You’ve probably become accustomed to paying taxes on your regular income, so it seems only natural that you’d need to pay taxes when receiving money or assets from an inheritance. The good news is that the estate giving the inheritance takes care of certain taxes, such as estate tax – not the recipient. Other taxes come into play though and it begs the question: how much inheritance is tax-free? Depending on what you do with the cash or property, an inheritance may incur certain taxes, regardless of the amount you receive.
Understanding Inheritance and Tax
When asking how much can you inherit without paying taxes, it’s comforting to know that the IRS does not consider an inheritance of any amount as income. This means you don’t need to include it on your regular tax return or pay any income taxes on the money or assets.
States also give you a free pass when it comes to income tax; while a handful of states require you to file an inheritance tax return, you won’t need to include an inheritance on your state income tax return. Rest assured that, regardless of the size of your inheritance, you may owe other types of tax, but you won’t owe any income tax.
Selling an Inheritance Property
If you inherit property such as real estate or stocks held outside of a tax-deferred account, the original cost basis of the asset is stepped-up, or adjusted, to current market value at the date of the original owner’s death. When you decide to sell your inherited assets and liquidate some or all of your new-found wealth, you’ll incur a tax liability on any capital gains, meaning the difference between the new, stepped-up basis and the sale price of your asset.
Inheritance and Property Acquisitions
For an inherited home, you won’t meet the requirements for the $250,000 capital gains exclusion unless you live in the property for two years after inheriting. However, since the property value is stepped-up to current fair market value, this minimizes your potential tax liability and proceeds over market value if you choose to sell the property right after you inherit.
After receiving your inheritance, you might choose to hold onto the property to get some appreciation in its value over time, although you could owe more in taxes upon selling if you go this route. For example, say your inherited home has increased in value over its stepped-up cost basis because the real estate market has improved.
Once you sell the home, you’ll pay capital gains tax on this appreciation. The same applies to your inherited stock portfolio; you’ll pay capital gains tax on the growth in value once you sell the shares.
Inheritance and Retirement Accounts
If you’ve inherited a 401(k) or traditional IRA account, when you take a distribution from either of these, you will incur a tax liability on the distribution amount. The IRS does recognize these distributions as taxable income, so you’ll need to include them on your regular tax return. Neither of these tax-deferred accounts receive the step-up basis treatment, and you may need to start taking the account’s required minimum distribution (RMD) each year.
If the original account owner had reached age 70 1/2 before death, the start date for you to take the required minimum distribution is based not on your retirement age, but the retirement age of the deceased, with the RMD amounts based on the longer of your life expectancy or the original owner's remaining life expectancy.
The estate of the deceased person itself is eligible for federal taxes if it is worth above a certain level, which is $11,580,000 in the 2020 tax year. This is what's known as estate tax or, informally, as the death tax.
State Taxes Around Inheritance
Although state governments do not count inherited money or property as income, a handful of states have inheritance and estate tax laws. You may have a tax liability to pay if you live in one of the few states that have these taxes in place.
Six states currently have an inheritance tax, while 14 impose an estate tax. Two states, Maryland and New Jersey, have both taxes. Estate taxes are paid by the estate of the deceased, while inheritance taxes are paid by the heirs.
- Nolo: If You Inherit a Home Do You Qualify for the $250,000/$500,000 Home Sale Tax Exclusion?
- IRS: Retirement Plan and IRA Required Minimum Distributions FAQs
- Tax Foundation: Does Your State Have an Estate or Inheritance Tax?
- Vanguard: RMD Rules for Inherited IRAs
- IRS: Estate Tax
- IRS. "Gifts & Inheritances." Accessed Feb. 6, 2020.
- IRS. "Topic No. 409 Capital Gains and Losses." Accessed Feb. 6, 2020.
- IRS. "Estate Tax." Accessed Feb. 6, 2020.
- IRS. "Frequently Asked Questions on Gift Taxes." Accessed Feb. 6, 2020.
- Tax Foundation. "Does Your State Have an Estate or Inheritance Tax?" Accessed Feb. 6, 2020.
- Nebraska Department of Revenue. "Chapter 17 - Inheritance Tax." Accessed Feb. 6, 2020.
- Pennsylvania Department of Revenue. "Inheritance Tax." Accessed Feb. 6, 2020.
- IRS. "Retirement Topics - Beneficiary." Accessed Feb. 6, 2020.
- IRS. "Capital Gains and Losses." Accessed Feb. 6, 2020.
- Congressional Research Service. "Capital Gains Tax Options: Behavioral Responses and Revenues," Page 2. Accessed Feb. 6, 2020.
- Oregon Department of Revenue. "Estate and Transfer Taxes." Accessed Feb. 6, 2020.
Cynthia Gaffney has spent over 20 years in finance with experience in valuation, corporate financial planning, mergers & acquisitions consulting and small business ownership. She has worked as a financial writer for online finance publications since 2011, including eHow Money, The Motley Fool, and Sapling.com. She has also edited for several online finance publications, including The Balance, Opposing Views:Money, Synonym:Money, and Zacks.com. A Southern California native, Cynthia received her Bachelor of Science degree in finance and business economics from USC.