Is Your Inheritance Taxable? Answers To 3 Important Questions

The passing of a loved one is an emotionally challenging time. Unfortunately, even what would normally be positive elements — such as receiving an inheritance — are tainted with difficult emotions. If you've received or will receive an inheritance from your loved one, you may have many financial and tax questions about it. To help you manage your rights and obligations, here are a few answers to common questions. 

Is an Inheritance Taxable Income?

In general, inherited money and assets (like real estate) are not considered income you must declare to the IRS on your Form 1040 and pay taxes on. This is logical since the person who left the asset to you likely paid taxes on the income used to buy them. This is good news, and it simplifies the process for most heirs. 

What About Income in Respect of a Decedent?

There is a special type of income known as income in respect of a decedent (IRD). This refers to income that was due to the person who passed away but which wasn't reported on their final personal tax return. It may include things like back wages, royalties, rental income, or gains on a sale they initiated. Either the estate or an heir usually receives this money instead. 

Unlike a straight inheritance, income in respect of a decedent is taxable income. If you receive any that has not been declared by the estate, declare it on your personal income taxes in the same way the late owner would have reported it. Any taxation depends on the type of income and how it's treated. 

Will Your Inheritance Always Be Tax-Free?

Just because you paid no income taxes to receive an inheritance doesn't necessarily mean it will always be tax-free. Any future income it earns for you will become taxable just as if it were your own income. Cash received may earn interest at the bank or dividends through financial investment. Copyrights may earn royalties. And the home you turn into a rental is reported as rental income to you.

Finally, if you sell the asset, you may have to pay taxes if you profit. Any profit (above what the item was worth on the date of death) on real estate, the sale of collectibles, or selling stocks is reported as a gain on your taxes and taxed at a rate appropriate for your income range. 

Where Should You Start?

Clearly, there are many nuances in how your inheritance and its financial potential are taxed. The best place to begin is to meet with a qualified tax preparation service in your state today. With their help, you can enjoy your inheritance without stress, just as your loved one would have wanted. For more information on tax services, contact a professional near you.