Navigating the complexities of US capital gains on gifted property doesn't have to be daunting. Here's a simplified guide to help you understand the essentials.
Gifting property involves transferring ownership of an asset from one person (the donor) to another (the recipient) without receiving payment in return. This process has specific tax implications in the United States, especially regarding capital gains tax.
Capital gains tax is applied to the profit made from selling an asset. When the recipient eventually sells a gifted property, the capital gain is determined by the difference between the sale price and the property's basis. This basis is crucial for calculating the correct tax liability.
The donor's basis in the property is generally the amount the donor originally paid for the property, plus any adjustments such as improvements or depreciation. This basis is passed on to the recipient of the gift.
Fair Market Value (FMV) is the price the property would sell for on the open market when the gift is made. FMV can fluctuate and may be lower or higher than the donor’s basis. Understanding the donor’s basis and FMV is essential for correctly calculating capital gains or losses.
When determining whether there is a gain or loss on the sale of a gifted property, different rules apply depending on whether the Fair Market Value (FMV) at the time of the gift is lower than the donor's basis.
If the FMV is lower than the donor's basis, FMV is used to calculate any loss. However, you will always use the donor's basis to calculate the gain if there is a gain. This ensures the calculation is accurate and compliant with IRS regulations, specifically Internal Revenue Regulations 1.1015-1(a)(2).
Please see this example. A acquires income-producing property by gift, which basis was $100,000 at the time of the gift. The FMV at the time of the gift was $90,000.
(1) A sells the property for $120,000; the gain is $20,000 by using the donor's basis.
(2) A sells the property for $50,000; the loss is $40,000, by using FMV.
(3) A sells the property for $95,000 without gain or loss. (To calculate gain, you should use $100,000; to calculate loss, you must use $90,000. Therefore, there is no gain or loss.)
Please note if the value of the property at the time of gift is less than the donor's basis bu subsequently increases above the donor's basis, and is then sold, the normal rule of using donor's basis will be used.
Calculating capital gains on gifted property can be complex, but there are ways to simplify the process. First, always keep detailed records of the donor’s basis, including any adjustments for improvements or depreciation.
Consider consulting a tax professional who can provide personalized advice and ensure all calculations comply with IRS regulations. Tax software can also help automate and simplify the process, reducing the risk of errors.
Tax laws always have exceptions. We aim to provide broad guidance in simple, understandable language. We recommend any reader consult with appropriate paid professionals to obtain tailored guidance after disclosing your facts and circumstances. Our blogs do not provide professional opinions to readers.