is subject to capital gains tax. The cost basis for inherited property is the fair market value (FMV) of the asset on the date of the decedent’s death. This concept is known as a “stepped-up basis.” For example, if someone bought stock for $10,000 and it was worth $50,000 at their death, the beneficiary’s basis is $50,000. If the beneficiary then sells the stock for $55,000, the taxable gain is only $5,000 ($55,000 – $50,000).
Inherited retirement accounts, such as IRAs and 401(k)s, often result in taxable income for beneficiaries. Distributions from pre-tax inherited retirement accounts are subject to federal income tax. The rules for these distributions vary depending on the beneficiary’s relationship to the deceased account owner.
Spousal beneficiaries have flexibility, able to roll the inherited funds into their own retirement accounts or treat the inherited IRA as their own. This allows for continued tax-deferred growth and distributions based on their own life expectancy or required minimum distribution (RMD) schedule. Non-spousal beneficiaries, however, face different rules.
For non-spousal beneficiaries who inherit a retirement account after 2019, the entire balance must be distributed within 10 years following the original account owner’s death. This is commonly referred to as the “10-year rule.” Beneficiaries can choose when to take distributions within this period, but the account must be depleted by December 31 of the 10th year following death. If the original owner had already begun taking RMDs, the non-spousal beneficiary may also be required to take annual distributions during the 10-year period.
Federal Estate Tax Considerations
Federal estate tax is a separate tax from federal income tax on inherited assets. This tax is levied on the total value of a deceased person’s estate before assets are distributed to beneficiaries. It is the estate, not the individual beneficiary, that is responsible for paying this tax.
The federal estate tax applies only to estates exceeding a high exemption amount. For individuals passing away in 2025, the federal estate tax exemption is $13.99 million. Married couples can effectively combine their exemptions, potentially shielding up to $27.98 million from federal estate tax.
If an estate’s value exceeds the exemption, the tax is applied only to the portion exceeding that amount. The maximum federal estate tax rate is 40%. Because of the high exemption amount, only a small percentage of estates in the United States are subject to federal estate tax.
State-Level Inheritance and Estate Taxes
Beyond federal taxes, some states impose their own taxes related to inheritances. These can take the form of either an estate tax or an inheritance tax.
A state estate tax functions similarly to the federal estate tax. An inheritance tax, conversely, is levied directly on the beneficiary receiving the inheritance. The tax rate and exemption amounts for state inheritance taxes depend on the beneficiary’s relationship to the deceased, with closer relatives like spouses or direct descendants being exempt or subject to lower rates.
The rules for state-level inheritance and estate taxes vary significantly across jurisdictions. Some states have no estate or inheritance tax, while others may impose one or both. It is important for beneficiaries to determine if their state of residence or the state where the deceased resided has such taxes, as these can impact the net amount received.
Reporting Inherited Income and Assets
Beneficiaries do not report the principal value of an inheritance itself as taxable income on their federal income tax return. However, any taxable income generated by inherited assets must be reported.
Income streams from inherited assets, like interest, dividends, and rental income, need to be included on your income tax return. Interest and ordinary dividends are reported on Schedule B. Rental income from inherited property is reported on Schedule E.
When inherited assets are sold, any capital gains or losses must be reported. This is done on Form 8949, with totals carried over to Schedule D. For inherited assets, you enter “Inherited” as the acquisition date to ensure proper long-term capital gain or loss treatment.
Distributions from inherited pre-tax retirement accounts are reported as ordinary income on your tax return. You receive a Form 1099-R from the retirement account custodian detailing the distribution amount. If the inheritance involved an estate that generated income and distributed it to you, you receive a Schedule K-1 from the estate, which indicates the taxable income to report.