Gifted property

What Is Gifted Property?

Gifted property refers to assets, such as money, real estate, or securities, that are transferred from one individual (the donor) to another (the donee) without the donor receiving full monetary consideration in return. This act of wealth transfer falls under the umbrella of tax planning and has significant implications for both the giver and receiver, particularly concerning gift tax laws and the recipient's adjusted basis in the asset. The Internal Revenue Service (IRS) defines a gift as any transfer to an individual, directly or indirectly, where full compensation in money or money's worth is not received.³⁷

History and Origin

The concept of taxing wealth transfers has a long history in the United States, with the federal gift tax specifically emerging to complement the estate tax. Early versions of inheritance taxes were levied to fund wars, such as the Civil War in 1862 and the Spanish-American War in 1898.³⁶ However, a loophole allowed individuals to avoid estate taxes by transferring assets during their lifetime. To address this, Congress enacted the first federal gift tax in 1924. This initial gift tax was repealed in 1926 but was reintroduced and made permanent in 1932, setting a precedent for its role as a "backstop" to the estate tax.³⁴, ³⁵ The gift tax rate was initially set below the estate tax rate to incentivize lifetime transfers and generate immediate revenue during the Great Depression.³³ A significant reform occurred with the Tax Reform Act of 1976, which unified the gift and estate tax regimes, establishing a single unified credit for lifetime and testamentary transfers.³¹, ³²

Key Takeaways

• Gifted property is a transfer of assets without full monetary exchange, typically impacting the donor's gift tax liability.
• The donee generally receives the donor's adjusted basis in the property, which is crucial for determining future capital gains tax.
• The IRS provides an annual gift tax exclusion and a lifetime exemption that significantly reduce or eliminate gift tax for most individuals.
• The responsibility for paying federal gift tax typically rests with the donor.
• Gifts to spouses (if a U.S. citizen), payments for tuition, medical expenses, and charitable contributions are generally exempt from gift tax.

Interpreting the Gifted Property

Understanding gifted property primarily involves recognizing its tax implications for both the donor and donee. For the donor, the primary concern is whether the value of the gift exceeds the annual gift tax exclusion or the lifetime exemption, potentially triggering gift tax liability. For the donee, the crucial aspect is determining their basis in the gifted property. This basis is essential because it is used to calculate any gain or loss when the donee eventually sells the property. Unlike inherited property, which typically receives a "step-up" in basis to the fair market value at the time of death, gifted property generally carries over the donor's original basis.²⁹, ³⁰

Hypothetical Example

Sarah wishes to gift 100 shares of ABC Corp. stock to her niece, Emily. Sarah purchased these shares years ago for $50 per share. At the time of the gift, the fair market value of ABC Corp. stock is $150 per share.

1. Donor's Cost Basis: Sarah's original cost basis is $50 per share, totaling $5,000 (100 shares x $50/share).
2. Fair Market Value at Gift: The market value at the time of the gift is $150 per share, totaling $15,000 (100 shares x $150/share).
3. Gift Value: The value of the gift is $15,000.
4. Annual Exclusion: Assuming the current annual gift tax exclusion is $18,000 (for 2024), Sarah's gift of $15,000 is below this threshold. Therefore, Sarah does not need to file a gift tax return, and no gift tax is immediately due.²⁸
5. Donee's Basis: For Emily, the donee, her basis in the gifted property for calculating future capital gains is generally Sarah's original adjusted basis of $50 per share. If Emily later sells the shares for $200 per share, her capital gain would be $150 per share ($200 sale price - $50 basis).

Practical Applications

Gifted property plays a significant role in estate planning and wealth transfer strategies. Individuals often use gifts to reduce the size of their taxable estate, potentially lowering future estate tax liabilities. This is achieved by taking advantage of the annual gift tax exclusion and the lifetime exemption. For instance, a person can gift up to the annual exclusion amount to an unlimited number of individuals each year without triggering gift tax or reducing their lifetime exemption.²⁶, ²⁷

Gifted property also has implications in real estate transactions, particularly when a property is sold for less than its fair market value to a family member; the difference is often considered a gift of equity.²⁵ Furthermore, gifting appreciated securities or other assets to a charitable organization can offer tax benefits to the donor, as outlined by IRS Publication 526, "Charitable Contributions."²³, ²⁴ These charitable contributions can often be deducted from the donor's income tax.

Limitations and Criticisms

While gifting property offers numerous benefits in tax planning and wealth transfer, there are limitations and potential complexities. A primary concern for the donee is the "carryover basis" rule. Unlike inherited property, which typically receives a step-up in basis, gifted property retains the donor's original adjusted basis. This means if the gifted property has significantly appreciated, the donee could face a substantial capital gains tax liability upon sale that the donor would have otherwise incurred.²¹, ²² This can sometimes make a gift less tax-efficient for the donee compared to an inheritance.

Another limitation arises if the fair market value of the property at the time of the gift is less than the donor's adjusted basis. In such cases, the donee must use the fair market value for calculating a loss upon sale, but the donor's basis for calculating a gain. This "double-basis" rule can result in situations where neither a gain nor a loss is recognized.²⁰ Furthermore, if a donee cannot establish the donor's basis, the IRS may impose a zero basis, leading to the entire sale price being taxed as gain.¹⁹ It is also crucial for donors to be aware of the lifetime exemption limits, as gifts exceeding both the annual gift tax exclusion and the lifetime amount will incur actual gift tax.¹⁸

Gifted Property vs. Inherited Property

The distinction between gifted property and inherited property is critical due to their differing basis rules and tax implications.

Confusion often arises because both involve the transfer of assets without direct payment by the recipient. However, the timing of the transfer and the resulting basis for the recipient are fundamentally different, leading to distinct tax consequences.

FAQs

1. Who pays the tax on gifted property?

Generally, the donor (the person making the gift) is responsible for paying any federal gift tax that may be due. The donee (the recipient) does not typically pay gift tax. However, the donee's basis in the gifted property will affect any capital gains tax they might owe if they later sell the property.¹⁰, ¹¹, ¹²

2. Is there a limit to how much property I can gift without paying tax?

Yes, the IRS sets an annual gift tax exclusion amount, which allows you to give up to a certain sum to any number of individuals each year without the gift being considered taxable or counting against your lifetime exemption. For example, in 2024, this amount is $18,000 per recipient, and in 2025, it is $19,000.⁸, ⁹ There is also a much larger lifetime exemption that shields gifts exceeding the annual exclusion from immediate tax, but these gifts reduce the amount that can be passed tax-free at death.

3. Do all property transfers count as taxable gifts?

No. Several types of transfers are exempt from gift tax. These include gifts that fall within the annual gift tax exclusion, gifts to your spouse (if they are a U.S. citizen), payments made directly to an educational institution for tuition, and payments made directly to a medical provider for medical expenses. Charitable contributions to qualified organizations are also exempt.⁵, ⁶, ⁷

4. How does receiving gifted property affect my taxes when I sell it?

When you receive gifted property, your basis for tax purposes is generally the donor's adjusted basis. This is known as a "carryover basis." If you later sell the property for more than this basis, you will owe capital gains tax on the profit. If the property's fair market value was lower than the donor's basis at the time of the gift and you sell it at a loss, your basis for calculating that loss is limited to the fair market value at the time of the gift.², ³, ⁴

5. What documentation do I need for gifted property?

As a donee, it's crucial to obtain information about the donor's adjusted basis in the property at the time of the gift. This is essential for calculating future capital gains or losses. If you cannot establish the donor's basis, the IRS may treat your basis as zero, which could result in a much larger taxable gain upon sale.¹ For the donor, records of the gift, its value, and any gift tax paid are important for tax compliance.