Money and property you receive as a gift, bequest, or inheritance are not subject to federal income tax. You do not report the value on your return, and the size of the transfer does not change that answer. What the exclusion does not cover is the tax on income the property produces after it reaches you, the tax on inherited retirement accounts and other deferred income the decedent was owed, and the capital gains tax you may face when you eventually sell. Those are the pieces that trip people up.
The General Rule
Federal law excludes the value of property acquired by gift, bequest, devise, or inheritance from your gross income.1Office of the Law Revision Counsel. 26 USC 102 – Gifts and Inheritances A $500,000 bequest from a relative, or a $50,000 check from a living family member, arrives without any federal income tax owed by you.
Any tax on the transfer itself falls on the giver or the estate, not on you. A donor who gives any one person more than $19,000 during 2026 files Form 709, but owes no gift tax until lifetime gifts exceed the exemption.2Internal Revenue Service. Gifts and Inheritances3Internal Revenue Service. Frequently Asked Questions on Estate Taxes4Internal Revenue Service. Whats New – Estate and Gift Tax Most estates fall well below that line, so most beneficiaries inherit without any federal tax being paid by anyone.
Income the Property Earns After You Receive It
The exclusion covers the property. It does not cover the income that property generates once it is yours.1Office of the Law Revision Counsel. 26 USC 102 – Gifts and Inheritances Interest on inherited cash, dividends from gifted stock, and rent from real estate transferred to you all count as your taxable income in the year you earn them. Once the account is in your name, banks and brokerages report the income on 1099-INT and 1099-DIV forms under your Social Security number.
Timing matters. If you inherit a brokerage account in August and it pays $3,000 in dividends between August and December, that $3,000 goes on your return. Dividends earned before the transfer belong on the decedent’s final return or the estate’s return. Rent works the same way: payments dated before the transfer are not yours; everything from the transfer date forward is.
Inherited U.S. savings bonds are a common source of confusion here, because Series EE and I bonds accumulate deferred interest that eventually has to be reported by someone. Whether that accumulated interest lands on your 1099-INT depends on whether the bond is reissued in your name and on whether the bond is electronic or paper. TreasuryDirect explains the mechanics, and IRS Publication 550 walks through how to back out interest that was already includable in someone else’s income if you cash a paper bond covering decades of built-up interest.5TreasuryDirect. Tax Information for EE and I Bonds
Inherited Retirement Accounts
This is the exception that catches the most beneficiaries by surprise. Inherited traditional IRAs and 401(k) accounts are fully taxable as ordinary income when you take distributions.6Office of the Law Revision Counsel. 26 USC 408 – Individual Retirement Accounts The original owner never paid income tax on that money, and the tax follows the money to whoever ends up with it. A $400,000 inherited IRA is not a $400,000 windfall. Depending on your bracket, the after-tax value could be closer to $280,000 or $300,000.
Most non-spouse beneficiaries have to empty the account within 10 years of the original owner’s death.7Office of the Law Revision Counsel. 26 USC 401 – Qualified Pension, Profit-Sharing, and Stock Bonus Plans If the original owner had already begun required minimum distributions, the IRS also expects you to take annual distributions during the 10-year window rather than waiting until year 10.8Internal Revenue Service. Retirement Topics – Beneficiary If they had not yet started distributions, you have flexibility on timing so long as the account is drained by the end of year 10. Missing a required distribution triggers a 25% excise tax on the shortfall, dropping to 10% if you correct it within two years. Spreading withdrawals across multiple years often keeps you in a lower bracket than a lump-sum withdrawal at the end of the window.
Inherited Roth IRAs follow the same 10-year timeline but with much friendlier tax treatment. Withdrawals of the original owner’s contributions are tax-free. Earnings are also tax-free provided the Roth was open for at least five years before the owner’s death; if it was younger than that, the earnings portion may be taxable when withdrawn.8Internal Revenue Service. Retirement Topics – Beneficiary
Surviving spouses get an option no one else does. A spouse can roll the inherited account into their own IRA, resetting the distribution clock and delaying withdrawals until their own required beginning date.
Other Income in Respect of a Decedent
Inherited retirement accounts sit inside a broader category the IRS calls income in respect of a decedent (IRD): income the decedent had a right to receive but that was not included on their final return.9Internal Revenue Service. Publication 559, Survivors, Executors, and Administrators Whoever receives IRD reports it as their own gross income in the year received.10Office of the Law Revision Counsel. 26 USC 691 – Recipients of Income in Respect of Decedents Common examples include:
- Unpaid wages or bonuses the decedent earned before death but had not yet been paid.
- Deferred compensation the decedent had a right to but had not collected.
- Guaranteed payments or distributive shares owed to the decedent’s partnership interest.
- Deferred interest on Series EE or I savings bonds that the decedent never reported.
IRD does not get a stepped-up basis at death, which is the reason it stays taxable. Ordinary inherited property has its basis adjusted to fair market value at death and often escapes tax on decades of built-up gain. IRD items keep their full tax liability, which is why inherited retirement accounts and unpaid wages remain fully taxable in your hands.
Life Insurance Proceeds
Life insurance death benefits sit in a different section of the code, but beneficiaries usually receive them alongside an inheritance and need the answer. Proceeds paid because of the insured person’s death are not included in gross income.11Office of the Law Revision Counsel. 26 USC 101 – Certain Death Benefits A $1 million death benefit paid to a named beneficiary arrives tax-free.
One common exception: any interest the insurance company adds on top of the death benefit is taxable. If the company holds the proceeds for months before paying, or you elect installments that include an interest component, that interest goes on your return.12Internal Revenue Service. Life Insurance and Disability Insurance Proceeds
Distributions From an Estate or Trust
Estates often take months or years to settle, and the assets keep earning income during that time. Bank balances collect interest, rental properties generate rent, portfolios pay dividends. The IRS uses distributable net income (DNI) to divide that income between the entity and the people it pays.13Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1
Say a trust distributes $50,000 to you and $5,000 of that came from income the trust earned during administration. You report the $5,000 as income. The other $45,000 is a distribution of principal, which is tax-free. The trust or estate sends a Schedule K-1 (Form 1041) breaking out exactly what kinds of income are passing through: interest, dividends, rents, capital gains. Each category keeps its character on your personal return, so long-term capital gains stay at capital gains rates rather than becoming ordinary income.
Read the K-1 carefully. Beneficiaries sometimes pay tax on the entire distribution when only the DNI portion is taxable, and the K-1 is what tells you which is which.
Basis and Capital Gains When You Sell
The income tax exclusion does not mean tax never enters the picture. When you eventually sell the asset, your capital gain or loss is measured against your basis, and inherited property and gifted property follow very different basis rules.
Inherited Property Gets a Stepped-Up Basis
Inherited property generally takes a basis equal to its fair market value on the date of death.14Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent If your parent bought a house in 1985 for $80,000 and it was worth $600,000 the day they died, your basis is $600,000. Selling it for $600,000 produces no taxable gain. Decades of appreciation are erased. The step-up can also go the other way: if the property has lost value, the basis steps down, and you cannot inherit a built-in loss to claim on your return.
Gifted Property Carries the Donor’s Basis
Gifts work the opposite way. You take on the same basis the donor had.15Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust If your aunt bought stock for $3,000 and gives it to you when it is worth $15,000, your basis is $3,000. Sell it for $15,000 and you have a $12,000 capital gain. The unrealized appreciation transfers with the property.
A quirk applies when the donor’s basis is higher than the property’s fair market value at the time of the gift. You use the lower fair market value for calculating a loss, which means a loss the donor could have claimed by selling the property themselves is unavailable to you. Sell at a price between the two figures and there is no recognized gain or loss at all.
For heavily appreciated assets, the difference between inheritance and lifetime gift can be dramatic. An asset with $200,000 in unrealized gain produces no capital gains tax if inherited but the full $200,000 gain if given as a lifetime gift. For families whose estates are comfortably below the $15 million exemption, holding appreciated assets until death is often the more tax-efficient choice.
Gifts and Bequests From Foreign Persons
Gifts and inheritances from foreign individuals or foreign estates get the same income tax exclusion as domestic transfers. You owe no income tax. The IRS does, however, impose a separate reporting requirement, and the penalties for missing it are severe.16Office of the Law Revision Counsel. 26 USC 6039F – Notice of Large Gifts Received From Foreign Persons
If gifts or bequests from a foreign individual or foreign estate total more than $100,000 in a tax year, report them on Part IV of Form 3520 and identify each gift over $5,000 separately.17Internal Revenue Service. Gifts From Foreign Person A lower threshold of $20,573 for 2026 applies to gifts from foreign corporations or partnerships. This is a filing requirement, not a tax.
The penalty for failing to file is 5% of the unreported gift for each month the return is late, capped at 25%.18Internal Revenue Service. Instructions for Form 3520 On a $200,000 gift, that reaches $50,000 for missing a form that would have cost nothing to file. Reasonable cause can waive the penalty, but the cheapest path is filing on time.
State Inheritance Tax
Federal treatment is uniform. State treatment is not. Five states levy an inheritance tax paid by the beneficiary rather than the estate: Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Iowa repealed its inheritance tax effective January 1, 2025.
Rates depend on your relationship to the deceased. Surviving spouses are typically exempt. Children and other direct descendants often qualify for full exemptions or very low rates. More distant relatives and unrelated beneficiaries face higher rates that can reach 16% depending on the state and amount. Maryland is the only state with both an estate tax and an inheritance tax, though credits usually prevent double taxation of the same assets.
Where you live is not always what matters. Inheritance tax is generally tied to where the decedent lived, so inheriting from someone in one of the five listed states can pull you into that state’s tax even if your own state has none.