Do I Have to Pay Taxes on Money or Things I Inherit?

When a loved one passes away and leaves you an inheritance, it's natural to wonder whether you'll face tax obligations on the assets you receive. Understanding how inheritance is taxed-and where it isn't-is essential to protecting your wealth and avoiding unnecessary surprises. This article provides a clear and comprehensive explanation of when inherited money or property may be taxed, which taxes apply, and how you can plan ahead.

Contact us by either using the online form or calling us directly at 414-253-8500 for legal assistance.

What Types of Taxes Could Apply to an Inheritance?

When people ask whether they'll owe taxes on an inheritance, they're usually referring to one or more of the following:

Estate Tax
Inheritance Tax
Income Tax
Capital Gains Tax

Let's look at each of these in detail.

Estate Taxes vs. Inheritance Taxes

Estate Taxes

The federal estate tax is a tax on the deceased person's estate before any distributions are made to heirs. However, most estates are not large enough to trigger the federal estate tax. For 2025, the federal estate tax exemption is $13.61 million per individual, which means estates valued below that amount are not subject to the tax.

In most cases, beneficiaries do not pay the estate tax directly-the estate itself pays it before assets are transferred.

Important: Some states have their own estate tax thresholds, which are often lower than the federal exemption. Proper estate planning can help minimize this exposure.

Inheritance Taxes

Unlike estate taxes, inheritance taxes are imposed on the recipient, not the estate. However, inheritance taxes are only levied in a few states, and even then, close family members are often exempt or taxed at a lower rate.

For example:

No inheritance tax exists at the federal level.
States like Pennsylvania, Nebraska, and Iowa do impose an inheritance tax.
Many states-such as Wisconsin, Minnesota, and California-do not have an inheritance tax.

Will I Owe Income Tax on My Inheritance?

In general, inherited money and property are not considered taxable income under federal law. That means you typically do not have to report inherited assets as income on your federal income tax return.

However, there are important exceptions:

Income in Respect of a Decedent (IRD)

If you inherit certain types of accounts or payments that the deceased earned but did not receive during their lifetime, you may owe income tax on them. Common examples include:

Unpaid wages
Deferred compensation
IRA or 401(k) distributions (unless the account was a Roth)

For example, if you inherit a traditional IRA, you'll likely have to pay income taxes on the distributions you receive, even though the account was part of your inheritance.

Trust Distributions

If you inherit assets through a trust, distributions from the trust may be taxable, depending on the trust structure. Trust income that is passed through to beneficiaries is usually taxed to the beneficiary, not the trust itself.

Capital Gains Tax and Inherited Property

While you typically won't owe income tax on inherited property, you may be subject to capital gains tax if you later sell that property.

Here's the key benefit: Step-Up in Basis

What is Step-Up in Basis?

When you inherit property, the IRS generally allows a "step-up" in the property's tax basis. This means the asset's value is "reset" to its fair market value at the date of the decedent's death.

Example:

Your parent bought a home in 1990 for $100,000.
At the time of their passing in 2025, the home is worth $400,000.
If you inherit the home and later sell it for $425,000, you only owe capital gains tax on the $25,000 difference, not on the entire $325,000 increase in value.

This rule can significantly reduce or eliminate capital gains taxes on inherited property.

How Inherited Retirement Accounts Are Taxed

Inherited retirement accounts, especially traditional IRAs and 401(k)s, are one of the few inherited assets that are taxed upon distribution. Here's how:

Non-Spouse Beneficiaries

Most non-spouse beneficiaries must withdraw the entire account within 10 years under the SECURE Act. These withdrawals are treated as ordinary income and taxed accordingly.

Spouse Beneficiaries

Spouses have more flexibility. They can:

Roll over the inherited account into their own IRA
Delay required distributions
Spread the tax liability over their lifetime

Inherited Roth IRAs, by contrast, are generally not taxable, provided the account has been open for at least five years.

Inheriting Real Estate, Vehicles, and Personal Property

When you inherit real estate, vehicles, or personal belongings, the tax implications depend on what you do with those assets.

Holding vs. Selling

Holding: If you keep the property, there is usually no immediate tax consequence.
Selling: You may owe capital gains tax, but again, thanks to the step-up in basis, this amount is often minimized.

Example - Real Estate

If you inherit a rental property and decide to sell it shortly after the decedent's death, you're only taxed on the gain beyond the stepped-up basis. However, if you hold it and rent it out, the rental income is taxable, and depreciation rules apply.

Gifts Received Before Death vs. Inheritances

Understanding the difference between gifts given before death and inheritances received after death is critical for tax planning.

Gifts during life may trigger gift tax filing requirements if they exceed the annual exclusion ($18,000 per recipient for 2025).
Inheritances after death do not trigger gift taxes for the recipient.

Also, gifts retain the original basis of the giver, meaning no step-up. That can lead to higher capital gains taxes if the recipient later sells the gifted asset.

Planning Opportunities to Reduce Taxes on Inheritances

Working with a knowledgeable estate planning attorney can help ensure you or your beneficiaries are in the best position to preserve wealth and minimize taxes.

Key Strategies Include:

Utilizing Trusts - Trusts can help delay taxation, reduce estate size, and control distributions.
Converting Traditional IRAs to Roth IRAs - Reduces taxable distributions to heirs.
Gifting During Life - Strategic lifetime gifting can reduce the size of your taxable estate.
Charitable Giving - Donating appreciated assets to charity can eliminate capital gains taxes.
Spousal Portability Elections - Allows married couples to effectively double their estate tax exemptions.

Common Mistakes to Avoid

Being unaware of inheritance tax rules can lead to costly missteps. Here are several errors to avoid:

Not accounting for IRD (Income in Respect of a Decedent)
Failing to take advantage of step-up in basis
Improper handling of inherited IRAs
Ignoring trust tax implications
Disregarding state-specific inheritance or estate tax laws

Each mistake could result in thousands of dollars in unnecessary taxes or penalties.

Contact an Inheritance Attorney for Tax Guidance

Inheritance and taxation laws are complex, and even small oversights can lead to large consequences. If you've recently inherited money or property-or you're planning your estate and want to reduce the tax burden on your beneficiaries-legal guidance is essential.

At Heritage Law Office, we help individuals and families understand and navigate the tax implications of inheritances. Our experienced attorneys can assist with:

Evaluating potential tax liabilities
Structuring your estate to reduce taxes
Managing inherited assets
Resolving disputes and tax issues

Contact us today by using the online form or calling us directly at 414-253-8500 to schedule a consultation.

Frequently Asked Questions (FAQs)

1. Is inheritance considered income for tax purposes?

No, most inherited assets are not considered taxable income at the federal level. However, certain types of assets-such as inherited retirement accounts-may result in taxable income when distributions are made.

2. Do I have to pay taxes if I inherit a house and sell it?

Possibly, but only on the gain above the stepped-up basis. The property's tax basis is adjusted to its fair market value at the time of the decedent's death, significantly reducing capital gains taxes when the home is sold.

3. What is a stepped-up basis, and why is it important?

A stepped-up basis adjusts the value of inherited property to its market value at the date of death. This limits capital gains taxes if the property is later sold and is one of the most beneficial tax provisions for heirs.

4. Are inherited retirement accounts taxed differently than other inherited assets?

Yes. Traditional IRAs and 401(k)s are generally taxable as ordinary income when distributed. Roth IRAs, if held long enough, are typically tax-free. Distribution rules and tax obligations vary based on whether the beneficiary is a spouse or non-spouse.

5. What happens if I inherit money from someone who lived in a state with an inheritance tax?

You may be subject to that state's inheritance tax, even if you live in a state without one. Each state has its own rules on who pays and at what rates, so consulting an attorney familiar with multi-state inheritance laws is recommended.