What is the tax basis on the sale of gifted property?

Understanding what your basis is in property that was gifted to you is important as it will determine the amount of tax due. The gift tax is calculated based on the fair market value of the property at the time of transfer. Typically, gift recipients are not liable to pay taxes, but if they later decide to sell the property they received as a gift, there are tax consequences because the recipient receives the donor’s tax basis in the property. The basis of gifted property is the amount the donor paid for the property, which is transferred to the donee. If any gift tax is paid on the gift, then the basis would increase by the amount of the gift tax.

Only gifts valued above a certain amount are required to be reported. Each year, the IRS adjusts this exclusion limit for gifts. For 2015-2017, the exclusion amount was stuck at $14,000; for 2018, the annual exclusion was increased to $15,000. This means that any gift valued at $15,000 or under is entirely exempt from taxation.

Examples

Example 1. Susan gifts her daughter Becky an heirloom necklace that cost $5,000.00 in 1945.  Its fair market value today is $10,000.00.  Becky’s basis in the gift is $5,000.00 since that was Susan’s original basis.  However, if the necklace had a fair market value of only $4,000.00 today because the cost of gold was down, then the basis would be $4,000.00 as the fair market value was less than the original purchase price of the necklace.

Example 2. David decides to retire and to gift his business to his son Mark.  David has owned the business for 40 years and his total basis in the business is $130,000.00.  The fair market value of the business is $200,000.00.  Mark’s new basis in the business is $130,000.

Example 3. Sam decides to retire and gift his business in 2016 to his daughter Mary.  Sam’s basis in the business is $1,500,000.00.  The business has a fair market value of $3,000,000.00.  Because the gift exceeds Sam’s lifetime exclusion for gifting the gift tax must be paid by Sam on $500,000.00.  Sam pays gift tax of $225,000.00.  Therefore Mary’s new basis becomes Sam’s basis plus the amount of the gift tax, for a total of $1,725,000.00 as that total is still less than fair market value. Assume Mary decides to sell the property. The fair market value at the time the gift was completed was $700,000 and the property sold for $1 million, but the father originally purchased the apartment complex for $500,000. Under federal law, the daughter’s taxable basis in the property would be $500,000 and she would be taxed on her gain of $500,000 (difference between the basis and sale price).

Case Studies: Insurance Implications of Gifted Property and Tax Basis