Prior-years basis in an inherited IRA is the after-tax money the original owner put into a Traditional IRA and never deducted, and every dollar of it can come out of the account tax-free once you know how to claim it. The catch is that the IRS will treat your entire inherited balance as pre-tax unless you prove otherwise, which means finding the decedent’s records, applying a specific formula to each withdrawal, and filing your own Form 8606 for every year you take a distribution.
What Prior-Years Basis Actually Is
Traditional IRA contributions are usually deductible: the owner takes a tax break upfront and pays income tax later when the money comes out. Some contributions are not deductible, either because the owner’s income was too high to qualify for the deduction or because they chose not to claim it. Those after-tax dollars are called basis, and they build up over the life of the account, sometimes across decades.
When the owner dies, the total unrecovered basis passes to whoever inherits the account. As the beneficiary, you can pull that basis out without paying income tax on it again. The whole reason the tax code tracks basis at all is to keep the same dollars from being taxed twice.
The original owner should have reported each year’s nondeductible contribution on IRS Form 8606, Nondeductible IRAs. Line 14 of that form carries a running total of the basis in the owner’s Traditional IRAs.1Internal Revenue Service. Form 8606 – Nondeductible IRAs The line 14 figure on the most recent Form 8606 filed before death is the number you’re trying to find.
Finding the Decedent’s Basis
The burden of proof is on you. Without documentation, every dollar you withdraw is taxable as ordinary income, regardless of how much basis was actually in the account.
Start with the decedent’s personal records. A Form 8606 should have been attached to every return in which the owner made a nondeductible contribution or took a distribution from a Traditional IRA that had basis.2Internal Revenue Service. Instructions for Form 8606 – Nondeductible IRAs If old returns are on hand, you can often reconstruct the entire contribution history from them.
When personal records fall short, the IRS gives you two ways to fill the gap. Form 4506-T requests transcripts of the decedent’s tax account, available for the current year and the prior nine years, with older years reachable through the same form.3Internal Revenue Service. Transcript Types for Individuals and Ways to Order Them Transcripts can confirm that a Form 8606 was filed and show the amounts reported, but they are not photocopies of the actual attachment.
If you need the full form with all line-by-line detail, file Form 4506 to request a copy of the return itself. That carries a processing fee and takes longer, but it delivers the complete Form 8606.3Internal Revenue Service. Transcript Types for Individuals and Ways to Order Them The IRA custodian’s records can sometimes corroborate contribution amounts, though custodians generally are not required to track whether contributions were deductible.
How the Pro-Rata Rule Recovers That Basis
You cannot pull the basis out first and leave the taxable money for later. Every distribution from a Traditional IRA is taxed under IRC Section 72, which means each withdrawal is a proportionate mix of taxable and tax-free money. This is the pro-rata rule.
The math is simple. Divide the remaining basis by the year-end fair market value of the inherited IRA. The result is the tax-free percentage of any distribution you take that year.
- Total basis: $10,000
- Year-end inherited IRA balance: $100,000
- Tax-free percentage: 10% ($10,000 ÷ $100,000)
- Distribution taken: $5,000
- Tax-free portion: $500
- Taxable portion: $4,500
After that distribution, remaining basis drops to $9,500. The next year, you rerun the calculation with $9,500 in the numerator and the new year-end balance in the denominator. Repeat until the basis is fully recovered or the account is empty. The percentage shifts each year as the account grows or shrinks, so the calculation matters even when the amounts are modest.
Keep the Inherited IRA Separate From Your Own
An inherited IRA is not lumped together with your own Traditional IRAs when running the pro-rata math. If you have your own Traditional IRA with basis and you also inherit one, you calculate the fraction for each pool independently. The inherited account’s basis and balance stand alone.2Internal Revenue Service. Instructions for Form 8606 – Nondeductible IRAs
The exception is a surviving spouse who elects to treat the inherited IRA as their own. That election folds the inherited assets and basis into the spouse’s personal IRA pool, and everything runs through one combined pro-rata calculation afterward.
When More Than One Person Inherits the Same IRA
Each beneficiary’s share of the original basis is proportional to their share of the account. If the IRA held $20,000 of basis and you inherited half, your basis is $10,000. Each beneficiary files a separate Form 8606 for their portion.2Internal Revenue Service. Instructions for Form 8606 – Nondeductible IRAs
Reporting the Recovery on Your Own Form 8606
Every year you take a distribution from the inherited IRA, you file your own Form 8606 to calculate and report the tax-free portion. You complete Part I using the inherited account’s basis and balance, not the numbers from any Traditional IRA you own personally. If you inherited IRAs from more than one person, file a separate Form 8606 for each decedent’s account.2Internal Revenue Service. Instructions for Form 8606 – Nondeductible IRAs
Skip the Form 8606 and the IRS has no way to know that part of your distribution was a return of after-tax money. The full amount lands on your return as taxable income. Filing the form is what actually makes the tax-free recovery happen. Failing to file also carries a $50 penalty per form, though the IRS can waive it for reasonable cause.4Office of the Law Revision Counsel. 26 U.S. Code 6693 – Failure to Provide Reports on Certain Tax-Favored Accounts or Annuities
How Your Payout Timeline Shapes the Recovery
How quickly you have to drain the inherited IRA controls how fast the basis comes out. The timeline depends on your relationship to the person who died.
Surviving Spouses
Spouses have the most flexibility. You can roll the inherited IRA into your own account, which merges the inherited basis with any basis you already have and lets you track the combined total on your annual Form 8606, subject to normal RMD rules once you reach the applicable age.5Internal Revenue Service. Retirement Topics – Beneficiary
You can also keep the account titled as inherited and use the life-expectancy payout method. That option preserves access before age 59½ without the 10% early withdrawal penalty, which would apply if you rolled the funds into your own IRA and withdrew early.
Non-Spouse Beneficiaries and the 10-Year Rule
Most non-spouse beneficiaries who inherited after 2019 must empty the account by December 31 of the year containing the tenth anniversary of the original owner’s death.5Internal Revenue Service. Retirement Topics – Beneficiary You choose how to spread distributions across that window, and the pro-rata rule applies to every one.
Waiting until year 10 recovers all remaining basis at once, but the taxable portion hits your income in a single year. Spreading distributions across the full decade often produces a lower total tax bill because it keeps you out of higher brackets in any one year.
Eligible Designated Beneficiaries
A narrow group can still stretch distributions over their own life expectancy instead of being forced into the 10-year window. The categories are:6Internal Revenue Service. Publication 590-B – Distributions from Individual Retirement Arrangements
- Surviving spouse
- Minor child of the account owner, until they reach the age of majority (at which point the 10-year clock starts)
- Disabled individual as defined by the IRS
- Chronically ill individual as defined by the IRS
- Someone not more than 10 years younger than the original owner
Stretching distributions over a life expectancy pulls basis out gradually, keeps annual taxable income lower, and extends the value of the tax-free portion further.
Annual RMDs Inside the 10-Year Window
This is the detail most beneficiaries miss. If the original owner died on or after their required beginning date for RMDs, you cannot simply wait until year 10 and drain the account. You must take annual required minimum distributions in years one through nine, with the remaining balance distributed by the end of year 10.7Internal Revenue Service. Notice 2024-35 – Certain Required Minimum Distributions If the owner died before that date, only the 10-year deadline applies, with no annual minimums in between.
The penalty for missing an RMD is an excise tax of 25% of the amount you should have taken, dropping to 10% if you correct the shortfall within two years.8Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs The pro-rata rule applies to those required distributions the same way it applies to any other withdrawal, so each RMD carries its tax-free slice.
The Estate Tax Deduction Most Beneficiaries Miss
If the original owner’s estate was large enough to owe federal estate tax, there is a separate deduction most people never claim. Inherited IRA distributions count as income in respect of a decedent, and the tax code lets you deduct the portion of estate tax attributable to those IRA assets.9Office of the Law Revision Counsel. 26 USC 691 – Recipients of Income in Respect of Decedents
The calculation compares the estate tax actually paid to what it would have been without the IRA assets in the estate. The difference is the total deduction available, and you claim your share each year in proportion to how much inherited IRA income you include in gross income that year. This is a miscellaneous itemized deduction that was not swept up in the 2017 suspension of other miscellaneous deductions.
This only applies when the estate actually crossed the federal estate tax threshold and paid tax. Below-threshold estates produce no deduction. For large estates, though, the offset can be substantial against the taxable portion of your distributions.
Mistakes That Erase the Benefit
The biggest one is never looking for the decedent’s Form 8606. Plenty of people inherit IRAs with meaningful basis and pay tax on every dollar because they didn’t know to ask. The 1099-R the custodian sends will not show basis. Proving it exists is on you.
A close second is accidentally rolling an inherited IRA into your own personal Traditional IRA when you’re not a spouse. That move strips the inherited status, can trigger a full taxable distribution, and tangles the basis tracking. Fixing it after the fact is far harder than getting it right the first time.
Third, ignoring annual RMDs when the original owner had already started taking distributions. The 25% missed-RMD penalty dwarfs the $50 penalty for a missing Form 8606, and it applies each year you miss.
Finally, basis recovery is not optional and cannot be timed. You do not get to skip it in low-income years and save it for later. The pro-rata rule applies mechanically to every distribution, and Form 8606 has to be filed for every year you take money out. Clean records from the beginning save hours of reconstruction later.