When it comes to estate and gift planning, one of the most important tax considerations is the cost basis of assets transferred to someone else—whether by gift or inheritance. The way basis is determined affects how much capital gains tax someone might owe if they later sell the property.
Unfortunately, these rules are often misunderstood or blended together. Let’s clarify the two key rules that apply in these situations: the dual basis rule for gifts and the step-up in basis for inherited property.
1. What Is Basis?
Basis is the value used to determine gain or loss when you sell an asset. Usually, it starts with what you paid for the asset (called the “cost basis”), and it can be adjusted over time (for example, by depreciation or improvements).
2. Basis for Gifted Property: The Dual Basis Rule
If someone gives you an asset during their lifetime (a gift), you generally inherit their original basis. But there’s a special twist if the asset has declined in value at the time of the gift.
When FMV < Donor’s Basis
If the fair market value (FMV) of the asset at the time of the gift is less than the donor’s basis, then a dual basis rule applies:
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For gains: Your basis is the donor’s basis.
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For losses: Your basis is the FMV at the time of the gift.
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If you sell in between those two amounts: You don’t recognize a gain or a loss.
This prevents taxpayers from passing along built-in losses to recipients who could otherwise deduct them to reduce their taxes.
Example:
Donor’s basis: $100
FMV at time of gift: $70
Donee later sells for $90
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No gain or loss is recognized, since $90 is between the FMV and donor’s basis.
3. Gift Taxes and Basis Adjustments
If the donor pays gift tax on the transfer, the donee’s basis can be increased by a portion of the gift tax paid. This is a limited exception meant to avoid double taxation.
For more details, see IRC § 1015(d).
4. Basis for Inherited Property: The Step-Up in Basis Rule
If you receive property from someone who has died, the rules are much more straightforward—and often more favorable.
Step-Up (or Step-Down) in Basis
Your basis is the fair market value at the date of the decedent’s death, regardless of what the decedent paid for it. This is called a step-up in basis, though if the asset lost value, it could be a step-down.
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This means that any capital gains during the decedent’s lifetime are wiped out.
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It often results in no capital gains tax if you sell the asset shortly after inheriting it.
Estate Tax Considerations
The estate might still owe estate tax, but that only applies above the federal exemption amount (which is $13.99 million in 2025 and is not expected to be much changed by Congress in 2025.
5. Summary: Gifts vs. Inheritances
|
Situation |
Basis Rule |
Tax Implications |
|---|---|---|
|
Gift (FMV > basis) |
Donor’s basis |
Gain taxed on full appreciation |
|
Gift (FMV < basis) |
Dual basis rule applies |
Different basis for gains vs. losses |
|
Inheritance |
FMV at date of death |
Gains during decedent’s life not taxed to heir |
Final Thoughts
Understanding these basis rules is critical for tax planning and avoiding surprises when selling gifted or inherited property.
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Gifts may carry built-in gains (or losses with limited deductibility).
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Inherited assets typically offer a clean slate with a new, often higher, basis.
Because these rules can get technical—especially when combined with estate and gift tax laws—it’s a good idea to consult a tax advisor or estate planning attorney before making large gifts or selling inherited property.
This article is for informational purposes only and does not constitute legal or tax advice. For advice specific to your situation, consult a qualified professional.
