Income tax basis can be an important factor in deciding whether to make gifts during your lifetime or transfer property at your death. This is because the income tax basis for the person receiving the property depends on whether the transfer is by gift or at death. This, in turn, affects the amount of taxable gain subject to income tax when the person sells the property.
What is income tax basis?
Income tax basis is the base figure used when determining whether you have recognized a capital gain or loss on the sale of property for income tax purposes. When you purchase property, your basis is generally equal to the purchase price. However, there may be some adjustments made to basis. If you sell the property for more than your adjusted basis, you’ll have a gain. Sell the property for less than your adjusted basis, and you’ll have a loss.
What is the income tax basis for property you receive by gift?
When you receive a gift, you generally take the same basis in the property that the person who gave you the property (the donor) had. This is often referred to as a “carryover” or “transferred” basis. The carried-over basis is increased – but not above fair market value (FMV) – by any gift tax paid that is attributable to appreciation in value of the gift (appreciation is equal to the excess of FMV over the donor’s basis in the gift immediately before the gift).
As an example, say your father gives you stock worth $1,000. He purchased the stock for $500. Assume the gift incurs no gift tax. Your basis in the stock, for purpose of determining gain on the sale of the stock, is $500. If you sold the stock for $1,000, you would have gain of $500 ($1,000 received minus $500 basis).
What is the income tax basis for property you inherit?
When you inherit property, you generally receive an initial basis in property equal to the property’s FMV. The FMV is established on the date of death or, sometimes, on an alternate valuation date six months after death. This is often referred to as a “stepped-up basis,” since basis is typically stepped-up to FMV. However, basis can also be “stepped-down” to FMV.
For example, say your mother leaves you stock worth $1,000 at her death. She purchased the stock for $500. Your basis in the stock is a stepped-up basis of $1,000. If you sold the stock for $1,000, you would have no gain ($1,000 received minus $1,000 basis).
Transfers within one year of death. If you transfer appreciated property to a person within one year of his or her death, and then you (or your spouse) receive the property back at that person’s death, the basis in the property is not stepped-up or down to FMV. Instead, the basis in the property is equal to that person’s basis immediately before death. (And this basis is likely pretty close to the basis you originally had in the property before you transferred it.)
Should I Make A Gift Now or Transfer at Death?
As the following example shows, income tax basis can be important when deciding whether to make gifts now or transfer property at your death.
You purchased land for $25,000. It is now worth $250,000. You give the property to your child (assume the gift incurs no gift tax), who then has a tax basis of $25,000. If your child sells the land for $250,000, your child would have taxable gain of $225,000 ($250,000 sales proceeds minus $25,000 basis).
If, instead, you kept the land and transferred it to your child at your death when the land is worth $250,000, your child would have a tax basis of $250,000. If your child sells the land for $250,000, your child would have no taxable gain ($250,000 sales proceeds minus $250,000 basis).
In addition to income tax basis, you might consider the following questions:
- Will making gifts reduce your combined Federal gift and estate taxes?
- Will making gifts reduce your state estate tax (if applicable), like that imposed by Massachusetts?
- Does the recipient need a gift now or can it wait? How long would a recipient have to wait until your death?
- What are the marginal income tax rates of you and the recipient?
- Do you have other property or cash that you could give?
- Can you afford to make a gift now?
Thinking About Gifting? Let’s Talk.
Deciding whether to give now or later involves more than generosity—it’s a strategic financial decision. If you’re considering making gifts to family or others, let’s explore how it fits into your broader estate, tax, and financial plan. Contact us today to discuss the best approach for your goals.
