When it comes to the question of taxes on inheritances, a lot of people assume that this is just a fact of life. Any time money finds its way into someone’s hands, the IRS will be looking for a share, right?
This may be true in general, but here’s some good news: In all likelihood, your estate will pass to the beneficiaries free of taxation.
Let’s look at the different types of taxes that could enter the picture one by one, so can see the full picture.
Federal and State Income Taxes
As a starting point, it helps to separate inheritances from income. An inheritance is generally not treated as income for tax purposes. When your beneficiaries receive assets from your estate, they are receiving property that remains after taxes were already addressed during your lifetime.
This is why most inheritances are not subject to federal or state income tax when they are received. The transfer itself does not create a new tax event simply because ownership changes.
However, there are important exceptions, and they explain much of the confusion around inheritance taxes.
Exceptions to the Rule
One exception involves income that is generated inside a trust after death and then distributed to beneficiaries.
If trust assets earn interest, dividends, or rental income, and that income is passed out to a beneficiary, it retains its character as taxable income. The tax applies because income was earned, not because an inheritance was received.
Another common exception involves traditional inherited retirement accounts. Traditional IRAs and other pre-tax retirement plans were never taxed during the original owner’s lifetime. When a beneficiary takes distributions from an inherited traditional IRA, those distributions are taxed as ordinary income.
Again, the tax attaches to the income character of the funds, not to the act of inheriting them.
Understanding this distinction removes a great deal of unnecessary concern. The inheritance itself is not taxed. Certain types of income associated with inherited assets may be.
Federal Estate Taxes
The federal estate tax operates at an entirely different level. This tax is imposed on the estate itself, not on the people who inherit from it.
When a federal estate tax applies, the estate pays the tax before any distributions are made to beneficiaries. Beneficiaries do not receive a tax bill for inheriting assets that were subject to estate tax. What they receive is what remains after the estate’s obligations are satisfied.
One critical fact often gets lost in conversations about estate taxes. Fewer than 1 percent of estates owe federal estate tax. The federal exemption is historically high, and most estates fall well below the threshold.
That said, Brentwood is an affluent community, and higher net worth households are more common here than in many parts of the country. If your estate approaches or exceeds federal estate tax threshold ($15 million in 2026), tax efficiency becomes a meaningful planning consideration.
For estates in this range, estate planning strategies can be used to manage exposure and preserve more wealth for beneficiaries. These strategies focus on structure, timing, and coordination rather than last-minute adjustments.
State Income and Inheritance Taxes
State-level taxes introduce another layer of analysis, and this is where location begins to matter.
Some states impose inheritance taxes, which are distinct from estate taxes. An inheritance tax is assessed based on who receives the property rather than the overall size of the estate. The tax is tied to the transfer of property to a beneficiary.
California does not impose an inheritance tax or a state estate tax. For California residents whose assets are located entirely within the state, this significantly reduces potential tax exposure.
However, state tax issues can still arise when assets or beneficiaries cross state lines.
Out-of-State Property
If you own property located in one of the states that imposes a state estate tax, that state may tax the transfer of that property at death if its value exceeds the state’s exclusion. The tax is imposed by the state where the property is located, regardless of where you live.
Similarly, if you inherit property that is located in a state with an inheritance tax, that tax may apply even if you are a California resident. In these cases, residency does not control the tax. The location of the asset and the laws of that state determine whether the tax applies.
This is why estate planning must account for asset location, not just domicile. Real estate, business interests, and other property tied to another state can bring that state’s tax rules into play.
Capital Gains Tax
Capital gains tax often causes confusion in the inheritance context, but the rules here are generally favorable.
Under normal circumstances, capital gains tax applies when you sell an asset for more than you paid for it. The difference between the purchase price and the sale price is the gain.
Inherited assets are treated differently because of the step-up in basis at death. The tax basis of most inherited assets is adjusted to their fair market value as of the date of death.
A simple example helps illustrate this. Suppose you purchased a home for $200,000 many years ago. At the time of your death, the home is worth $800,000. Your beneficiary inherits the property with a new tax basis of $800,000.
If the beneficiary later sells the home for $800,000, there is no capital gain. If the property sells for slightly more, capital gains tax applies only to the amount above the stepped-up basis.
This rule often eliminates capital gains tax entirely for inherited assets. It applies to real estate and to many investment assets, such as stocks and mutual funds.
The step-up in basis is one of the most valuable tax features of estate planning and a key reason why inheritances are frequently received tax-free.
When Taxes Do Become a Real Planning Issue
While most inheritances pass without being taxed, certain circumstances make tax planning more relevant.
Large estates that approach federal estate tax thresholds require careful coordination. Assets that produce taxable income after death may affect beneficiaries differently depending on how distributions are structured.
Property located in other states can introduce estate or inheritance tax exposure under those states’ laws.
These situations are not the norm, but they are predictable. Tax issues arise because of estate size, asset type, or location, not because inheritances are automatically taxed.
Recognizing when you fall into one of these planning categories allows you to address issues proactively rather than reactively.
Summing It Up
Taxes on inheritances are often misunderstood. In most cases, beneficiaries receive inherited assets without paying tax simply for receiving them. Federal estate tax affects only a small fraction of estates, and California does not impose its own estate or inheritance tax.
Taxes become relevant only in specific, identifiable situations involving estate size, income-producing assets, or property located in other states. When you understand how each tax category works, uncertainty gives way to clarity.
With proper estate planning, you can address potential tax issues in advance and allow your beneficiaries to receive their inheritances with confidence rather than concern.
Take Action Today!
Even if taxes will not be a source of concern, an investment in professional estate planning assistance will pay significant dividends in the long run. To get started, call our Brentwood, CA estate planning office at 925-516-4888 or send us a message through our contact page.
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