What you inherit, what you owe, and the step-up in basis

After · 9 min read

Inheriting money or property is not itself taxable income to you. What can be taxed is what happens next. When you sell inherited property, your gain is measured against its fair market value at the date of death rather than what the deceased person originally paid, which is called the step-up in basis and which frequently eliminates decades of accumulated gain. The main exception is income in respect of a decedent: money the person had earned but not yet received, such as a final paycheck or a traditional retirement account, which is taxable to whoever receives it and keeps the character it would have had. Get a written valuation as at the date of death for anything you might one day sell.

Why it exists

The logic is that the transfer of wealth at death is dealt with, if at all, by the estate tax, so taxing the recipient again on the same transfer would be taxing it twice. That is why the Internal Revenue Service states that inherited property is not taxable income to the recipient.

The step-up in basis follows from the same idea. If the estate is valued at death for transfer tax purposes, that value becomes the starting point for the recipient. The practical effect is large: a house bought in 1974 and inherited in 2026 carries a basis of its 2026 value, and half a century of appreciation is never taxed as capital gain.

Income in respect of a decedent is the exception because it was never taxed at all. A final paycheck, an unpaid bonus, accrued interest, or a traditional retirement account represents income the person earned and would have paid tax on. Death does not erase that, so the tax follows the money to whoever receives it.

How it actually works

Basis starts at the date of death value. The Internal Revenue Service explains that basis in inherited property is generally the fair market value on the date of the decedent's death, or the fair market value on an alternate valuation date where the executor files Form 706 and elects it. When you later sell, you report the sale on Schedule D and Form 8949 and you are taxed only on the gain above that basis.

This is why valuation is not a formality. For a house, that means a written appraisal or a documented broker opinion as at the date of death. For securities, it means the value on that date. For a business or a collection, it means a professional appraisal. Reconstructing a date of death value five years later, from memory, is the single most common avoidable tax problem in inherited property.

Identify income in respect of a decedent separately. It is income the person had a right to but had not received when they died. It retains its character, so what would have been ordinary income remains ordinary income and what would have been capital gain remains capital gain. It does not get a step-up in basis. Traditional retirement accounts are the largest example most families meet.

Then check the state layer, which is separate from all of the above. Some states impose an inheritance tax, which is charged to the person receiving rather than to the estate, and which often varies by how closely related you were to the person who died. Some states impose an estate tax at a threshold far below the federal one. Many impose neither. Because this varies by state, and because it can turn on your own relationship to the deceased person, check your state department of revenue directly.

Where you stand

You are entitled not to report an inheritance as income. If you receive cash, a house or a portfolio, that receipt is not income to you. What you must report is income earned after you receive it, and any gain when you sell.

You are entitled to the stepped up basis, and you are the one who must be able to prove it. The Internal Revenue Service will not have the date of death value on file. Obtain the appraisal now, while it is straightforward, and store it with the will and the death certificate. This is the highest value administrative act in this entire discipline relative to the effort it takes.

You are entitled to know before you accept a retirement account what the tax will be. Inherited traditional retirement accounts carry deferred income tax and are governed by distribution rules that depend on your relationship to the deceased person and on when they died. Ask a tax professional before taking a distribution, not after, because the timing choices are frequently irreversible.

State treatment varies in a way that federal treatment does not. An inheritance tax is charged to you personally in the states that levy one, often at a rate that depends on whether you were a spouse, a child, a sibling or unrelated. The state in question is generally the one where the deceased person lived, not where you live. Confirm with that state's department of revenue.

What to do

The mistakes that cost people

Failing to get a date of death appraisal for real estate. Years later the gain is calculated against whatever you can prove, and what you can prove is often the original purchase price.
Treating an inherited traditional retirement account like inherited cash. It carries deferred income tax and its own distribution deadlines, and a single wrong withdrawal can be costly.
Reporting an inheritance as income on your own return. It is not income, and correcting it afterward is more work than getting it right once.
Assuming no inheritance tax because your own state has none. The relevant state is generally where the deceased person lived.

Words you will meet

basis: The value used to measure gain when you sell, which for inherited property generally starts at the date of death value.
step-up in basis: The reset of an inherited asset's basis to its fair market value at the date of death, which erases gain accumulated during the owner's lifetime.
alternate valuation date: A date six months after death that an executor may elect on Form 706 to value the estate instead of the date of death.
income in respect of a decedent: Income the person had earned but not received before their death, which is taxable to whoever receives it and does not get a step-up in basis.
inheritance tax: A state tax charged to the person receiving an inheritance, usually at a rate depending on how closely related they were to the deceased person.
capital gain: The amount by which a sale price exceeds your basis in the asset sold.

What this does not cover

This module does not cover the detailed distribution rules for inherited retirement accounts, which changed for many beneficiaries under recent legislation and depend on the date of death, or the tax treatment of inherited property located outside the United States.

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