Prior years’ basis in an inherited IRA is the after-tax money the original owner put into a Traditional IRA but never deducted, and every dollar of it comes out of the inherited account tax-free when you take distributions. The catch is that the IRS assumes the whole balance is pre-tax unless you prove otherwise. Proving it means finding the decedent’s records, applying a specific formula to each withdrawal, and filing Form 8606 every year you take money out.
What Basis Actually Is
Traditional IRA contributions are usually deductible: the owner skips tax now and pays it later when the money comes out. Some contributions are not deductible, either because the owner’s income was too high to qualify or because they chose not to claim the deduction. Those after-tax dollars are basis. The reason to track them is simple: they were already taxed once, and no one should pay tax on them twice.
Basis builds year by year over the life of the account, sometimes across decades. When the owner dies, whatever basis remains unrecovered passes to the beneficiary along with the account itself. That number, fixed as of the date of death, is what you get to pull out tax-free over time.
The original owner was supposed to record it on IRS Form 8606, Nondeductible IRAs. Line 14 of that form shows the running total across all of the owner’s Traditional IRAs.1Internal Revenue Service. Form 8606 – Nondeductible IRAs The line 14 figure on the most recent filing before death is your starting point.
Finding Proof of the Basis
The burden of proof is entirely on you. No documentation, no tax-free recovery. The custodian’s 1099-R will not tell you basis exists; custodians generally are not required to track whether contributions were deductible.
Start with the decedent’s own tax records. Form 8606 should have been attached to every return where the owner made a nondeductible contribution or took a distribution from an IRA that had basis.2Internal Revenue Service. Instructions for Form 8606 – Nondeductible IRAs Old returns going back far enough can let you reconstruct the contribution history yourself.
If personal records are missing, the IRS has two options. Form 4506-T requests transcripts of the decedent’s tax account. Transcripts for the current year and the prior nine are available, and older years can be pulled through the same form. Transcripts confirm a Form 8606 was filed and report the amounts, but they are not photocopies of the form itself. For the actual form with all its line-by-line detail, file Form 4506. That costs a fee and takes longer, but you get the full attachment.3Internal Revenue Service. Transcript Types for Individuals and Ways to Order Them
The Pro-Rata Rule
You cannot pull the basis out first and leave the taxable balance for later. Federal tax law taxes every Traditional IRA distribution under IRC Section 72, which means each withdrawal contains a proportionate mix of taxable and tax-free money. This is the pro-rata rule.
The math: divide total unrecovered basis by the year-end fair market value of the inherited IRA. That percentage is the tax-free share of every distribution you take that year. An example:
- Total basis: $10,000
- Year-end inherited IRA balance: $100,000
- Tax-free percentage: 10%
- Distribution taken: $5,000
- Tax-free portion: $500
- Taxable portion: $4,500
Remaining basis drops to $9,500. Next year, recalculate the percentage using $9,500 against the new year-end balance. Repeat until either the basis is exhausted or the account is empty.
Inherited IRAs Stay Separate
An inherited IRA is not pooled with your own Traditional IRAs for the pro-rata calculation. If you have your own IRA with its own basis and you also inherited one, each pool runs its own calculation independently.2Internal Revenue Service. Instructions for Form 8606 – Nondeductible IRAs The one exception is a surviving spouse who elects to treat the inherited IRA as their own; that election merges everything into one pool.
Multiple Beneficiaries
When several people inherit the same IRA, each person’s share of the basis matches their share of the account. If the account carried $20,000 in basis and you inherited half, your basis is $10,000. Each beneficiary files a separate Form 8606 for their own portion.2Internal Revenue Service. Instructions for Form 8606 – Nondeductible IRAs
Reporting the Recovery on Your Return
Every year you take a distribution from the inherited account, you file your own Form 8606 to calculate and report the tax-free portion. Complete Part I using the inherited account’s basis and balance, not your own IRA’s numbers. If you inherited 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 and the IRS has no way to know part of your distribution was after-tax. The full amount lands on your return as taxable income. Filing the form is what makes the tax-free treatment happen. Missing it also carries a $50 penalty per form, waivable 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 Fast You Have to Empty the Account
The distribution timeline controls how quickly you recover the basis, and it depends on who you are relative to the person who died.
Surviving Spouses
Spouses have the most options. You can roll the inherited IRA into your own, combining the inherited basis with any basis you already had, and take distributions on your own schedule under normal RMD rules.5Internal Revenue Service. Retirement Topics – Beneficiary Or you can keep it as an inherited IRA and use the life-expectancy method. Keeping it inherited helps if you are under 59½ and need access, because inherited IRA distributions are exempt from the 10% early withdrawal penalty.
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 owner’s death.5Internal Revenue Service. Retirement Topics – Beneficiary Within that window you have flexibility, and the pro-rata rule applies to every distribution.
Waiting until the final year to take it all recovers the remaining basis in one shot, but the taxable slice hits your income in a single year. Spreading distributions across the full decade usually produces a lower total tax bill by keeping you out of higher brackets. The basis percentage shifts year to year as the account rises or falls, so running Form 8606 annually matters even for small withdrawals.
Eligible Designated Beneficiaries
A narrow group can still stretch distributions over their own life expectancy instead of the 10-year window. The IRS categories are:6Internal Revenue Service. Publication 590-B – Distributions from Individual Retirement Arrangements
- Surviving spouse
- Minor child of the account owner, only until 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 long life expectancy keeps annual taxable income lower and drags basis recovery out over many years.
Annual RMDs Inside the 10-Year Window
This is the piece most beneficiaries miss. If the owner died on or after their required beginning date for RMDs, you cannot coast for nine years and cash out in year 10. You must take annual required minimum distributions in years one through nine, with whatever is left distributed by the end of year 10.7Internal Revenue Service. Notice 2024-35 – Certain Required Minimum Distributions
The excise tax on a missed RMD is 25% of the shortfall, dropping to 10% if you correct within two years.8Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs The pro-rata rule applies to those RMDs like any other distribution, so each one carries its share of tax-free basis.
The Estate Tax Deduction for Large Estates
If the original owner’s estate was large enough to owe federal estate tax, a separate deduction sits alongside your basis recovery. 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 would have been owed without the IRA assets. The difference is your total available deduction, claimed each year in proportion to how much inherited IRA income you report. This only applies when the estate actually paid federal estate tax. Below the threshold, there is nothing to deduct.
Mistakes That Make Basis Disappear
The biggest one is never looking for the original owner’s Form 8606 in the first place. Plenty of people inherit accounts with meaningful basis and pay tax on every dollar because they never asked. The 1099-R will not flag it. It is on you to prove it exists.
A close second, for non-spouses, is accidentally rolling the inherited IRA into a personal Traditional IRA. That move destroys the separate status of the account and can trigger a full taxable distribution. Fixing it is harder than getting it right the first time.
Third, ignoring annual RMDs when the owner had already started taking them. The 25% penalty per missed year dwarfs the $50 penalty for a missing Form 8606.
Fourth, treating basis recovery as optional. You cannot skip it in low-income years and save it for later. The pro-rata rule applies mechanically to every withdrawal, and Form 8606 has to be filed every year you take one. Clean records from the first distribution forward save hours of reconstruction later.