Receiving money or property through inheritance or as a gift can feel like a financial windfall, but it often raises important questions: Do I owe taxes on this? Will the IRS come calling? And how do I report it? The answer depends on several factors, including the amount received, who gave it to you, and the applicable federal or state laws. This blog will explore these scenarios in detail to help you understand your tax obligations—or lack thereof—when it comes to inheritances and gifts.
Understanding the Difference: Gift vs. Inheritance
Though both gifts and inheritances involve receiving assets without direct compensation, they are treated differently under tax law:
- Gift: A transfer of money or property during someone’s lifetime, given without expecting something in return.
- Inheritance: Assets passed to you after someone’s death, usually through a will or trust.
Each has different tax implications depending on the circumstances.
Are Inheritances Taxable to the Recipient?
In most cases, inheritances are not taxable to the beneficiary. That means if you inherit money, property, or other assets, you generally do not have to report it as income on your federal tax return. However, there are exceptions:
- Income in Respect of a Decedent (IRD): If you inherit assets that the deceased had a right to receive (e.g., unpaid wages, traditional IRA distributions), you may owe income tax when you collect it.
- Estate Tax: This tax is paid by the estate of the deceased before the assets are distributed. In 2024, only estates worth more than $13.61 million are subject to federal estate tax.
- State Inheritance Tax: While the federal government doesn’t impose an inheritance tax, a few states do—namely Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Whether you owe state tax depends on the state and your relationship to the deceased.
What About Property and Capital Gains Tax?
Inherited property generally gets a “step-up in basis.” This means the cost basis of the property is adjusted to its fair market value (FMV) on the date of the decedent’s death. This can significantly reduce capital gains tax if you sell the property:
Example: Your father bought a house for $100,000, and it’s worth $500,000 when he passes. If you inherit and sell it shortly after for $510,000, you would only pay capital gains tax on $10,000—not the full $410,000 appreciation.
Are Gifts Taxable to the Recipient?
Unlike income, gifts are generally not taxable to the person receiving them. However, the IRS keeps an eye on large gifts to prevent people from avoiding estate taxes. The burden of reporting and potentially paying tax lies with the giver, not the recipient.
Annual Gift Tax Exclusion: As of 2024, an individual can give up to $18,000 per person per year without needing to file a gift tax return. For married couples, that limit doubles to $36,000 per recipient.
If a gift exceeds this threshold, the donor must file IRS Form 709 (United States Gift and Generation-Skipping Transfer Tax Return), but this doesn’t necessarily mean tax is due. Instead, the amount over the limit reduces the donor’s lifetime estate and gift tax exemption (currently $13.61 million).
What Counts as a Gift?
Gifts can take many forms beyond just money:
- Real estate
- Stocks or other investments
- Vehicles
- Forgiven debts
- Tuition or medical expenses (paid directly to the institution/provider may be excluded from gift limits)
When You Might Owe Tax on a Gift or Inheritance
There are some instances where taxes might be involved:
- Inherited IRAs or 401(k)s: You’ll owe income tax on distributions unless it’s a Roth account.
- Gifts from foreign individuals: Gifts from foreign persons exceeding $100,000 in a year must be reported to the IRS on Form 3520, even though no tax may be due.
- Inherited annuities or life insurance: These may trigger taxable income depending on payout structure and contract details.
Do I Have to Report Gifts or Inheritance to the IRS?
Generally, recipients are not required to report gifts or inheritances on their tax returns. However, there are situations where you do need to report:
- Inherited IRD: Must be reported as income.
- Large foreign gifts: Must be disclosed on Form 3520.
- Sale of inherited property: Any capital gain or loss must be reported on Schedule D.
State-Level Inheritance and Gift Taxes
While there is no federal inheritance tax, some states impose inheritance or gift taxes:
- Inheritance Tax States: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania
- State Gift Tax: Connecticut is the only state that imposes a separate gift tax as of 2024.
Always consult your state’s tax agency or a tax advisor if you live in or receive assets from someone in one of these states.
Gift Splitting for Married Couples
If you and your spouse want to give more than the annual exclusion to one person, you can use “gift splitting.” For example, you can jointly give $36,000 to a child in 2024 without triggering the need to reduce your lifetime exemption. However, you’ll need to file Form 709 and elect gift splitting on it.
IRS Forms to Know
- Form 709: Used by the giver to report gifts over the annual exclusion
- Form 706: Used by estates to report estate tax liability
- Form 3520: Used by recipients to report large foreign gifts or inheritances
- Schedule D: Used to report capital gains from selling inherited assets
What You Should Keep for Records
Even if no tax is due, it’s smart to keep documentation of the inheritance or gift in case questions arise later:
- Gift letters or written confirmations
- Appraisals or valuations of property received
- Proof of the decedent’s date of death and value of assets at that time
- Bank statements showing transfers
Tips to Reduce Tax Liability
- Use the step-up in basis when selling inherited property to reduce capital gains.
- Time large gifts over multiple years to stay under the exclusion limits.
- Consider qualified transfers for medical or educational expenses to avoid gift taxes.
- Work with estate planners if you expect to inherit or give large sums.
Conclusion: Know What’s Taxable and What’s Not
In most cases, you don’t owe taxes on gifts or inheritances you receive—but there are important exceptions to be aware of. Understanding when and how the IRS may impose taxes on inherited assets or generous gifts can save you from future tax issues and ensure you’re making the most of your windfall.
Whether it’s a family inheritance, a gift from a loved one, or a distribution from an IRA, the best strategy is to stay informed, keep accurate records, and consult a tax professional if you’re unsure. With the right approach, you can protect your financial future while staying on the right side of the tax code.
