Is That Inheritance Taxable?

Article Highlights:

• Estate Tax 
• Estate Tax Exemption 
• Fair Market Value at Date of Death 
• Step up in Basis 
• Community Property 
• Deferred Untaxed Income 

Are inheritances taxable? This is a frequently misunderstood taxation issue, and the answer can be complicated. When someone passes away, all of their assets (their estate) will be subject to estate taxation, and whatever is left after paying the estate tax passes to the decedent’s beneficiaries.

Sound bleak? Don’t worry, very few decedents’ estates ever pay any estate tax, primarily because the tax code exempts a liberal amount of the estate’s value from taxation; thus, only very large estates are subject to estate tax. In fact, with the passage of the Tax Cuts & Jobs Act (tax reform), the estate tax exemption has been increased to $11,580,000* for 2020 and will be inflation-adjusted in future years. That generally means that estates valued at $11,580,000* or less will not pay any federal estate taxes, and those in excess of the exemption amount only pay estate tax on the excess amount. Of interest, there are less than 10,000 deaths each year for which the decedent’s estate exceeds the exemption amount, so for most estates, there will be no estate tax and the beneficiaries will generally inherit the entire estate.

* Note that, as with anything tax-related, the exemption is not always a fixed amount. It must be reduced by prior gifts in excess of the annual gift exemption, and it can be increased for a surviving spouse by the decedent’s unused exemption amount.

Of course, once a beneficiary (also referred to as an heir) receives the inherited asset, any income generated by that property—be it interest from cash, rent from real estate, dividends from stocks, etc.—will be taxable to the beneficiary, just as if the property had always been the beneficiary’s.

Because the value of an estate is based upon the fair market value (FMV) of the assets owned by the decedent on the date of their death (or in some cases, an alternative valuation date six months after the decedent’s date of death, which is rarely used), the beneficiaries will generally receive the inherited assets with a basis equal to the same FMV determined for the estate. What this means to a beneficiary is that if they sell an inherited asset, they will measure their gain or loss from the inherited basis (FMV at date of death).


This FMV valuation of inherited assets is frequently referred to as a step up in basis, which is really a misnomer because the FMV can, under some circumstances, also be a step down in basis.

If the decedent was married at the time of death and resided in a community property state, and if the property was held by the couple as community property, the beneficiary spouse will generally receive a basis equal to 100% of the FMV of the property, even though the spouse will have only inherited the deceased spouse’s share.

Not all inherited assets received by the beneficiary fall under the FMV regime. If the decedent held assets that included deferred untaxed income, those assets will be treated differently by the beneficiary. Examples of those include inherited:


This is just an overview of issues related to being the beneficiary of an inheritance. If you have questions related to the tax ramifications of a potential or actual inheritance, please give this office a call.

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