Gift, Loan, or Inheritance: Why Form 3520 Cares About the Difference

Why classification matters

The same $200,000 wire transfer can produce three completely different outcomes for Form 3520:

• Pure gift — Reportable on Form 3520 Part IV Line 54 (if over $100,000) as a gift.
• Bona-fide loan — Not reportable on Form 3520. Disclosure obligations under other rules (interest-rate testing, possible US-source-interest withholding) but not Form 3520.
• Inheritance / bequest — Reportable on Form 3520 Part IV Line 54 as a bequest (same line, slightly different conceptual treatment).

How the IRS tells them apart

The IRS looks at facts and circumstances:

Indicators of a gift:

• No promissory note.
• No interest rate or below-AFR interest rate.
• No repayment expectation.
• The donor characterized it as a gift in a card, email, letter.
• The donor's home country gift tax filing (if any) characterized it as a gift.
• Recurring transfers with no underlying business reason.

Indicators of a bona-fide loan:

• Written promissory note signed by both parties.
• Interest rate at or above the IRS applicable federal rate (AFR) for the term and month.
• Defined repayment schedule.
• Actual repayments being made.
• The transferor records the transfer as a loan in their personal accounts.
• Security or collateral (rare for family loans but strengthens the case).

Indicators of inheritance:

• A foreign decedent died.
• A foreign probate process distributed the property.
• The transfer was specified in the decedent's will or by foreign intestacy rules.
• Other heirs received proportional distributions.

What if your transfer falls somewhere in between

The hardest cases are "informal family loans" where no paperwork exists. The IRS default position for undocumented family transfers from foreign relatives is gift — they will treat it as reportable on Form 3520 unless you can show it was a loan.

If you want to defend a family transfer as a loan:

1. Sign a promissory note now, even if late. It does not need to be filed anywhere. Just signed by both parties, kept in your records.
2. Set an interest rate at or above the current AFR for the loan term. The AFR is published monthly by the IRS.
3. Start making interest payments, even small ones. A written record showing periodic payments back to the lender strengthens the loan position.
4. Keep records of the lender's intent at the time of transfer — even an email saying "I'm wiring you the money for the house, you'll pay me back when you can" is some evidence of loan intent.

A worked example

Your foreign uncle wired you $300,000 in 2024. You used $250,000 toward a house down payment and $50,000 for a wedding. There was no written agreement. You "intend" to pay your uncle back.

Three possible characterizations:

1. Treat as gift. You file Form 3520 Part IV Line 54 reporting $300,000 from your uncle. No US income tax owed. You move on.

2. Treat as loan. You sign a promissory note now (back-dated to the wire date) at the current AFR. You make periodic interest payments. You do not file Form 3520. Your tax return shows interest expense if you can deduct it (typically the $250,000 house portion if you itemize). Form 1098 or substitute is not strictly required for foreign lenders but the IRS could ask.

3. Treat as partial-gift / partial-loan. Split the $300,000 — say $100,000 gift, $200,000 loan. The $100,000 gift portion is below the threshold so no Form 3520. The $200,000 loan portion has a promissory note. This is technically defensible but invites scrutiny.

The risk in option 2 is that the IRS recharacterizes the loan as a gift years later, after the statute of limitations on Form 3520 has not started to run (no Form 3520 was filed). The penalty would be up to $75,000 (25% of $300,000) for failure to file.

The conservative call: when in doubt, file Form 3520 reporting the transfer as a gift. Over-disclosure is not penalized. Misclassification can be.

What our app does

When you add a transaction, we ask: "Was this a gift, an inheritance, or a loan?" If you say loan, we ask whether you have a written promissory note. If yes, no Form 3520 for that transaction. If no, we strongly recommend treating it as a gift for reporting purposes and add a note in your records explaining the choice.

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3520file is software, not a CPA firm or law firm. We prepare IRS Form 3520 based on the facts you provide. For advice on your specific situation, talk to a tax attorney or CPA. The above is plain-English explanation, not tax advice.