You've inherited money or property, and one of the first questions that comes to mind: How much of this am I going to lose to taxes?
The good news: most inheritances don't trigger income taxes at the federal level. But depending on what you inherited, where you live, and what you do with the assets, you could face taxes you weren't expecting.
Here's what you need to know.
The Federal Estate Tax (Probably Doesn't Apply to You)
When someone passes away, their estate may owe federal estate taxes before any assets are distributed to heirs. But this only applies to very large estates.
For 2024, the federal estate tax exemption is $13.61 million per person. If the deceased person's estate is worth less than that, no federal estate tax is owed.
If the estate exceeds the exemption, the estate—not you, the beneficiary—pays the tax before you inherit anything. So by the time the inheritance reaches you, the estate tax has already been handled.
Key point: You, as the beneficiary, don't pay federal estate tax. The estate does, before assets are distributed.
State Estate and Inheritance Taxes (This Might Apply)
Some states have their own estate or inheritance taxes, with much lower exemption thresholds than the federal level.
Estate taxes are paid by the estate before distribution. States with estate taxes include Connecticut, Hawaii, Illinois, Maine, Massachusetts, Maryland, New York, Oregon, Rhode Island, Vermont, Washington, and Washington D.C.
Inheritance taxes are paid by the beneficiary after receiving the inheritance. States with inheritance taxes include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
Maryland is the only state with both an estate tax and an inheritance tax.
If you inherit assets from someone who lived in one of these states, you may owe state taxes even if no federal estate tax applied. The rate and exemptions vary by state and sometimes by your relationship to the deceased (spouses and close relatives often get favorable treatment).
Income Taxes on Inherited Assets
Here's where it gets more nuanced: the inheritance itself is usually not taxed as income, but income generated by inherited assets is taxable.
Inherited cash: No income tax. The money comes to you tax-free.
Inherited property (real estate, stocks, etc.): No income tax when you inherit it. But if you sell it later, you may owe capital gains tax on any appreciation from the date you inherited it to the date you sold it.
Inherited retirement accounts (IRAs, 401(k)s): This is the big exception. Distributions from inherited traditional IRAs and 401(k)s are taxed as ordinary income when you withdraw the money. And under current law (the SECURE Act), most non-spouse beneficiaries must withdraw all funds within 10 years, which can create significant tax bills.
Inherited Roth IRAs: Distributions are tax-free, but you still must withdraw all funds within 10 years under the SECURE Act (for most non-spouse beneficiaries).
Inherited income-producing assets: If you inherit a rental property, dividend-paying stocks, or interest-bearing accounts, the income they generate going forward is taxable to you.
The Step-Up in Basis (A Huge Tax Break)
One of the most valuable tax benefits of inheriting assets is the step-up in basis.
How it works: When you inherit property (stocks, real estate, etc.), your cost basis is "stepped up" to the fair market value on the date of death. This eliminates capital gains taxes on any appreciation that occurred during the deceased person's lifetime.
Example: Your parent bought a house in 1980 for $100,000. It's now worth $500,000. If they sold it while alive, they'd owe capital gains tax on $400,000 of appreciation. But if you inherit it after they pass, your cost basis becomes $500,000. If you sell it immediately for $500,000, you owe zero capital gains tax.
This is one of the most significant tax advantages in the tax code, and it applies to most inherited assets except retirement accounts.
Inherited Retirement Accounts (The 10-Year Rule)
If you inherit a traditional IRA or 401(k) from someone other than your spouse, you're subject to the SECURE Act's 10-year rule.
You must withdraw all funds from the account within 10 years of the original owner's death. Each withdrawal is taxed as ordinary income.
This can create a significant tax problem if the inherited IRA is large. Pulling out $500,000 over 10 years means an extra $50,000 of taxable income per year, which could push you into a higher tax bracket.
Spousal exception: If you inherit an IRA from your spouse, you can roll it into your own IRA and delay required minimum distributions (RMDs) until you reach age 73. This is far more tax-efficient than the 10-year rule.
Strategy: Work with a CPA to model the most tax-efficient withdrawal strategy over the 10 years. Sometimes it makes sense to withdraw more in low-income years and less in high-income years to manage your tax bracket.
What About Selling Inherited Property?
If you inherit property (a house, stocks, collectibles), you don't owe taxes on the inheritance itself. But if you sell it later, you'll owe capital gains tax on any appreciation since the date of death.
Example: You inherit a house valued at $400,000 on the date of death. Two years later, you sell it for $450,000. You owe capital gains tax on the $50,000 gain, not the full $450,000.
If you sell the property quickly after inheriting it, your gain (and your tax bill) will be minimal.
If you hold onto it for years and it appreciates further, you'll owe capital gains tax on that appreciation when you eventually sell.
States Without Inheritance or Estate Taxes
If you live in (or the deceased lived in) one of these states, you likely won't owe state-level taxes on your inheritance:
Alabama, Alaska, Arizona, Arkansas, California, Colorado, Delaware, Florida, Georgia, Idaho, Indiana, Kansas, Louisiana, Michigan, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia, Wisconsin, Wyoming.
Planning Tips to Minimize Taxes
If you inherited an IRA: Work with a CPA to create a 10-year withdrawal strategy that minimizes your tax burden.
If you inherited property: Consider your timeline for selling. If you plan to sell, doing it sooner rather than later minimizes capital gains (due to the step-up in basis). If you plan to keep it, understand that future appreciation will be taxable when you eventually sell.
If you're considering gifting to others: Be aware of gift tax rules. You can give up to $18,000 per person per year (2024 limit) without triggering gift tax reporting.
If the inheritance is large: Consult with an estate planning attorney and CPA. There may be strategies to minimize taxes on future growth, protect assets from creditors, or structure distributions to heirs in a tax-efficient way.
The Bottom Line
Most people don't owe income taxes on the inheritance itself. But they might owe:
- State estate or inheritance taxes (depending on where they live)
- Income taxes on distributions from inherited retirement accounts
- Capital gains taxes when they sell inherited property
The key is understanding what you inherited, how it's taxed, and planning accordingly so you don't get hit with unexpected tax bills later.
We help clients navigate these exact situations, coordinating with CPAs and estate attorneys to minimize taxes and maximize the value of what they've inherited.
This material is for educational purposes only and should not be considered tax or legal advice. Inheritance tax laws vary by state and are subject to change. Federal estate tax exemptions are scheduled to decrease in 2026 unless Congress acts. Consult with a qualified CPA and estate planning attorney regarding your specific situation.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Great Valley Advisor Group, a registered investment advisor and separate entity from LPL Financial.
Chesapeake Financial Planners | 2402 Scotlon Ct, Forest Hill, MD 21050 | (410) 652-7868 | www.chesapeakefp.com
