Does Inheritance Count as Income: Rules and Exceptions

Receiving an inheritance can come with an immediate question: How much of it will you actually get to keep after taxes? The good news is that inherited cash and property generally don’t count as federal taxable income when you receive them. But taxes can still surface later, particularly with inherited investments, real estate and retirement accounts. Understanding when an inheritance becomes taxable can help you avoid surprises before you spend, sell or withdraw the assets.

A financial advisor can help you decide how to best invest your inheritance, or prepare for the potential tax consequences.

Does an Inheritance Count as Taxable Income?

In most cases, receiving an inheritance does not create federal taxable income for the beneficiary. If you inherit $100,000 in cash, for example, you generally do not report that $100,000 as income on your federal income tax return simply because you received it. The same general exclusion applies to many other forms of inherited property, including stocks, bonds and real estate.

A key distinction is between receiving an inherited asset and earning income from it afterward. While the asset itself may not be taxable income, interest, dividends, rent and other earnings it produces after you inherit it can generally be taxable. Selling inherited property for more than its applicable tax basis can also result in a taxable capital gain.

The type of property inherited can also affect future taxes. A traditional IRA, for example, generally isn’t treated as taxable income when the beneficiary takes ownership of the account. However, taxable distributions from that account may be subject to ordinary income tax. Inherited investments and real estate can follow different rules, including potential adjustments to their cost basis. Because of this, identifying exactly what was inherited is an important step in determining the potential tax consequences.

What About Estate and Inheritance Taxes?

Federal estate tax is separate from federal income tax. When applicable, the deceased person’s estate, rather than the individual beneficiary, typically pays it. Because the federal estate tax exemption is relatively high, many estates will not owe federal estate tax. That said, exemption amounts and other rules can change over time.

State-level taxes add another consideration. Some states impose estate taxes, inheritance taxes or both. An inheritance tax generally applies to a beneficiary receiving property. The amount owed may depend on factors like the value inherited and the beneficiary’s relationship to the deceased. As a result, an inheritance that creates no federal income tax liability could still have state tax consequences.

When an Inheritance Can Create Taxable Income

Although receiving an asset may not generate taxable income, subsequent earnings on it can. Interest on inherited cash, dividends from stocks, rental income from real estate and capital gains from selling investments may all create tax liabilities.

Inherited traditional IRAs and other tax-deferred retirement accounts generally receive different treatment. Beneficiaries may owe ordinary income tax when taking taxable distributions, with withdrawal requirements depending partly on the beneficiary’s relationship to the original account owner, among other factors.

Click Your State to Get Matched With Financial Advisors That Serve Your Area

Choose your state and answer some questions to get matched with up to three fiduciary advisors that serve your area.

How Different Inherited Assets Are Taxed

Consider four beneficiaries who each inherit assets worth $100,000. Their potential tax consequences could look very different.

Inherited Asset	Taxable When Received?	What Could Trigger Tax Later?
$100,000 in cash	Generally no	Interest earned after inheritance
$100,000 in investments	Generally no	Dividends or gains when sold
$100,000 in real estate	Generally no	Rent or gain from a later sale
$100,000 in a traditional IRA	Generally no	Taxable distributions

As you can se, two people can inherit the same dollar amount yet face substantially different future tax bills. The type of asset, its cost basis, any subsequent earnings and how or when it is sold or withdrawn can all affect taxation.

How Cost Basis Can Affect Taxes on Inherited Property

Many eligible inherited investments and property generally receive a basis adjustment to fair market value as of the owner’s date of death. If inherited stock is valued at $100,000 at death and later sells for $110,000, the beneficiary may have a $10,000 capital gain, rather than a gain calculated using the deceased owner’s original purchase price.

Not every inherited asset qualifies for this treatment. Traditional retirement accounts, for example, don’t receive the same stepped-up basis treatment. Instead, taxable distributions generally remain subject to ordinary income tax.

What to Do Before Using or Selling an Inheritance

Before selling, withdrawing or spending inherited assets, it’s useful to determine exactly what you received and how each asset is taxed. Cash, taxable investments, real estate and retirement accounts can have very different tax consequences. Gathering account statements, estate documents and valuation records can help establish the information necessary to make informed decisions.

For inherited stocks, funds or real estate, determining the applicable cost basis is particularly important. Eligible inherited assets generally receive a basis adjustment to their fair market value at the previous owner’s death, although exceptions apply. Knowing that value can help you estimate whether selling an asset will produce a capital gain or loss and how large it may be.

Inherited retirement accounts require additional planning because withdrawals can create taxable income. Taking a large distribution from an inherited traditional IRA, for example, could increase taxable income for that year and potentially affect other parts of your tax situation. Beneficiaries may also face specific distribution deadlines and requirements. As such, understanding the rules that apply to the account before withdrawing money is important.

Taxes aren’t the only consideration. An inheritance can significantly change your investment allocation, cash reserves and progress toward goals, such as retirement, buying a home or paying down debt. Before making a major purchase or immediately selling inherited investments, consider how the new assets fit with your existing portfolio and financial plan.

A financial advisor can help evaluate inherited assets as part of a broader investment and tax strategy. This could include deciding which assets to keep or sell, coordinating retirement-account distributions and planning around potential capital gains. At the same time, they’ll take into account how the inheritance may affect long-term financial goals.

Bottom Line

An inheritance generally does not count as federal taxable income when you receive it, but that does not mean it is entirely tax-free. Inherited investments, real estate and retirement accounts can generate taxes through interest, dividends, rent, capital gains or taxable distributions. Additionally, cost basis rules can influence how much you owe when selling certain assets. Understanding the tax treatment of each asset before selling, withdrawing or spending it can help you avoid unexpected tax consequences and make the inheritance part of a broader financial plan.

Tips for Tax Planning

A financial advisor can help you plan out your retirement taxes, or prepare for big life events such as receiving an inheritance. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Consider using an income tax calculator if you’re not sure how you’re tracking for what you might owe in tax next year.