What Inherited Assets Are Not Taxable?

Most inherited assets are not directly taxed as income to the beneficiary at the federal level upon receipt. While the inheritance itself generally isn't considered taxable income for the individual receiving it, the estate of the deceased may be subject to federal estate taxes, and a handful of states levy their own inheritance taxes. Additionally, certain assets, like stocks, could incur capital gains taxes when you decide to sell them.

Understanding Inheritance Taxation

It's crucial to distinguish between different types of taxes that may apply to inherited wealth. The question "What inherited assets are not taxable?" primarily refers to assets that are not taxed as income to the beneficiary. Taxes related to an inheritance typically fall into two main categories:

• Estate Tax: This is a tax on the right to transfer property at death. It's paid by the deceased's estate before assets are distributed to beneficiaries. Federal estate tax applies only to very large estates, with a high exemption threshold.
• Inheritance Tax: This is a tax on the right to receive property from a deceased person. It's paid by the beneficiary receiving the assets and is imposed by a limited number of states, not the federal government.

Common Inherited Assets Generally Not Taxed as Income

The vast majority of assets you inherit will not be considered taxable income for you, the beneficiary. This means you won't report their value on your income tax return simply because you received them.

Let's look at common examples:

• Cash and Bank Accounts: Inherited cash, whether from bank accounts, Certificates of Deposit (CDs), or other liquid assets, is generally not taxable income to the beneficiary. This holds true unless the estate's total value exceeds the applicable federal estate tax exemption or if a state-specific inheritance tax applies to the amount received.
• Stocks, Bonds, and Mutual Funds: Inherited securities like stocks, bonds, and mutual funds are also typically not taxed as income when you receive them. However, they can become subject to capital gains tax if you sell them later for a profit. The "stepped-up basis" rule usually applies, which means your cost basis for these assets is reset to their fair market value on the date of the original owner's death. This often helps minimize or eliminate capital gains tax if you sell them shortly after inheriting.
• Real Estate: Inherited real estate, such as a home, land, or commercial property, is generally not taxed as income to the beneficiary. Similar to securities, the property usually receives a stepped-up basis, resetting its value for capital gains purposes to the fair market value at the time of the original owner's death.
• Tangible Personal Property: Items like jewelry, art, collectibles, vehicles, furniture, and other personal belongings are typically not taxed as income when inherited. Their value is generally considered part of the overall estate for estate tax purposes, but the beneficiary does not pay income tax on receiving them.
• Life Insurance Proceeds: The death benefit from a life insurance policy, when paid to a named beneficiary, is almost always received tax-free. This is one of the most common ways to transfer wealth without income tax implications for the recipient.

Assets That May Have Tax Implications

While the focus is on non-taxable assets, it's important to be aware of common exceptions that do carry tax implications, as this helps clarify the "not taxable" category.

• Inherited Retirement Accounts (IRAs, 401(k)s): Unlike other assets, inherited pre-tax retirement accounts are generally taxable as income when withdrawals are made by the beneficiary. The specific rules depend on the type of account and the beneficiary's relationship to the deceased (e.g., spouse vs. non-spouse beneficiary).
• Rental Income from Inherited Property: If you inherit a property and decide to rent it out, any rental income you earn after the inheritance date will be subject to ordinary income tax.
• Interest/Dividends Accrued Post-Death: While the inherited principal of cash or investments is not taxed, any interest, dividends, or other income generated by those assets after the original owner's death will be taxable to you as income.

Key Considerations for Inherited Assets

Understanding the nuances of inheritance tax can help you navigate the process more smoothly.

• Stepped-Up Basis: This is a significant advantage for inherited assets. For most assets like stocks and real estate, the cost basis is "stepped up" to their fair market value on the date of the decedent's death. This means if you sell the asset for more than this stepped-up value, you'll only pay capital gains tax on the appreciation since the death, not the appreciation from when the original owner purchased it.
• Federal Estate Tax Exemption: For federal purposes, the vast majority of estates do not owe estate tax due to a very high exemption amount (which is adjusted annually for inflation). This means only estates with values exceeding this significant threshold are subject to federal estate tax.
• State-Specific Laws: A few states impose their own estate taxes or inheritance taxes. It's crucial to check the laws of the state where the deceased lived and where the assets are located, as these can impact the taxability of your inheritance.

Overview of Inherited Assets and Tax Treatment

In summary, while the estate of the deceased might face taxes, most inherited assets are not considered taxable income for the beneficiary who receives them.