When you receive a valuable gift, something like property worth at least a few thousand dollars, you need to record the gift's basis. This lets you keep track of how much you will owe the IRS when you sell the gift property so that you avoid any nasty surprises come tax time. A gift's basis depends on its adjusted basis before the transfer, its fair market value at the time of the gift and whether any gift taxes were paid on the transfer.
The Gift's Basis
The basis of a gift is the total money that was spent on the gift by the original owner. This is usually the original purchase price plus any money spent on purchase fees or improvements to the asset. The IRS does not tax the return of an investment in an asset. This would scare people away from investing.
When you sell your gift, you only owe income tax if you make more than the gift's basis. The sale proceeds up to your basis are completely tax free. As a result, a higher basis means less of a tax bite when you sell your gift property.
Higher Fair Market Value
The fair market value of your gift is what it would be worth if you sold it the day of the gift. If at the time of the gift the property's fair market value is higher than its basis, it's easy to figure out your gift's basis. In this case, your gift keeps the same basis as before.
It does not matter how high the gift's fair market value is at the time of the gift; it keeps the old owner's original basis and does change from this transfer. If the original owner gives you a house worth $100,000 today, but he spent $50,000 on it originally, your basis in the gift house is $50,000.
Lower Fair Market Value
If you receive a gift that lost value and has a lower fair market value than its original basis, it gets a bit more complicated. You need to keep track of both the original owner's basis and the fair market value at the time of the gift.
If you sell the gifted property for more than the original basis, your gain is the sale proceeds over the original basis. If you sell the property for less than the fair market value at the time of the gift, your taxable loss is the difference between the sale price and the gifted fair market value. You can deduct your taxable loss from the gains on other sales. If you sell the property for a price between the gifted fair market value and original basis, you do not have a gain or loss.
Lower Fair Market Value Example
Let's say you were given a house that is worth $50,000 today but was originally purchased for $100,000. The fair market value of the gift is lower than its original basis.
If you sell the house for $110,000, more than the original basis, you make a taxable gain of $10,000, the sale price minus the original basis. If you sell the house for $40,000, you get a deductible taxable loss of $10,000, the difference between the fair market value at the time of the gift and the sale price. If you sell the house for $70,000, a price in between the basis and the fair market value at the date of the gift, there is no taxable event. You don't owe any tax and will not receive a tax deduction.
Application of Gift Tax
There is one way that a property's basis can change as a result of a gift. The IRS taxes large transfers of property through the gift tax. As of 2019, if a taxpayer gives more than $15,000 worth of property in one year to one person, he's made a taxable gift and could owe taxes. There are a number of exceptions to the gift tax, so it doesn't apply to every gift.
The person giving the gift is responsible for paying the gift tax. If the donor does pay gift tax on a transfer, the gift tax is added to the property's basis. If someone gives you a house worth $115,000, he's made a $100,000 taxable gift. If he owes $35,000 worth of gift tax, that bill is added to your new house's basis. When you later sell the property, you receive up to $135,000 tax-free.