Does Gifted Stock Get a Step-Up in Basis? Unveiling the Tax Implications

No, gifted stock generally does not receive a step-up in basis at the time of the gift. Instead, the recipient (the “donee”) typically inherits the donor’s (the giver’s) basis in the stock. However, understanding the nuances of this “carryover basis” and potential adjustments is crucial for minimizing future capital gains taxes. Let’s delve into the complexities of gifted stock and its tax implications with the precision of a seasoned financial veteran.

The Fundamentals of Basis and Capital Gains

Before diving into the specifics of gifted stock, it’s essential to grasp the concepts of basis and capital gains.

• Basis: In simple terms, the basis is your cost in an asset for tax purposes. When you purchase stock, your basis is typically the purchase price plus any commissions or fees you paid. This number becomes critical when you eventually sell the stock.
• Capital Gains: A capital gain is the profit you make when you sell an asset for more than its basis. Capital gains are taxed, and the tax rate depends on how long you held the asset (short-term vs. long-term) and your income.

Understanding the Carryover Basis Rule for Gifted Stock

The carryover basis rule dictates that when you receive stock as a gift, you generally assume the donor’s original basis. This means if your Aunt Mildred bought stock for $10 a share and gifts it to you when it’s worth $50 a share, your basis is $10, not $50. This is a key concept to remember.

Let’s look at a detailed example:

• Aunt Mildred buys 100 shares of Company XYZ stock for $10 per share ($1,000 total).
• Years later, the stock is worth $50 per share ($5,000 total).
• Aunt Mildred gifts the 100 shares to you.
• Your basis in the stock is $1,000 (Aunt Mildred’s original basis).
• If you sell the stock for $60 per share ($6,000 total), your capital gain is $5,000 ($6,000 selling price – $1,000 basis).

The Gift Tax and Basis Adjustment

While the carryover basis rule generally applies, there’s a crucial adjustment that can sometimes occur if the donor paid gift tax. The basis of the gifted stock can be increased (but not above its fair market value at the time of the gift) by the portion of the gift tax paid that is attributable to the appreciation in value of the gift.

Let’s continue our example:

• Assume Aunt Mildred paid gift tax on the $4,000 appreciation ($5,000 fair market value – $1,000 basis).
• Let’s say the gift tax paid on the $4,000 appreciation was $500.
• Your basis would then be increased by the $500 of gift tax paid on the appreciation.
• Your new basis would be $1,500 ($1,000 original basis + $500 gift tax adjustment).

This adjustment mitigates the impact of double taxation – gift tax paid by the donor and capital gains tax paid by the donee.

What if the Fair Market Value is Lower Than the Donor’s Basis?

A wrinkle arises if the fair market value of the stock at the time of the gift is lower than the donor’s basis. In this scenario, for the purpose of determining a loss if you later sell the stock, your basis is the fair market value at the time of the gift. However, for determining a gain, the basis is the donor’s basis.

Consider this scenario:

• Aunt Mildred buys 100 shares of Company ABC stock for $50 per share ($5,000 total).
• The stock’s value plummets to $20 per share ($2,000 total).
• Aunt Mildred gifts the shares to you.

If you later sell the stock for $15 per share ($1,500 total), your basis for calculating the loss is $2,000 (the fair market value at the time of the gift). Your capital loss is $500 ($2,000 – $1,500).

However, if you sell the stock for $60 per share ($6,000 total), your basis is $5,000 (Aunt Mildred’s original basis). Your capital gain is $1,000 ($6,000 – $5,000).

This rule prevents you from claiming a larger loss than the donor could have claimed.

Importance of Tracking the Donor’s Original Basis

Accurate record-keeping is crucial. When receiving stock as a gift, obtain documentation of the donor’s original purchase price (the basis) and the date of purchase. This information will be essential when you eventually sell the stock to accurately calculate your capital gains or losses. If the donor’s records are unavailable, you may need to estimate the basis using other available information, like brokerage statements or historical stock prices, and potentially consult with a tax professional.

Seeking Professional Guidance

Navigating the complexities of gifted stock and its tax implications can be challenging. Consulting with a qualified tax advisor or financial planner is always recommended. A professional can analyze your specific situation, provide tailored advice, and help you develop tax-efficient strategies.

Frequently Asked Questions (FAQs)

Here are some common questions regarding the basis of gifted stock.

1. Does gifted stock avoid capital gains tax entirely?

No, gifted stock doesn’t avoid capital gains tax. It simply transfers the potential tax liability to the recipient. When the recipient sells the stock, they will be responsible for paying capital gains tax on the difference between the selling price and the basis (with any applicable adjustments for gift tax).

2. What happens if the donor’s basis is unknown?

If the donor’s basis is unknown, you’ll need to estimate it. You can use historical records, brokerage statements, or other documentation to determine the likely purchase price. If that’s not possible, you may need to treat the basis as zero, which means the entire sale proceeds will be considered a capital gain. Consulting with a tax professional is highly recommended in this situation.

3. Can I donate appreciated stock to charity instead of gifting it to a family member?

Yes, donating appreciated stock to a qualified charity can be a tax-efficient strategy. You may be able to deduct the fair market value of the stock (subject to certain limitations), and you avoid paying capital gains tax on the appreciation. This can be a win-win situation for both you and the charity.

4. How does gifting stock to a minor affect the basis?

The same carryover basis rule applies when gifting stock to a minor. The minor’s basis is generally the donor’s original basis. The tax implications for the minor will depend on their individual circumstances, such as their income level and whether the “kiddie tax” applies.

5. Is there a limit on the amount of stock I can gift without incurring gift tax?

Yes, there is an annual gift tax exclusion. For 2024, the annual gift tax exclusion is $18,000 per recipient. You can gift up to this amount to as many individuals as you like without incurring gift tax. Gifts exceeding this amount may be subject to gift tax, but only after exceeding your lifetime gift and estate tax exemption.

6. What are the holding period rules for gifted stock?

The recipient’s holding period for gifted stock includes the donor’s holding period. This is crucial for determining whether any capital gain on a subsequent sale is taxed at the more favorable long-term capital gains rates.

7. Can I gift stock in a retirement account?

Generally, you cannot directly gift stock held in a retirement account like a 401(k) or IRA. These accounts have specific rules regarding withdrawals and distributions. Gifting assets from these accounts would typically involve taking a taxable distribution first, and then gifting the proceeds.

8. How does a stock split or stock dividend affect the basis of gifted stock?

A stock split or stock dividend doesn’t change the overall basis. It simply adjusts the basis per share. For example, if you receive a 2-for-1 stock split, you’ll double the number of shares you own, but your basis per share will be halved.

9. What if the stock was acquired through an employee stock purchase plan (ESPP)?

The basis of stock acquired through an ESPP depends on whether the plan is qualified or non-qualified. Generally, the basis includes the purchase price plus any compensation income recognized at the time of purchase. This information should be reflected on your W-2 form.

10. If I gift stock and then buy it back, does that change the basis?

Gifting stock and then buying it back (a wash sale) doesn’t change the basis for the recipient of the gift. The wash sale rule only applies to losses, not gains.

11. How is basis determined for stock inherited from an estate?

Inherited stock receives a step-up in basis to its fair market value on the date of the decedent’s death. This is a significant advantage compared to gifted stock. This means when the heir sells the stock, the capital gains tax is only due on any appreciation since the date of death.

12. What if the stock is held in a trust?

The tax implications for stock held in a trust depend on the type of trust. Revocable trusts are generally treated as pass-through entities, meaning the grantor (the person who created the trust) is taxed on the income. Irrevocable trusts have more complex tax rules, and it’s best to consult with a tax advisor.

By understanding the nuances of the carryover basis rule, the potential gift tax adjustment, and the importance of accurate record-keeping, you can navigate the tax implications of gifted stock with confidence. Remember, seeking professional guidance is always a wise decision when dealing with complex tax matters.