Tax Implications of Inheritance

Receiving an inheritance often raises questions about taxes. Many people worry that inherited money or property will immediately create a tax bill, but the rules are more nuanced.

This article explains the tax implications of inheritance, including what is taxable, what is not, and which situations require extra attention.

🟢 IS INHERITANCE TAXABLE INCOME?

In most cases, inheritance itself is not taxable income for federal income tax purposes.

This means:

🔹 Inherited cash is usually not taxed when received

🔹 The value of inherited property is generally not reported as income

🔹 Receiving an inheritance alone does not increase your income tax

However, taxes may apply after you receive the inheritance, depending on the asset type.

🟢 ESTATE TAX VS. INHERITANCE TAX

These two terms are often confused but are very different.

🔹 Estate tax is paid by the estate before assets are distributed

🔹 Inheritance tax is paid by the beneficiary (in states that impose it)

There is no federal inheritance tax, but a small number of states do impose inheritance taxes. Federal estate tax applies only to very large estates.

🟢 TAX IMPLICATIONS WHEN YOU SELL INHERITED PROPERTY

Selling inherited property can create tax consequences.

Key concept: stepped-up basis

🔹 The asset’s tax basis is usually reset to its fair market value at the date of death

🔹 This often significantly reduces capital gains tax

🔹 Only appreciation after inheritance is generally taxable

This rule commonly applies to inherited real estate, stocks, and other investments.

🟢 INHERITED REAL ESTATE: WHAT TO WATCH FOR

Inherited real estate often has favorable tax treatment, but details matter.

Important considerations:

🔹 Whether the property is sold immediately or later

🔹 Whether it becomes a rental

🔹 Whether depreciation is claimed after inheritance

While stepped-up basis reduces gains, future use can still create taxable income.

🟢 INHERITED RETIREMENT ACCOUNTS (SPECIAL TAX RULES)

Retirement accounts are treated differently from other inherited assets.

Common inherited accounts include:

🔹 Traditional IRAs

🔹 Roth IRAs

🔹 401(k)s

Tax implications may include:

🔹 Taxable distributions from traditional accounts

🔹 Required distribution timelines

🔹 Different rules depending on beneficiary type

These accounts often require careful planning to avoid unexpected taxes.

🟢 TRUSTS AND INHERITANCE TAX CONSIDERATIONS

When inheritance is received through a trust, tax treatment can vary.

Trust-related considerations include:

🔹 Whether income is distributed or retained

🔹 Whether the trust files its own tax return

🔹 Whether income is passed through to beneficiaries

Trust structure directly affects how and when taxes apply.

🟢 COMMON MISUNDERSTANDINGS ABOUT INHERITANCE TAXES

🔹 “All inheritance is taxable”→ Usually incorrect.

🔹 “I must report inherited money as income”→ Typically not required.

🔹 “Stepped-up basis eliminates all taxes forever”→ It reduces capital gains, but future income may still be taxable.

🟢 A PRACTICAL RULE OF THUMB

🔹 Receiving inheritance → usually not taxable income

🔹 Selling inherited assets → review capital gains rules

🔹 Inherited retirement accounts → expect taxable distributions

🔹 Trust distributions → tax treatment depends on structure

Understanding what you inherited matters more than how much you inherited.

🟢 NEED HELP UNDERSTANDING INHERITANCE TAX IMPLICATIONS?

Inheritance often intersects with estate planning, real estate, and long-term tax strategy.

At Pacific Change, we help clients:

🔹 Understand the tax impact of inherited assets

🔹 Plan sales of inherited property

🔹 Navigate inherited retirement account rules

🔹 Coordinate trust and personal tax reporting

If you’ve inherited assets or expect to - we’re happy to help you understand the tax implications and plan accordingly.