Is your inheritance taxable? Usually not, with exceptions.

By Tresp, Day & Associates · July 12, 2022

“Will I owe tax on what I inherit?” is one of the first questions heirs ask. The general answer is comforting, but the exceptions matter, and missing them can create an unexpected bill.

The general rule: no income tax

Money or property you inherit is not treated as taxable income at the federal level. Inherit a house, a bank account, or investments, and you don’t report the value as income. Most inherited assets also receive a “stepped-up” cost basis to their value at the date of death, which can significantly reduce capital-gains tax if you later sell.

The key exception: retirement accounts

Inherited traditional retirement accounts are different. Because the money was never taxed going in, withdrawals from an inherited traditional IRA or 401(k) are taxed as ordinary income to you, and current rules generally require the account to be drawn down within about ten years. Careful planning around inherited retirement accounts can meaningfully reduce the tax hit.

Estate tax vs. inheritance tax

Federal estate tax, if any, is paid by the estate before assets are distributed, not by the heirs. A handful of states impose a separate inheritance tax; California does not. Because the details depend on the assets and the state, coordinate with your advisors. Tresp, Day & Associates helps families plan transfers with taxes in mind. This is general information, not tax advice.