What Happens When You Inherit Money?

Inheriting money can bring both financial relief and a series of questions about how to manage these new assets. Navigating the receipt of inherited funds requires careful attention to legal procedures, the nature of the assets received, and applicable tax considerations.

Understanding the Inheritance Process

When an individual passes away, their assets undergo a legal process for transfer to heirs. This process often involves probate, a court-supervised procedure that validates the deceased person’s will and oversees the distribution of assets. Probate applies to assets solely owned by the deceased without specific beneficiary designations or joint ownership, ensuring the assets are distributed according to the will or, if no will exists, according to state intestacy laws.

Assets held within a trust bypass probate, as the trust dictates distribution to beneficiaries. The trustee manages and distributes the trust’s assets according to the deceased’s terms. This direct transfer can streamline the inheritance process and maintain privacy, as trust documents are not typically part of public court records.

Many financial accounts and policies transfer assets directly to named beneficiaries, avoiding probate. Life insurance policies, retirement accounts (IRAs, 401(k)s), and certain bank or investment accounts allow the account holder to name specific individuals to receive assets upon their death. These beneficiary designations ensure a direct and efficient transfer of funds outside the formal probate system.

Assets held in joint ownership with rights of survivorship transfer directly to the surviving owner. This applies to various asset types, including real estate, bank accounts, and investment accounts. The surviving joint owner automatically assumes full ownership, simplifying the transfer and bypassing probate for that asset.

Identifying Inherited Assets and Their Characteristics

Inheritances can comprise various types of assets, each with distinct management and tax implications. Cash and funds held in bank accounts are straightforward, representing immediate liquidity for the beneficiary. These assets transfer directly to the heir’s account once estate or trust administration is complete.

Real estate, like a home or land, involves the transfer of legal title to the beneficiary. Upon inheriting real property, beneficiaries use its fair market value at the previous owner’s death as the new tax basis for the property. This updated basis is significant if the property is later sold, as it impacts the calculation of any potential capital gains.

Investments like stocks, bonds, and mutual funds receive a “step-up in basis” to their fair market value on the date of the decedent’s death. This means that if the assets have appreciated in value over time, the beneficiary’s cost basis is reset to this higher value. If the beneficiary subsequently sells these investments, capital gains tax is only owed on any appreciation that occurs after the date of death, potentially minimizing tax liability.

Retirement accounts, including IRAs and 401(k)s, consist of pre-tax funds. When these accounts are inherited, distributions are taxable income. Non-spousal beneficiaries (for owners who passed away in 2020 or later) are subject to the “10-year rule,” which requires the entire account balance to be withdrawn by the end of the tenth year following the original owner’s death. Spousal beneficiaries often have more flexible options, including rolling the inherited funds into their own retirement accounts.

Tangible personal property includes vehicles, jewelry, art, collectibles, and household goods. The value of these items is typically their fair market value at the time of inheritance. While these assets may not have immediate tax implications upon receipt, their sale could trigger capital gains taxes if their value has appreciated significantly since the date of death.

Taxation of Inherited Funds

Understanding inheritance tax implications is important, as different taxes apply based on asset and jurisdiction. The federal estate tax is levied on the deceased’s estate before asset distribution. This tax applies only to very large estates, with a $13.99 million per individual exemption in 2025. For estates exceeding this, the tax is paid by the estate, not beneficiaries.

Beyond the federal level, some states also impose their own estate taxes. As of late 2023, 12 states and the District of Columbia levy an estate tax, with exemption levels varying significantly from state to state. Similar to the federal estate tax, these state-level taxes are generally paid by the estate before the assets are transferred to the heirs.

An inheritance tax is paid directly by the beneficiary, distinct from estate taxes. Only a few states impose an inheritance tax, including Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Rates depend on the beneficiary’s relationship; closer relatives (spouses, children, grandchildren) are often exempt or taxed lower, while distant relatives or unrelated beneficiaries may face higher rates. Maryland imposes both an estate tax and an inheritance tax.

Income tax applies when inherited assets generate income or are sold. Distributions from inherited retirement accounts (IRAs, 401(k)s) are taxable as ordinary income when withdrawn. Non-spousal beneficiaries must withdraw the entire balance within ten years of the original owner’s death, with specific rules based on the owner’s death date and RMD status.

Capital gains tax may apply when appreciated assets like real estate or investments are sold. However, due to the “step-up in basis,” the cost basis resets to their fair market value at the original owner’s death. This can significantly reduce or eliminate capital gains tax if sold shortly after inheritance, as taxable gain is calculated only on appreciation after the date of death. Other income-generating assets, like rental property, produce taxable rental income.

Initial Steps After Receiving an Inheritance

Once an inheritance has been received or transferred, several immediate actions can help beneficiaries manage their new assets effectively. Confirm receipt of all inherited assets and meticulously review and retain all accompanying documentation. This includes distribution statements, transfer forms, and any official letters from the estate executor, trustee, or financial institutions.

Verify how the inherited assets are now titled. For example, financial accounts may be in an individual name, an inherited IRA account, or held as joint property. Understanding the new ownership structure is crucial for managing the assets and for future tax reporting.

Reviewing account statements for financial assets is a necessary step. This allows beneficiaries to understand the initial value of the inherited holdings, identify specific investments, and become aware of any associated fees or characteristics of the new accounts. This review provides a clear financial picture of the inherited portfolio.

Maintain organized records of all inherited assets. This includes documenting their fair market values at the time of inheritance, which is essential for establishing the stepped-up basis for tax purposes if the assets are later sold. Keeping track of any related expenses, such such as legal or appraisal fees, can also be beneficial.

For complex inheritances or substantial sums, considering professional consultation can be a valuable next step. Engaging a tax professional or a financial advisor can provide guidance tailored to the beneficiary’s specific situation, helping to navigate tax obligations, investment strategies, and long-term financial planning. This consultation focuses on using the inheritance wisely within the beneficiary’s overall financial landscape.