Cost Basis for Gifted Assets: Understanding the Tax Implications
Introduction:
Gifts are a common way for individuals to transfer assets to their loved ones during their lifetime. While gift-giving may seem straightforward, it is important to consider the tax implications that come with it. One critical aspect of gifting is determining the cost basis of the asset being transferred. In this article, we will delve into the concept of cost basis and explore its significance when dealing with gifted assets.
What is Cost Basis?
Cost basis refers to the original value or purchase price of an asset, which is used to calculate capital gains or losses when selling or transferring ownership. It serves as a reference point for determining taxable income associated with an investment.
For instance, if you purchased stocks at $50 per share and later sold them for $70 per share, your capital gain would be $20 per share. The cost basis in this scenario would be $50 since it represents what you initially paid for each share.
Determining Cost Basis for Gifted Assets:
When assets are gifted rather than sold, calculating the cost basis becomes slightly more complex. The determination depends on various factors such as how the donor acquired the asset and its fair market value (FMV) at different points in time.
1. Original Purchase by Donor:
If the donor purchased the asset themselves, then their original purchase price typically serves as the cost basis for calculating capital gains or losses upon selling or gifting it. This assumes that no adjustments have been made since acquiring it.
For example, if your mother bought a painting 20 years ago for $5,000 and now gifts it to you, your cost basis would also be $5,000.
2. Inherited Assets:
In some cases, gifted assets may have been inherited by the donor from someone else rather than being personally purchased. When an individual inherits an asset upon someone’s death (step-up in basis), the cost basis is adjusted to its FMV on the date of death. This means that if the donor received an inherited asset and later gifted it to you, your cost basis would be the FMV at the time of their inheritance.
For instance, if your uncle inherited a piece of land valued at $100,000 from his father (your grandfather), and he subsequently gifts it to you when its value has increased to $150,000, your cost basis for calculating future capital gains or losses would be $150,000.
3. Donor’s Basis Carryover:
In some cases, rather than using their original purchase price as the cost basis for gifting assets they acquired themselves, donors may choose to transfer their own cost basis to the recipient. This approach is commonly referred to as “carryover” or “donor’s basis carryover.”
Let’s say your aunt purchased stocks for $10 per share several years ago and now gifts them to you when their value has risen to $20 per share. If she opts for donor’s basis carryover, your cost basis would also be $10 per share instead of being adjusted based on its current FMV.
It is important to note that donor’s basis carryover can have significant tax implications in terms of potential capital gains taxes when selling the asset in the future. It may also limit opportunities for tax-efficient strategies like stepped-up basis upon inheriting an asset.
4. Gift Tax Considerations:
Gifts exceeding a certain threshold are subject to gift taxes under U.S. tax laws. However, these taxes are generally paid by the donor rather than the recipient. The value of a gift determines whether it falls within taxable limits.
Currently (as of 2021), individuals can gift up to $15,000 annually ($30,000 for married couples) without triggering any gift tax obligations under what is known as the annual exclusion amount. Gifts exceeding this amount require the donor to file a gift tax return, although they may not always result in actual taxes due.
It is important to remember that gifts do not receive a “step-up” in basis like inherited assets. This means that when you sell a gifted asset, your capital gains will be calculated based on the cost basis determined at the time of gifting.
Conclusion:
Understanding cost basis for gifted assets is crucial for both donors and recipients. The determination of cost basis depends on various factors such as original purchase by the donor, inheritance with step-up in basis, donor’s basis carryover, and gift tax considerations.
When receiving gifted assets, it is vital to keep records of the cost basis information provided by the donor. These records will help you accurately calculate capital gains or losses when selling or transferring ownership of these assets in the future.
If you have any doubts or complexities surrounding your situation, consulting with a qualified tax professional can provide personalized guidance tailored to your specific circumstances.