Inheriting Money? Here’s How Taxes Really Work on IRAs, Roths, and Real Estate
- Kirk Reagan
- Feb 11
- 3 min read
Updated: Feb 12
If you’ve inherited money or you’re doing life planning to leave assets to your heirs, one of the biggest mistakes I see is assuming all inherited assets are taxed the same. They’re not. And getting this wrong can easily cost your family tens or even hundreds of thousands of dollars in unnecessary taxes.
Let’s break this down into the three major categories of assets you can inherit and what the tax rules really look like.
1. Taxable Accounts & Real Property: The Step-Up in Basis Advantage
Taxable assets include brokerage accounts, individual stocks, mutual funds, business interests, and real estate like a home or rental property. These assets are subject to capital gains tax when sold but inheritance changes the rules.
When someone passes away, these assets generally receive a step-up in basis. That means the cost basis is reset to the fair market value on the date of death.
Example: If a home was purchased for $100,000 and is worth $1,000,000 when the owner dies, the new basis becomes $1,000,000. If the heir sells it for $1,000,000, there is zero capital gains tax. The $900,000 of gains simply disappears.
This also applies to rental properties even depreciation recapture goes away at death.
If the asset grows after the date of death, only the growth after that point is taxable. The step-up locks in the value as of the decedent’s death.
Assets that typically qualify include:
Real estate
Stocks and bonds
Mutual funds and ETFs
Business interests
Certain valuable personal property
Community Property vs. Common Law States — A Big Deal for Married Couples
Where you live matters.
Community property states include: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
In these states, when one owner of a jointly held asset dies, both halves of community property receive a full step-up in basis — not just the deceased owner's half. That can completely eliminate capital gains for the survivor.
In common law states (most other states), only the deceased owner's half gets stepped up. The survivor keeps their original basis on their share, which can leave a taxable gain later.
This one rule alone can dramatically change estate planning strategies for married couples.
2. Tax-Deferred Accounts: Traditional IRAs and 401(k)s
These include traditional IRAs, rollover IRAs, and traditional 401(k)s. There’s no step-up in basis here. These accounts were never taxed going in, so they’re fully taxable coming out.
Key rules:
No early withdrawal penalties for beneficiaries, regardless of age.
Every dollar withdrawn is taxed as ordinary income.
For deaths after January 1, 2020, most non-spouse beneficiaries must empty the account within 10 years under the SECURE Act.
That means a large inherited IRA can push heirs into higher tax brackets if distributions aren’t planned carefully. For more information on the pitfalls of this, check out this video: https://youtu.be/0hTORROh_d4
3. Roth IRAs: The Best Asset to Inherit
Roth IRAs are the crown jewel of inheritance.
For beneficiaries:
No early withdrawal penalties.
Distributions are tax free.
The account can continue to grow tax free.
Still subject to the 10-year rule, but no tax due when withdrawn.
This makes Roth accounts incredibly powerful for multi-generational planning when used correctly.
Why This Matters for Life Planning
Understanding these rules isn’t just about inheriting money, it’s about how you leave it. Smart planning can:
Reduce or eliminate capital gains for heirs.
Spread taxable income over years instead of one big hit.
Prioritize Roth conversions when they make sense.
Structure property ownership to maximize step-up benefits.
The goal is simple: keep more of your money in your family and less going to taxes.
Disclaimer: This article is for educational purposes only and is not personal financial advice. Every situation is unique. Consult a qualified professional before making decisions about your own planning.
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