You are required to inform Medicaid that she rec'd the inheritance, but not turn the money over to them. It is likely that her Medicaid will also end until the money has been spent down to the allowed income limit. Following is information from a webpage where someone asked a very similar question.
Q: My mother is currently on Medicaid. She has Alzheimer's Disease. We have been informed that she will be receiving a inheritance from a recently deceased family member. How does this work with Medicaid? I know that she will no longer will be eligible for Medicaid. But what happens with this money? Do they have the right to monitor her money? Tell us how this money can be used?
A: You have it right. When your mother receives her inheritance, you or whoever is representing her will have to inform the Medicaid agency for your state. Medicaid coverage will then end until she has again spent down her money to the countable asset limit, $2,000 in many states. The money can be spent for anything that will benefit your mother, including prepaying her funeral, travel, dining out, clothes, television, DVD player, and paying off any debts she may have. In most cases, your mother cannot make gifts with her money. However, there are some exceptions to this rule and in some states good planning techniques that may permit some gifting. To be sure, you will need to consult with a qualified elder law attorney in your state.
What state is your mother in? I may be able to find more definitive information relating to the state.