Gifting property can be a way for one person to shift paying tax on gain, but this does not mean that the gain escapes tax free. Under § 1015, a donor may transfer property to a donee, and if there is built in gain with the property, then the done will take a basis in the property equivalent to that of the donor. Note, simply transferring the property through a gift transaction does not trigger gain recognition. Section 1015 simply sets up the basis requirements for gift transactions.
However, the basis is a little trickier when it comes to property with loss. When the donor has a basis in property greater than the fair market value and chooses to transfer it as a gift, the donee does not simply take the donor’s basis. This is a situation where there is built in loss at the time of transfer. In other words, in the case where the donor has a basis higher than the actual value at the time of gift, there are more basis concerns that must be taken into account upon the next disposition.
For instance, if the donor has basis in the property of $50,000 and the fair market value at the time of the gift is $40,000, the donee will wait until he later disposes of the property to determine what his basis will be for gain or loss purposes. If the donee later sells the property for $30,000, then under §1015, the donee will take a basis equivalent to the fair market value, which was $40,000. This will allow the donee to recognize a loss of $10,000 rather than $20,000 if he had taken a basis equivalent to the donor’s basis.
What is the reasoning for this? Congress does not favor the idea of a transfer of loss among taxpayers. Therefore, Congress tries to limit this transfer through permitting a taxpayer only to recognize loss for the actual loss accrued in that particular taxpayer’s hands. If the code allowed the taxpayer to recognize loss of $20,000, then this would allow the taxpayer to recognize a loss that he truly did not incur. Rather, a loss of $10,000 directly correlates to the taxpayers’ loss beginning from the date of transfer. The other $10,000 of loss simply is lost for purposes of gift transactions.
On the other hand, if the taxpayer received the property at a time when the FMV of the property had been $40,000 and later sold for $65,000, then the taxpayer would have recognized only $15,000 of gain, rather than $25,000. The code does allow taxpayers to transfer basis in regard to gain because essentially some tax is still being collected. In contrast, on a loss, the government is losing money completely, not only on excluding taxable income but also by reducing taxable income.
Finally, consider a situation where a taxpayer received property where the fair market value was $40,000 when the property was gifted, but later the donee sells the property for $45,000. In this case, the taxpayer will neither recognize gain nor loss (Regulation 1.1015-(a)(2)). Why? In the case above, using the fair market value as the basis would result in a gain whereas using the donor’s basis would result in a loss. This creates a conflicting result with congress’s intent so the regulations under § 1.1015 help identify this loophole and close any gaps that raise basis concerns. When gifting property, it is important to identify first and foremost whether there was built in gain or loss at the time of the gift. In a situation where the taxpayer will receive property with a built-in gain, the tax consequences are rather favorable and tend to be straightforward. However, in the case where a taxpayer receives loss property, the donee must wait until his own disposition before truly identifying the tax consequences he will have. Keep in mind, different rules add a new level of complexity when a donor gifts property, but there is also some consideration in the mix. This results in a part gift part sale and special rules apply.
You can speak with Denver tax attorney and business attorney by contacting The McGuire Law Firm.