Taxes on Inheritance: What Heirs Actually Owe
Inheritance Tax and Estate Tax Are Not the Same Thing
The two get used interchangeably in conversation, and the difference decides who writes the check. Taxes on inheritance come in both shapes, and they are structurally different.
An estate tax is imposed on the estate before anything is distributed. The executor computes it, the estate pays it, and the beneficiaries receive whatever survives. The federal government imposes one. Twelve states and the District of Columbia impose their own.
An inheritance tax is imposed on the person who receives. The rate depends on the relationship between the decedent and the beneficiary, a child pays one rate, a sibling pays a higher one, a friend pays the highest, and it is the beneficiary’s liability even when the executor writes the check. There is no federal inheritance tax and never has been. Five states impose one.
The distinction matters for two reasons. First, an estate can be too small for any estate tax and still generate an inheritance tax bill, because most inheritance tax regimes have tiny exemptions for non-relatives. Second, the state that matters for inheritance tax is generally where the decedent lived or where the real property sits, not where the heir lives. A nephew in Los Angeles who inherits from an aunt in Harrisburg pays Pennsylvania inheritance tax on the transfer.
Then there is income tax, which is the one people forget. Inherited property is not income under IRC Section 102, but income the property generates after death is, and a few kinds of inherited assets carry income tax with them by design. That is where most real bills come from.
The Federal Rule: An Estate Tax, and Most Estates Never File
The federal estate tax applies to the taxable estate of a decedent who was a United States citizen or resident, reported on Form 706, due nine months after the date of death with a six-month extension available on Form 4768. The top rate is 40 percent.
What keeps almost everyone out is the basic exclusion amount. Legislation enacted in July 2025 set the exclusion at $15 million per person for decedents dying in 2026, indexed for inflation in later years. Confirm the current figure on the IRS estate tax page before relying on it. This number has changed repeatedly and will change again.
Two more provisions shrink the taxable base before the exclusion even applies. The unlimited marital deduction under Section 2056 lets a citizen spouse inherit any amount free of estate tax. The charitable deduction under Section 2055 does the same for qualified charities. A married couple with careful planning can therefore pass roughly twice the individual exclusion.
That doubling is not automatic. Portability, the ability of a surviving spouse to use the deceased spouse’s unused exclusion, requires the executor to file a Form 706 for the first spouse to die, even when no tax is owed and no filing would otherwise be required. Estates that were not required to file for any other reason generally have five years from the date of death to make a simplified late portability election under the applicable revenue procedure. Missing it is the most expensive clerical error in estate administration: a surviving spouse can lose eight figures of exclusion because nobody filed a return for an estate that owed nothing.
Gifts interact with all of this. The estate tax and the gift tax share one lifetime exclusion, so lifetime taxable gifts reported on Form 709 reduce what remains at death. Gifts within the annual exclusion, $19,000 per recipient in 2025, adjusted periodically, do not count against it and do not require a return.
The Five States That Tax the Heir
Five states currently impose an inheritance tax. Iowa completed its phase-out, and the tax no longer applies to deaths on or after January 1, 2025.
| State | Who is exempt | Rates on everyone else |
|---|---|---|
| Pennsylvania | Surviving spouse; a parent inheriting from a child aged 21 or under | 4.5% to lineal descendants, 12% to siblings, 15% to all others |
| New Jersey | Class A: spouse, children, grandchildren, parents, grandparents | 11% to 16% for siblings and children-in-law above a $25,000 exemption; 15% to 16% for everyone else |
| Kentucky | Class A: spouse, children, grandchildren, parents, siblings | 4% to 16% for Class B above a $1,000 exemption; 6% to 16% for Class C above $500 |
| Maryland | Spouse, children and other lineal relatives, parents, grandparents, siblings | 10% on transfers to everyone else |
| Nebraska | Surviving spouse; beneficiaries under age 22 | 1% to immediate relatives above $100,000; 11% to remote relatives above $40,000; 15% to others above $25,000 |
Read the exempt column carefully, because that is where the money is. In every one of these states, spouses and children are exempt or nearly so. The tax falls on siblings, nieces and nephews, cousins, unmarried partners, and friends. A Pennsylvania resident who leaves a $600,000 estate to her brother generates $72,000 of Pennsylvania inheritance tax. The same estate left to her daughter generates $27,000. The same estate left to her husband generates nothing.
Maryland is the only state that imposes both an inheritance tax and an estate tax. New Jersey repealed its estate tax for deaths on or after January 1, 2018 but kept the inheritance tax. Nebraska’s version is collected at the county level rather than by the state.
States That Tax the Estate, and New York’s Cliff
Twelve states plus the District of Columbia impose a separate estate tax: Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. Their exclusions run far below the federal one. Oregon’s is $1 million and Massachusetts’s is $2 million, which means a paid-off house and a retirement account can produce a state estate tax return in either state. Connecticut is the only state with its own gift tax.
New York deserves its own paragraph because of how the exclusion phases out. The state exclusion sits just above $7 million and is indexed annually. The figure for deaths in 2025 was $7,160,000, and the current-year amount is published by the New York State Department of Taxation and Finance. Estates above the threshold file Form ET-706 within nine months of death.
Here is the part that surprises people. New York does not phase the exclusion out gradually. An estate up to the basic exclusion amount pays nothing. An estate between 100 and 105 percent of that amount loses the exclusion proportionally. An estate above 105 percent loses the entire exclusion and is taxed on the whole amount from the first dollar. Practitioners call it the cliff, and the effective marginal rate inside that narrow band exceeds 100 percent. An extra dollar of assets can cost far more than a dollar of tax.
New York also adds back certain taxable gifts made within three years of death when computing the New York gross estate. The provision has been amended and extended more than once, so check the current statute rather than an old summary.
Residency is the fight that produces the biggest numbers. New York taxes the estate of a domiciliary on everything, and the estate of a nonresident on real and tangible property located in the state. A retiree who moves to Florida but keeps the Manhattan apartment, the New York doctors, and the New York voter registration is a target for a domicile audit, and the audit happens after the person is gone and cannot explain anything.
Stepped-Up Basis Under IRC 1014
This is the provision that makes most inheritances tax-free in practice, and it is the one heirs most often misunderstand.
Under IRC Section 1014, the basis of property acquired from a decedent is its fair market value on the date of death. Whatever the decedent paid disappears. A brownstone bought in 1974 for $58,000 and worth $2,400,000 on the date of death has a basis of $2,400,000 in the heir’s hands. Sell it the following month for $2,400,000 and the taxable gain is zero. The lifetime of appreciation is never taxed to anyone.
Several details ride along with the rule. The executor may elect the alternate valuation date under Section 2032, six months after death, but only if the election decreases both the value of the gross estate and the estate tax due, which means it is unavailable to an estate that owes no tax. Under Section 1223(9), inherited property is automatically treated as held long-term regardless of how briefly the heir owns it, so a sale two weeks after death still gets long-term capital gain rates. In the nine community property states, Section 1014(b)(6) steps up both halves of community property when the first spouse dies, not just the decedent’s half, a significant advantage over joint tenancy in a common law state.
Two limits deserve attention. Section 1014(e) shuts down a scheme: appreciated property given to someone within one year of their death, which then passes back to the donor or the donor’s spouse, gets no step-up. And Section 1014(f), with the reporting rules in Section 6035, requires basis consistency. The value an heir uses cannot exceed the value reported on the estate tax return. When a Form 706 is required, the executor files Form 8971 with a Schedule A to each beneficiary, generally within 30 days of the earlier of the return’s due date or its actual filing.
The practical takeaway is that a date-of-death appraisal is worth paying for. An heir who sells real estate three years later and has no contemporaneous valuation is negotiating with an examiner over a number that could be worth six figures of tax.
Income in Respect of a Decedent: The Big Exception
Some assets carry income tax with them, and they get no step-up. IRC Section 691 calls these items income in respect of a decedent, income the decedent had earned but had not yet reported when they died.
The list is longer than most heirs expect. Traditional IRA and 401(k) balances, because the money was never taxed. Unpaid wages, commissions, and bonuses. Accrued but unpaid interest. Accrued interest on Series EE and Series I savings bonds where the decedent deferred it. Accounts receivable of a cash-basis business. Deferred compensation. The remaining gain on an installment sale note. Declared but unpaid dividends.
Section 1014(c) expressly denies these items a basis step-up. The heir reports the income when received, at their own marginal rate, exactly as the decedent would have. A $900,000 traditional IRA is not a $900,000 inheritance. It is a $900,000 obligation to pay income tax over some period, and for a New York City beneficiary in the top brackets the combined federal, state, and city rate can approach half.
There is a partial offset that goes unclaimed constantly. Under Section 691(c), a beneficiary who reports IRD may deduct the portion of the federal estate tax attributable to that item. The deduction survived the 2017 elimination of miscellaneous itemized deductions because Section 67(b)(7) removes it from that category. It only exists where federal estate tax was actually paid, which is rare, but when it applies it is large, and it requires information from the estate tax return that the beneficiary usually has to ask for.
Life insurance runs the other way. Death benefits are excluded from gross income under Section 101(a), so a $1,000,000 policy is $1,000,000 of after-tax money. The proceeds may still be included in the taxable estate if the decedent owned the policy, which is a different question from whether the beneficiary pays income tax on them.
Inherited IRAs and the 10-Year Rule
The SECURE Act rewrote inherited retirement accounts for deaths after December 31, 2019, and it is the single biggest change to taxes on inheritance in a generation.
The old rule let a non-spouse beneficiary stretch distributions over their own life expectancy. A 30-year-old could spread a father’s IRA across fifty years. The new rule gives most beneficiaries ten. The account has to be fully distributed by December 31 of the tenth year after the year of death, and there is no partial-year credit and no extension.
A narrow group escapes it. Eligible designated beneficiaries, a surviving spouse, a minor child of the account owner until the age of majority, a disabled or chronically ill individual, and anyone not more than ten years younger than the decedent, may still use life expectancy. A minor child’s exception ends at majority, at which point the ten-year clock starts.
Final regulations issued in 2024 settled the question that had confused everyone: whether annual distributions are required inside the ten years. The answer depends on when the owner died relative to their required beginning date. If the owner had already reached the age at which required minimum distributions begin, the beneficiary must take annual distributions in years one through nine and empty the account by year ten. If the owner died before that date, no annual distributions are required. The beneficiary can wait and take the whole thing in year ten. The IRS waived penalties for missed annual distributions in the transition years, and the requirement is fully in effect now. The IRS guidance for IRA beneficiaries is the place to check your specific facts.
Inherited Roth IRAs follow the ten-year rule too, but with no annual distributions required during the period, and qualified distributions remain tax-free. That combination, ten years of continued tax-free growth followed by a tax-free withdrawal, makes an inherited Roth the most valuable dollar in most estates.
This page is general information and not tax or legal advice. State inheritance rules, domicile, and retirement account elections turn on facts specific to your family, and some choices cannot be undone, talk to a licensed CPA and an estate attorney before you retitle an account, sell inherited property, or take a distribution.
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Frequently Asked Questions
Do you have to pay taxes on an inheritance?
For most people receiving most assets, no. Taxes on inheritance rarely start with the receipt itself, because the receipt is not taxable income. IRC Section 102 states that gross income does not include the value of property acquired by gift, bequest, devise, or inheritance. A $400,000 check from your mother’s estate does not appear on your Form 1040, does not require a schedule, and does not raise your tax bracket.
But there are four ways an inheritance produces a real tax bill, and knowing which one applies to you is the whole question.
One: the estate itself owed estate tax. This is paid by the estate before distribution, so the heir sees a smaller inheritance rather than a tax bill. The federal exclusion is high enough that a very small share of estates file Form 706 at all. State estate taxes are the more likely trigger, because state exclusions run far lower, a New York estate above roughly $7 million, a Massachusetts estate above $2 million, an Oregon estate above $1 million.
Two: you live in, or inherited from someone in, an inheritance tax state. Pennsylvania, New Jersey, Kentucky, Maryland, and Nebraska tax the beneficiary based on relationship. Spouses and children are exempt or nearly so; siblings, nieces, nephews, and unrelated beneficiaries are not.
Three: you inherited an asset that carries income tax with it. This is the category that produces most of the surprise. Section 691 items, traditional IRAs, 401(k) balances, unpaid wages, accrued savings bond interest, installment notes, a cash-basis business’s receivables, are income in respect of a decedent, and the heir pays income tax on them as they are received. There is no basis step-up for these under Section 1014(c).
Four: the property generates income or gain after you receive it. Section 102(b) is explicit that income from inherited property is taxable. Rent on an inherited building is ordinary income, reported on Schedule E, and depreciation starts over on the stepped-up value. Dividends on inherited stock are dividends. Interest on an inherited bank account is interest. And gain above the date-of-death value when you eventually sell is capital gain, always long-term no matter how briefly you held it.
Run a realistic estate. A Queens widow dies leaving three assets to her son: a house worth $890,000 that she bought in 1981 for $72,000, a brokerage account worth $410,000 with an original cost of $150,000, and a traditional IRA worth $520,000. Total value $1,820,000, comfortably below both the federal and New York estate tax thresholds, so no estate tax return is required beyond confirming that. New York has no inheritance tax, so nothing there either.
Now the income tax. The house takes a basis of $890,000 under Section 1014. If the son sells it eight months later for $915,000, his taxable gain is $25,000 minus selling costs, not $843,000. The brokerage account also steps up to $410,000, so liquidating it immediately produces almost no gain. The IRA is the different animal: it is income in respect of a decedent, there is no step-up, and the son must empty it within ten years. If he takes it evenly, that is roughly $52,000 of additional ordinary income per year for a decade, taxed at his marginal federal rate plus New York State and New York City tax. On $520,000, a combined effective rate near 40 percent means about $208,000 of tax over the ten years. The inheritance is real. So is the bill, and it comes only from one of the three assets.
The common mistake: assuming the whole inheritance is taxed, or assuming none of it is. Both errors cost money. Heirs who think everything is taxable often liquidate a stepped-up brokerage account in a panic and pay a capital gains tax they never owed. Heirs who think nothing is taxable spend an entire inherited IRA in year one, stacking a half-million dollars of ordinary income into a single tax year and pushing themselves into the top bracket plus the 3.8 percent net investment income surtax on their other income. A second mistake is retitling an inherited IRA into your own name. A non-spouse beneficiary who does that has made a taxable distribution of the entire account, and it cannot be undone.
Two smaller items catch heirs in the first year. A decedent’s final Form 1040 still has to be filed for the year of death, covering income through the date of death, and it is due on the normal April deadline of the following year. Medical expenses paid by the estate within one year of death may be elected onto that final return rather than the estate return, which sometimes produces a refund the family did not expect. And if the estate holds assets long enough to earn income during administration, the estate itself files Form 1041 and issues Schedule K-1s to beneficiaries for whatever is distributed. None of this makes the inheritance taxable. It just means paperwork exists in the year of death that did not exist before, and Publication 559 walks an executor through the sequence.
Reporting is lighter than people expect. There is no federal form for receiving an inheritance. If the estate or a trust distributes income to you during administration, you receive a Schedule K-1 from Form 1041 and report your share. If you inherit a foreign account or receive a large gift or bequest from a foreign person, separate reporting on Form 3520 applies with penalties that start high. And if the estate filed a Form 706, watch for a Schedule A from Form 8971 telling you the basis you are required to use.
Going forward, the first thing to do with any inheritance is to sort the assets into three buckets: stepped-up assets you can sell freely, income in respect of a decedent that will be taxed as you take it, and everything else. That one page determines your entire tax picture. Our tax strategy team works through that sorting with beneficiaries before anything is sold. This is general information and not advice about your inheritance; have a licensed CPA review the specific assets and your state before you act.
How much can you inherit before federal estate tax applies?
Far more than almost anyone has, and the question is slightly misframed. Federal taxes on inheritance are really a tax on the estate, not on the heir, so the threshold is measured against everything the decedent owned rather than against what any one beneficiary receives. Ten people can split a $12 million estate and pay nothing; one person can receive $500,000 from a $40 million estate that owed a great deal.
The measuring stick is the basic exclusion amount. Legislation enacted in July 2025 set it at $15 million per person for decedents dying in 2026, indexed for inflation afterward. That figure has moved repeatedly over the past decade and is politically contested, so verify the current amount on the IRS estate tax page rather than trusting any article, including this one, more than a year after it was written. The rate above the exclusion tops out at 40 percent.
Getting to the taxable estate takes several steps. Start with the gross estate, which is broader than most people assume: everything owned at death at fair market value, the decedent’s share of jointly held property, retirement accounts, life insurance the decedent owned or controlled, annuities, business interests, and certain gifts made within three years of death. Subtract debts, mortgages, funeral costs, and administration expenses. Subtract the unlimited marital deduction under Section 2056 for anything passing to a citizen spouse, and the charitable deduction under Section 2055. Add back lifetime taxable gifts. Apply the exclusion. What remains is taxed.
Married couples get two exclusions, but only with paperwork. Portability lets a surviving spouse add the deceased spouse’s unused exclusion amount to their own, and it requires the executor to file Form 706 for the first death and make the election on it, even when the estate owes nothing and would not otherwise file. Estates not otherwise required to file generally have five years from the date of death to make a simplified late election under the applicable revenue procedure. Beyond that window, the only route is a private letter ruling request, which is expensive and discretionary.
Work the numbers on a couple. A husband dies in 2026 with $4 million of assets, all passing to his wife. No estate tax is due because of the marital deduction. His executor has a decision: file a Form 706 nobody requires, or skip it. If she skips it, roughly $15 million of his exclusion evaporates. Suppose the wife dies eleven years later with a combined estate of $19 million. With portability elected, her available exclusion is her own indexed amount plus his preserved amount, comfortably enough to owe nothing. Without it, she has only her own. If her exclusion by then is, say, $19 million after indexing, she is fine either way; if the exclusion has been reduced by future legislation to $7 million, the failure to file that first return costs her heirs roughly $4.8 million at a 40 percent rate. Filing the return costs a few thousand dollars. That asymmetry is why a Form 706 for the first spouse to die is worth serious consideration in any estate of real size.
State thresholds are the practical constraint for most families. Twelve states and the District of Columbia impose an estate tax with exclusions far below the federal amount, and none of them offer portability the way the federal system does. A few states have added limited versions, but the general rule is that an unused state exclusion is lost. New York’s exclusion is just above $7 million, indexed, with the details published by the New York State Department of Taxation and Finance. A New York couple with a $9 million estate owes no federal tax and can owe substantial New York tax if everything passes outright to the survivor and then to the children.
The common mistake: forgetting life insurance. A term policy with a $3 million death benefit that the decedent owned is included in the gross estate at its full face value, and it is the single most common reason a family that thought it was well under the line finds out otherwise. Ownership is the trigger, not who receives the money. The fix, an irrevocable life insurance trust, has to be set up during life and has a three-year lookback if an existing policy is transferred into it. The second mistake is undervaluing a closely held business or a piece of real estate and assuming nobody will check. Valuation is the most litigated issue in estate tax, and a qualified appraisal is what starts the statute of limitations running.
Two situations change the analysis completely. A surviving spouse who is not a United States citizen does not get the unlimited marital deduction, property passing to them is taxable unless it goes into a qualified domestic trust under Section 2056A, with a United States trustee and withholding on principal distributions. Families where one spouse holds a green card rather than citizenship are frequently caught by this, and the fix has to exist in the documents or be created by the executor before the return is filed. Separately, a nonresident alien decedent who owned United States property gets an exclusion of only $60,000 against the value of United States situs assets, not the citizen exclusion. A foreign national who owns a Manhattan apartment can leave an estate tax bill that dwarfs anything the family anticipated.
Filing mechanics are unforgiving. Form 706 is due nine months after death, with a six-month extension available on Form 4768 that extends time to file but not time to pay. Interest runs from the original due date. An estate holding an illiquid business may qualify to pay the tax attributable to that business in installments under Section 6166, which is a genuine lifeline for family companies that would otherwise have to sell.
Looking ahead, treat the current exclusion as temporary regardless of what the statute says, because it has been temporary for twenty years. Families near the state thresholds should be reviewing their plans every few years rather than every few decades. Our guide to QTIP trusts covers one of the structures used to preserve a state exclusion at the first death. This page is general information and not advice about your estate; a licensed CPA and an estate attorney should review the numbers and the documents together.
Which states have an inheritance tax, and who actually pays it?
State-level taxes on inheritance exist in five states: Pennsylvania, New Jersey, Kentucky, Maryland, and Nebraska. The person who pays is the beneficiary, and the rate depends on how closely that beneficiary was related to the person who died. Iowa’s inheritance tax finished phasing out and no longer applies to deaths on or after January 1, 2025.
The mechanics are worth understanding because they invert the usual intuition. An estate tax asks how much the decedent had. An inheritance tax asks who is receiving. A $500,000 estate can generate more tax than a $5 million estate if the smaller one goes to a nephew and the larger one goes to a spouse.
Pennsylvania is the most frequently encountered because the exemptions are narrow and the rates apply from the first dollar. Transfers to a surviving spouse are taxed at zero, as are transfers to a parent from a child aged 21 or under. Lineal descendants, children, grandchildren, and also parents inheriting from an adult child, pay 4.5 percent. Siblings pay 12 percent. Everyone else, including nieces, nephews, cousins, friends, and unmarried partners, pays 15 percent. There is a discount for paying within three months of death. Pennsylvania also reaches non-probate assets: jointly held property and payable-on-death accounts are generally taxable.
New Jersey repealed its estate tax for deaths on or after January 1, 2018 but retained the inheritance tax. Class A beneficiaries, spouse, civil union partner, children, grandchildren, parents, grandparents, are fully exempt. Class C, which covers siblings and a child’s spouse or widow, gets a $25,000 exemption and then pays graduated rates from 11 to 16 percent. Class D, everyone else, pays 15 to 16 percent with only a small threshold. Charities are Class E and exempt.
Kentucky exempts Class A: spouse, parents, children, grandchildren, and siblings. Class B, nieces, nephews, half-siblings, aunts, uncles, great-grandchildren, and children-in-law, gets a $1,000 exemption and pays 4 to 16 percent. Class C, everyone else, gets $500 and pays 6 to 16 percent.
Maryland is the only state with both an inheritance tax and an estate tax. The inheritance tax is a flat 10 percent, but the exempt list is broad: spouse, children and other lineal descendants, parents, grandparents, siblings, and a child’s spouse are all exempt. In practice the tax falls on nieces, nephews, cousins, and friends.
Nebraska collects at the county level. After the 2022 reform, immediate relatives pay 1 percent on amounts above a $100,000 exemption, remote relatives, aunts, uncles, nieces, nephews and their descendants, pay 11 percent above $40,000, and everyone else pays 15 percent above $25,000. Surviving spouses are exempt, and beneficiaries under age 22 are exempt entirely.
Here is what the relationship rule does in dollars. A Pittsburgh woman dies with a $780,000 estate: a $520,000 house, $210,000 in savings, and a $50,000 car. Scenario one, everything to her husband, Pennsylvania inheritance tax of zero. Scenario two, everything split between two adult daughters, 4.5 percent, or $35,100. Scenario three, everything to her brother, 12 percent, or $93,600. Scenario four, everything to her longtime partner of thirty years to whom she was never married, 15 percent, or $117,000. Same assets, same state, same year. The difference between the first and last scenario is a marriage certificate.
The common mistake: assuming your own state controls. It does not. Inheritance tax is generally imposed by the decedent’s state of domicile on all personal property, and by the state where real property is located regardless of anyone’s domicile. A California beneficiary inheriting from a Pennsylvania aunt owes Pennsylvania tax. A New Jersey resident inheriting a Pennsylvania rental property owes Pennsylvania tax on that property even though New Jersey would have exempted the same person as Class A. The second mistake is thinking a beneficiary designation avoids the tax, payable-on-death accounts, jointly held property, and in some states life insurance payable to the estate are all reachable.
New York, for the record, has no inheritance tax. It has an estate tax with its own low exclusion and a hard cliff, described by the New York State Department of Taxation and Finance, and New Yorkers who confuse the two often plan for the wrong thing entirely. The IRS guide for survivors and executors covers the federal side, but state inheritance taxes are administered entirely by the states and have their own returns, deadlines, and discounts.
Filing is a state process with state forms and state deadlines, and nothing about it runs through the IRS, the federal system has no inheritance tax to file for. Pennsylvania uses Form REV-1500, due nine months after death, with a 5 percent discount for payments made within three months. New Jersey uses Form IT-R for Class A and the inheritance tax return series for other classes, and it will not release certain assets until a tax waiver is issued, banks in New Jersey routinely freeze a portion of an account until that waiver arrives. Kentucky, Maryland, and Nebraska each have their own return and their own timetable, and Nebraska’s is filed in the county court where the estate is administered. Executors who assume the federal deadline governs everything miss these routinely, and interest starts running from the state due date.
Planning around an inheritance tax is possible and mostly involves changing who receives rather than how much. Lifetime gifts remove property from the taxable transfer in some states, though several impose lookback periods of one to three years. Passing property through a spouse who is exempt, then to the ultimate beneficiary, can convert a 15 percent transfer into a 4.5 percent one in Pennsylvania. Charitable bequests are exempt everywhere. None of this works if the will is never revisited, and most of the expensive outcomes come from documents written decades before the family changed.
Going forward, if you own property in one of these five states or are likely to inherit from someone who lives there, get the relationship classification confirmed early. It is the single variable that determines the bill. Our guide to state tax questions covers the domicile and situs rules that decide which state gets to ask. This page is general information rather than advice about your situation; a licensed CPA and an attorney in the relevant state should review the facts.
How does stepped-up basis work when you inherit property?
The basis of inherited property resets to its fair market value on the date of death. Whatever the decedent paid for it stops mattering, and the appreciation that accumulated during their lifetime is never subject to income tax by anyone. That single rule, in IRC Section 1014, does more to reduce taxes on inheritance than the estate tax exclusion does.
Compare it to a lifetime gift and the contrast is sharp. A gift carries the donor’s basis to the recipient under Section 1015, carryover basis. A bequest resets it. A mother who gives her son stock she bought for $40,000, now worth $300,000, hands him a $260,000 built-in gain. The same mother who leaves him the same stock at death hands him a $300,000 basis and no gain at all. This is why giving away highly appreciated assets during life is often the wrong move, and why the standard advice runs the other way: gift high-basis assets, bequeath low-basis ones.
Several rules travel with the step-up. The executor may elect the alternate valuation date under Section 2032, using values six months after death, but only if the election reduces both the gross estate and the estate tax, so it is unavailable to an estate that owes no tax, which is nearly all of them. Under Section 1223(9), inherited property is automatically long-term, so an heir who sells the week after death still gets long-term capital gain treatment. Section 1014(e) blocks a specific abuse: appreciated property given to a dying person within one year of death that passes back to the donor or the donor’s spouse gets no step-up.
Community property is the biggest structural difference among states. In the nine community property states, Section 1014(b)(6) steps up the entire community property interest when the first spouse dies, both halves, not just the decedent’s. In a common law state like New York, jointly held property between spouses generally gets a step-up on only the decedent’s half. Survivors in common law states who hold everything jointly often lose half of the available step-up without knowing the option existed.
Then there is basis consistency. Section 1014(f) and the reporting rules in Section 6035 require that the basis an heir claims not exceed the value reported on the estate tax return. When a Form 706 is required, the executor files Form 8971 with a Schedule A to each beneficiary, generally within 30 days of the earlier of the return’s due date or its actual filing. Penalties apply for late or incorrect statements. For the vast majority of estates that never file a 706, no Form 8971 exists, and the burden of proving date-of-death value falls entirely on the heir, years later, in an examination.
Work an example that shows the money. A father dies owning a two-family house in Astoria he bought in 1979 for $61,000. A date-of-death appraisal values it at $1,430,000. His daughter inherits it, rents both units for four years, and sells for $1,585,000 with $95,000 of selling costs. Her adjusted basis starts at $1,430,000, reduced by the depreciation she claimed on the rental, roughly $52,000 per year on the building portion for four years, call it $190,000, so her adjusted basis is about $1,240,000. Amount realized is $1,490,000. Gain is $250,000, of which the $190,000 of depreciation is unrecaptured Section 1250 gain taxed at up to 25 percent and the remaining $60,000 is long-term capital gain. Total federal tax in the neighborhood of $57,000, plus New York State and City.
Now run it without the step-up. Basis would have been $61,000 less depreciation, gain would have been roughly $1,619,000, and the federal tax would have exceeded $350,000 before state tax. The step-up saved close to $300,000 of federal tax on one house, and the only thing the family had to do to earn it was obtain an appraisal.
The common mistake: not getting a date-of-death valuation. It is the cheapest insurance in estate administration, a formal appraisal for real estate, and for securities the average of the high and low trading prices on the date of death, which brokerages will produce on request. Heirs who sell four years later with nothing but a Zillow screenshot are negotiating from a weak position. A second mistake is assuming everything steps up. Retirement accounts, annuities, and other income in respect of a decedent under Section 691 get no step-up at all, per Section 1014(c). A third is forgetting that depreciation taken after the inheritance reduces the new basis, which surprises heirs who rent an inherited house for a decade before selling.
Valuation method varies by asset and it matters. Publicly traded securities are valued at the mean of the high and low trading prices on the date of death, and a brokerage will produce a date-of-death statement on request. Real estate needs a qualified appraisal as of the date of death, not a market analysis prepared by a broker hoping for the listing. A closely held business needs a formal valuation, which is also the document that starts the limitations period running on that value. Mutual funds use the closing net asset value. Bonds, partnership interests, and collectibles each have their own conventions, and Publication 559 points to the rules for each. One more trap specific to houses: the Section 121 exclusion on a principal residence belongs to the person who lived there, so an heir who never occupied the house cannot use it. The step-up is the entire benefit available.
One planning note that runs against instinct: a surviving spouse’s estate plan should think hard before locking appreciated assets into a credit shelter trust at the first death. Those assets avoid the second estate tax, but they also miss the second step-up. With federal exclusions high and state exclusions low, the right answer is often a state-only credit shelter with a mechanism to capture the federal step-up. That is a document decision, not a filing decision, and it has to be made before anyone dies.
Going forward, get the appraisal, keep it with the estate file, and record the stepped-up basis in your own records the year you inherit rather than the year you sell. Our guide to capital gains strategies covers what to do with a stepped-up asset once you hold it. This page is general information and not tax advice about your property; have a licensed CPA confirm your basis and the depreciation history before you sign a contract of sale.
What are the inherited IRA rules under the SECURE Act 10-year rule?
For most non-spouse beneficiaries of an owner who died after December 31, 2019, the entire account has to be distributed by December 31 of the tenth calendar year following the year of death. The stretch IRA, which let a young beneficiary spread distributions across a lifetime, is gone for them.
Start with who escapes the rule. Eligible designated beneficiaries may still use life expectancy distributions: a surviving spouse; a minor child of the account owner, but only until the age of majority, after which the ten-year clock starts; a beneficiary who is disabled within the meaning of Section 72(m)(7); a chronically ill beneficiary; and any individual not more than ten years younger than the decedent. That last category quietly covers most sibling and partner beneficiaries of similar age. Everybody else, adult children, grandchildren, nieces, friends, is a designated beneficiary subject to the ten years.
The question that took four years to resolve was whether annual distributions are required inside the ten-year window or whether a beneficiary could wait and take everything in year ten. Final regulations issued in 2024 answered it, and the answer splits on the owner’s required beginning date. If the owner died on or after the date their own required minimum distributions had to begin, the beneficiary must take annual distributions in years one through nine based on their single life expectancy and empty the account by the end of year ten. If the owner died before that date, no annual distributions are required and the beneficiary can take the money in any pattern, as long as the account is empty by the deadline. The IRS waived penalties for missed annual distributions during the transition years while the rules were unsettled; that relief has ended and the requirement is live. Check the current position on the IRS page for IRA beneficiaries.
Spouses have options nobody else does. A surviving spouse can roll the account into their own IRA and treat it as their own, which restarts the ordinary distribution rules based on their age; can remain a beneficiary and take life expectancy distributions; or, under a provision effective in 2024, can elect to be treated as the deceased employee for required distribution purposes, which is valuable when the deceased spouse was younger. Each choice produces a different distribution schedule, and the right one depends on the age gap and whether the survivor needs the money before age 59 and a half.
Now the tax planning, which is where the real money is. The distribution is ordinary income in the year received. Nothing about the ten-year rule requires even distributions, so for owners who died before their required beginning date the beneficiary chooses the timing, and timing is worth a great deal.
Take a Manhattan software engineer, age 41, who inherits a $700,000 traditional IRA from her father, who died at 68, before his required beginning date. Her own salary is $210,000. Option one: wait and take the whole $700,000 in year ten. That single year, her taxable income jumps to roughly $910,000, most of the IRA lands in the top federal bracket, and New York State and City add roughly 10 percent more. Federal and state tax on the distribution alone approaches $340,000. Option two: take roughly $70,000 a year for ten years. Each year adds $70,000 on top of $210,000, keeping her mostly in the 32 percent federal bracket rather than the top one. Total tax across the decade lands closer to $270,000. Same account, same ten years, roughly $70,000 of difference, decided by spreading the withdrawals. Option three, better still if she has a low-income year, a sabbatical, a business loss, a year between jobs, is to take a larger slice in that year and less in others.
Inherited Roth IRAs are a different and better story. The ten-year rule applies, but because a Roth owner is always treated as dying before the required beginning date, no annual distributions are required during the period. Qualified distributions are tax-free. The optimal strategy is therefore the opposite of the traditional IRA: leave the money untouched for the full ten years of tax-free growth, then withdraw the whole thing tax-free in year ten.
The common mistake: retitling. A non-spouse beneficiary cannot roll an inherited IRA into their own IRA. The account has to stay titled as an inherited IRA naming the decedent, something like “John Smith, deceased, for the benefit of Jane Smith”, and any transfer between custodians must be a direct trustee-to-trustee transfer. A beneficiary who takes a check and redeposits it has made a fully taxable distribution of the entire account, and there is no 60-day rollover fix. The second mistake is missing a required annual distribution: the excise tax under Section 4974 is 25 percent of the shortfall, reduced to 10 percent if corrected within the correction window, and reported on Form 5329. The third is missing the year-ten deadline entirely, which puts the whole account in one tax year at the worst possible rate.
The paperwork is simple but specific. Distributions from an inherited account arrive on Form 1099-R with a code in Box 7 identifying a death distribution, and they are not subject to the 10 percent early distribution penalty regardless of the beneficiary’s age. Federal withholding defaults apply unless you elect otherwise, so a beneficiary who wants to control the timing of tax payments should coordinate withholding with estimated payments rather than letting the custodian decide. Publication 590-B covers the distribution mechanics in detail.
Trusts named as IRA beneficiaries deserve their own warning. A see-through trust that qualifies can pass beneficiary status through to the individuals behind it, but a trust that fails the requirements can force a five-year payout or worse, and trust tax brackets reach the top rate at a very low income figure. Trust language written before 2020 was drafted for the stretch rules and often produces bad results now. Any trust named as a beneficiary of a retirement account should be reread.
Going forward, model the distribution schedule the year you inherit, not the year the deadline arrives. Look at your expected income across the full ten years and place the larger withdrawals in the lower years. Our guide to trustee duties covers the parallel questions when a trust rather than an individual is the beneficiary. This page is general information and not advice about your account; have a licensed CPA review your beneficiary category and distribution plan before you take the first withdrawal.