Most inheritances are not taxed at the federal level, but the rules depend on what you inherit and where you live

The federal government does not tax money or property you receive as an inheritance. The person who died may have owed estate taxes before the money reached you, but once it is in your hands, you do not report it as income on your federal tax return. However, some inheritances do trigger taxes later — not on the inheritance itself, but on the income it generates after you receive it. A few states also tax inheritances directly, and inherited retirement accounts have their own rules.

The confusion usually comes from mixing up two different things: the transfer of the inheritance (which is usually tax-free) and the income that inheritance produces (which is usually taxable). Understanding which applies to you depends on what you inherited and what you do with it.

Key Takeaways

  • Federal law does not tax inheritances themselves — money or property you receive from someone's estate is not reported as income.
  • You do pay taxes on income generated by inherited assets after you receive them, such as interest, dividends, or rent from inherited property.
  • Inherited retirement accounts like IRAs and 401(k)s have mandatory withdrawal rules that create taxable income, and the timeline depends on your relationship to the person who died.
  • Six states (Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania) tax inheritances directly, though rates and exemptions vary by state and by your relationship to the deceased.
  • Inherited property receives a "step-up" in basis, meaning you owe capital gains tax only on increases in value after you inherited it, not on gains that happened before.

Income from inherited money and property is taxable

Once you own an inherited asset, any income it produces is taxable. If you inherit $50,000 in cash and put it in a savings account, the interest you earn is taxable income. If you inherit rental property, the rent is taxable income. If you inherit stocks or bonds, the dividends are taxable income. This is true whether you inherit from a relative, a friend, or anyone else.

You report this income on your federal tax return the same way you would report income from any other source. Interest goes on Schedule B, dividends on Schedule B or Schedule 1, rental income on Schedule E. The inheritance itself never appears on your return — only the money it makes after you own it.

State income tax rules vary. Most states tax investment income the same way the federal government does. A few states have no income tax at all. Check your state's tax authority website if you are unsure whether your state taxes the type of income your inheritance generates.

Inherited retirement accounts have mandatory withdrawal rules

Inherited IRAs and 401(k)s are different. You cannot straightforward leave the money there untouched. The IRS requires you to withdraw money on a schedule, and those withdrawals are taxable income. The timeline and amount depend on your relationship to the person who died and when they died.

If you inherited an IRA or 401(k) from a spouse, you have the most flexibility — you can roll it into your own retirement account and follow your own withdrawal rules. If you inherited from a non-spouse (a parent, sibling, friend, or anyone else), the rules are stricter. For accounts inherited after 2019, you generally must withdraw all the money within 10 years. The exact schedule depends on whether the account owner had already started taking required distributions before they died.

Each withdrawal is taxable as ordinary income in the year you take it. If you inherit a $200,000 IRA and must empty it over 10 years, you will owe income tax on whatever portion you withdraw each year. The tax bill can be substantial, so many people work with a tax professional or financial advisor to plan the withdrawal schedule in a way that spreads the tax burden across years.

Six states tax inheritances directly

Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania tax inheritances at the state level. The tax is paid by the person who inherits, not by the estate. The rate and what is exempt depend on your relationship to the person who died.

In most of these states, spouses and children are exempt or taxed at a lower rate than more distant relatives or unrelated people. For example, New Jersey taxes inheritances from parents or grandparents at 11 to 16 percent, but inheritances from unrelated people at 15 to 16 percent. Kentucky exempts spouses, children, and grandchildren entirely but taxes other heirs. The rules are specific to each state and change occasionally, so if you live in one of these states or inherited from someone who did, contact that state's tax authority or a tax professional for the current rates and exemptions.

If you live in a state that does not tax inheritances but inherited from someone in a state that does, you generally do not owe the inheritance tax. The tax is based on where the person who died lived or where the property is located, not where you live.

The step-up in basis reduces capital gains tax on inherited property

When you inherit property — real estate, stocks, a business, or anything else with a value that can change — you get a tax advantage called a step-up in basis. This means the IRS treats the value of the property on the date of death as your starting point for calculating capital gains tax.

Here is how it works: Suppose someone bought stock for $10,000 thirty years ago and it is worth $100,000 when they die. You inherit it. You do not owe capital gains tax on the $90,000 gain that happened before you inherited it. Your basis is stepped up to $100,000. If you sell it when ready for $100,000, you owe no capital gains tax. If you hold it and sell it later for $110,000, you owe capital gains tax only on the $10,000 gain that happened after you inherited it.

This step-up applies to all inherited property at the federal level. Some states do not recognize it, so check your state's rules if you inherited property and plan to sell it. The step-up is one reason inherited assets can be more tax-efficient than assets you have held for a long time.

Inherited property you sell may trigger capital gains tax

If you inherit property and sell it, you may owe capital gains tax on the increase in value between the date you inherited it and the date you sold it. The step-up in basis means you do not owe tax on increases that happened before you inherited it, only on increases after.

Long-term capital gains rates (for property held more than one year) are lower than short-term rates (for property held one year or less). If you inherit property worth $100,000 and sell it three months later for $105,000, you owe short-term capital gains tax on the $5,000 gain. If you hold it for over a year before selling, you owe long-term capital gains tax, which is usually lower.

This applies to real estate, stocks, vehicles, collectibles, and any other property with a measurable value. If you inherit cash, there is no capital gains tax — cash does not appreciate or depreciate. If you inherit a home and live in it, you may be able to exclude up to $250,000 of gain (or $500,000 if you are married) under the primary residence exclusion, but the rules are specific and depend on how long you owned and lived in the home.

Inherited life insurance proceeds are usually not taxable

If you are the beneficiary of a life insurance policy, the death benefit you receive is not taxable income at the federal level. You do not report it on your tax return. This is true whether the policy was on a relative, a friend, or a business partner.

However, if the policy earns interest while it sits in the insurance company's account before you claim it, that interest is taxable. If you inherit a policy and choose to receive the payout in installments rather than a lump sum, the interest portion of each payment is taxable. The insurance company will tell you how much of each payment is the death benefit (not taxable) and how much is interest (taxable).

Some states tax life insurance proceeds, though this is rare. Check your state's rules if you live in an unusual situation, such as inheriting a policy from a non-relative or receiving a very large payout.

When to talk to a tax professional about your inheritance

You do not need professional help for a straightforward inheritance of cash or personal items. But if you inherited a retirement account, rental property, a business, significant investments, or property in a state that taxes inheritances, a tax professional can help you understand what you owe and when. They can also help you plan withdrawals from inherited retirement accounts in a way that minimizes your tax bill across multiple years.

If you are unsure whether something you inherited will trigger taxes, the cost of one consultation with a CPA or tax attorney is usually far less than the cost of owing taxes you did not expect. Many tax professionals offer free initial consultations.

Frequently Asked Questions

Do I have to report an inheritance on my tax return?

No. The inheritance itself does not go on your federal tax return. You only report income that the inheritance generates after you receive it — interest, dividends, rent, or withdrawals from retirement accounts.

What if I inherit money from outside the United States?

Money is money. If you inherit funds from abroad, you do not owe federal tax on the transfer itself. However, you do owe tax on any income the money generates after you receive it, the same as with any other inheritance. If the country where the money came from taxes inheritances, you may owe tax there, but that is between you and that country's tax authority.

Can I avoid taxes by inheriting property instead of cash?

Not entirely, but inherited property can be more tax-efficient. You get a step-up in basis, so you do not owe capital gains tax on increases in value before you inherited it. However, you do owe capital gains tax on increases after you inherit it, and you owe income tax on any income the property generates (rent, dividends, interest).

Do I owe taxes if I inherit from someone who did not live in the United States?

The federal government does not tax inheritances based on where the person lived. However, some countries tax inheritances, and some U.S. states do. If you inherited from someone who lived abroad, check whether that country taxes inheritances and whether you live in one of the six U.S. states that do.

What happens if I inherit a retirement account and do not take the required withdrawals?

The IRS charges a penalty equal to 25 percent of the amount you should have withdrawn but did not. This penalty can be reduced to 10 percent if you correct the mistake within two years. If you inherited a retirement account and are unsure about the withdrawal rules, contact the financial institution holding the account or speak with a tax professional.