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The Internal Revenue Service doesn't impose a tax on most inherited property. However, if the property earned income while the decedent was alive, you may owe tax on the amount you receive after his death. You must also pay income tax on any amount you earn after the assets are legally yours.
Federal Inheritance Tax
The federal government doesn't require heirs to pay taxes on the property they receive from deceased individuals. However, if the net value of the deceased's estate exceeds a certain amount, the estate may owe taxes to the IRS before property can pass to heirs. At the time of publication in October 2012, estates owed taxes only if they had net value in excess of $5,120,000. Assets passed to a surviving spouse or non-profit organization are exempt from federal estate taxes.
State Inheritance Tax
According to the website NOLO.com, you may owe inheritance tax if you live in or inherit property from Pennsylvania, New Jersey, Nebraska, Maryland, Kentucky, Iowa or Indiana. In most of these states, the tax rate you pay depends on the relationship between you and the deceased. For example, none of these states imposes tax on property inherited by surviving spouses, and children who inherit property are taxed at lower rates. Some states also exempt a certain amount of your inheritance from taxation.
Income Earned Before Death
Sometimes an asset you receive may have earned income before the previous owner died that wasn't paid until after you were the asset's owner. In such cases, you must pay tax on the income you receive. For example, if you inherit a bond from your father and receive an interest payment from the bond that was earned before your father died, you must pay tax on the amount of the interest. The value of the bond itself is still exempt from tax.
After you become the owner of a given asset, you are responsible for paying tax on the income it earns. For example, if you inherit rental property, you must include the payments you receive from tenants in your taxable income. Likewise, if you sell inherited property and earn a profit, you may owe capital or ordinary gains tax, depending on the type of asset and the nature of the sale.
Individual Retirement Accounts
If you inherited an IRA from a decedent who was more than 70 1/2 years old at the time of his death, you must take minimum required distributions based on your own life expectancy from the IRA each year. Because money contributed to the IRA was tax-free, you must pay income tax at your regular rate on the amount of any distribution you receive.
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