Know the Basic Tax Rules
Usually, the value of property you inherit isn’t included in your gross income for federal income tax purposes. This means you generally don’t owe income tax simply for receiving an inheritance.
However, income generated by inherited property is taxable. For example, interest, dividends or rental income produced by inherited investments or real estate must be reported on your tax return.
If you later sell inherited property, any gain may also be taxable. In most cases, the tax basis of inherited property is stepped up to its fair market value at the loved one’s date of death. This means that you won’t owe capital gains tax on appreciation that occurred before you inherited the asset.
Some inherited assets are classified as “income in respect of a decedent” (IRD). This refers to income the deceased person earned but didn’t receive before death, such as certain retirement account distributions, unpaid wages or deferred compensation. If you inherit IRD, you must generally report the amounts as taxable income. Because IRD can also be subject to estate tax, you may be eligible for an income tax deduction for estate taxes paid on those amounts.
If you’ve inherited a retirement plan, you generally won’t have to pay income tax on the entire balance immediately (unless you withdraw it all immediately). But if you’re someone other than the surviving spouse, you probably will have to not only begin taking annual required minimum distributions — which will likely be subject to income taxes unless it’s a Roth account — but also deplete the account within 10 years.
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Estate taxes may apply if the value of your loved one’s estate exceeds federal or state exemption thresholds. These taxes are typically paid by the estate rather than the beneficiaries. So before making financial decisions, determine the net value of your inheritance after any estate taxes and other expenses are settled.
With proper planning, an inheritance can strengthen your financial position without leading to unnecessary tax exposure. Contact the office if you have questions about how inherited assets may affect your current tax situation or long-term financial strategy.
