Understanding the Tax Rules of Inheritance: What Beneficiaries Need to Know
- Aaron Engleman, Two Teachers' Tax Service
- Dec 5, 2025
- 4 min read
Updated: Dec 8, 2025
Inheriting money or property from a loved one can provide meaningful financial support, but it also comes with important tax considerations. While most Americans will never face federal inheritance or estate taxes thanks to very high exemption limits, the tax impact depends largely on what type of asset is inherited. Understanding how different inherited assets are taxed—especially IRAs, investment accounts, and real estate—can help beneficiaries make informed, strategic financial decisions.
This guide breaks down the taxability of inherited IRAs, how the “step-up in basis” works, which inherited assets are not taxable, and what to consider when planning the next steps.
Inherited Traditional IRAs: What Gets Taxed?
A traditional IRA is funded with pre-tax dollars, meaning taxes were never paid on the contributions. Because of this, when a beneficiary inherits a traditional IRA, the IRS requires income tax to be paid on the distributions received.
Spousal Beneficiaries
A surviving spouse has the greatest flexibility. They may:
Roll the inherited IRA into their own IRA
Treat the account as their own
This generally allows the spouse to delay taking distributions until they reach the required minimum distribution (RMD) age, offering more time for tax-efficient planning.
Non-Spouse Beneficiaries After 2019
The SECURE Act significantly changed the rules. Most non-spouse beneficiaries who inherit a traditional IRA after 2019 must withdraw the entire account within 10 years of the original owner’s death. These withdrawals are taxed as ordinary income, and taking a large distribution in a single year may push the beneficiary into a higher tax bracket.
Non-Spouse Beneficiaries Before 2020
Those who inherited a traditional IRA before 2020 may still be eligible for “stretch IRA” treatment, allowing distributions to be taken over their life expectancy.
Inherited Roth IRAs: Tax-Free Benefits
Roth IRAs operate differently because contributions were made with after-tax dollars. As a result, most inherited Roth IRA withdrawals are tax-free.
Spousal Beneficiaries
A spouse can treat the Roth IRA as their own, and qualified withdrawals remain completely tax-free.
Non-Spouse Beneficiaries
Non-spouses are also subject to the 10-year rule. However:
Distributions are generally tax-free
The account must have been open for at least five years for tax-free treatment
This makes inherited Roth IRAs one of the most tax-advantaged assets for beneficiaries.
The “Step-Up in Basis”: A Major Tax Advantage
One of the most important tax provisions for heirs is the step-up in basis. This rule applies to inherited assets such as real estate, stocks, and other investments that have increased in value.
How the Step-Up Works
When an asset is inherited:
Its cost basis resets to its fair market value (FMV) on the date of death
All appreciation during the original owner’s lifetime is effectively erased for tax purposes
The beneficiary only pays capital gains tax on growth that occurs after inheriting the asset.
Example
Original purchase price: $50,000
Value at death: $200,000 (new cost basis)
Sold immediately for $200,000 → No capital gains tax
Sold later for $220,000 → Only $20,000 is taxable
This provision can save heirs substantial amounts in taxes.
What Is Not Taxed When Inherited?
While some inherited assets trigger taxes when sold or withdrawn, several are not taxable at the moment of inheritance:
✔ Cash and Property
Cash, personal property, and real estate are not considered taxable income when inherited at the federal level.
✔ Life Insurance Proceeds
A lump-sum death benefit paid to a named beneficiary is typically not taxable. However, investment growth or interest paid over time is taxable.
✔ Most Estates Avoid Federal Estate Tax
In 2025, the federal estate tax exemption is $13.99 million per individual and $27.98 million for married couples, meaning very few estates owe federal estate taxes.
✔ Spousal Transfers
The unlimited marital deduction allows U.S. citizens to inherit unlimited amounts from a spouse tax-free.
Estate Tax vs. Inheritance Tax: Know the Difference
Although people often use the terms interchangeably, estate tax and inheritance tax operate differently.
Estate Tax (Federal)
Paid by the estate before assets are distributed
Affects only very large estates due to high exemption limits
Inheritance Tax (State-Level)
Paid by the beneficiary after receiving inherited assets
As of 2025, only five states impose this tax: Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania
Many of these states exempt spouses and other close relatives
Beneficiaries should check the rules for their specific state.
Smart Strategies for Managing an Inheritance
Receiving an inheritance is both a financial and emotional experience. Proper planning can help avoid costly mistakes.
✔ Plan IRA Withdrawals Wisely
Spreading traditional IRA withdrawals across the 10-year period may reduce annual taxable income and prevent bracket increases.
✔ Consider Timing When Selling Stepped-Up Assets
Holding inherited real estate or investments may allow additional appreciation, but any post-inheritance gains are taxable.
✔ Review State Laws
If the deceased or beneficiary lived in a state with inheritance or estate tax, rules may vary.
✔ Consult a Professional
A tax professional or financial advisor can help navigate tax rules and maximize the long-term benefits of inherited assets.
Final Thoughts
Understanding the tax rules surrounding inherited assets is essential to making informed decisions and protecting your financial future. Whether dealing with IRAs, investment accounts, or real estate, beneficiaries can benefit greatly from knowing how inheritance taxes work—and when they don’t apply.
With careful planning and professional guidance, you can ensure that what you’ve inherited is managed wisely and tax-efficiently. We're here to assist you! At Two Teachers’ Tax Service, we’re committed to guiding you through every stage of the process.
Two Teachers’ Tax Service
269-449-8277
Comments