Is Inherited Money Tax Free?
The death of a loved one raises legal and financial questions, such as who receives money and other assets the deceased person leaves behind and whether taxes are due on those assets. The federal government imposes an estate tax that applies to the assets a decedent leaves behind, but it does not apply to the recipients of inheritance. If you inherit money or property, you generally don't have to pay taxes on your inheritance unless you live in a state with an inheritance tax.
When someone dies, her money and property become a pool of assets called an estate. A personal representative known as an executor is responsible for distributing the estate according to the decedent's will and paying any taxes due on the estate out of the estate's assets. The federal estate tax generally applies to estates with assets exceeding $5,120,000. If you receive inheritance from a wealthy individual, the money you receive may have been subject to estate tax but you don't have to pay estate taxes yourself.
While estate taxes could reduce the amount of money you receive as inheritance, the federal government does not tax the recipients of inheritance directly. A tax that applies to the recipients of inheritance is called an inheritance tax. According to Nolo, seven states impose inheritance taxes: Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania.
Even though the federal government doesn't tax inheritance, you might owe federal taxes if you sell inherited property. When you buy or inherit an asset like a stock or a home, the value of the asset might increase over time. If you sell property at a price that is higher than your basis in the property -- usually the amount you paid for the property -- the difference between the sale price and your basis is subject to capital gains tax. In the case of inherited property, your basis is the value of the property when the person who left it to you died.
Certain retirement accounts let owners save money on a pre-tax or tax-deductible basis, which delays income tax on funds till retirement. If you inherit a traditional individual retirement account, 401k or similar tax-advantaged account, you have to pay income tax on your withdrawals. Roth IRAs are funded with after-tax contributions, so you generally don't have to pay tax on Roth IRA withdrawals.
Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.