Carryover Basis

Carryover basis describes what happens to basis when property changes hands by gift: under section 1015 of the Internal Revenue Code the recipient's basis "shall be the same as it would be in the hands of the donor," so the giver's cost carries over and the accumulated gain is transferred along with the asset. The recipient pays no income tax on receiving the gift, and pays capital gains tax on the whole of the appreciation, including everything that accrued before they owned it, when they eventually sell.

A word on the name, because it is a case where the popular term and the official one diverge. Neither section 1015 nor its regulation uses the phrase "carryover basis" — the statute's heading is "Basis of property acquired by gifts and transfers in trust," and the regulation's is "Basis of property acquired by gift after December 31, 1920." The Code's own defined term for the concept is "transferred basis property" at section 7701(a)(43): property whose basis is "determined in whole or in part by reference to the basis in the hands of the donor, grantor, or other transferor." Publication 551 does use "carryover basis" five times, and not once for a gift: four are about allocating basis in a like-kind exchange and the fifth is about a distribution from a non-grantor trust. Its gift section says "the donor's adjusted basis" throughout, under headings that name the two cases outright. The phrase is nonetheless what practitioners say and what readers search for, so it is the name used here, with the caution that a tax professional will hear it as slightly loose — historically "carryover basis" was a basis-at-death term of art, from the repealed 1976 regime and the 2010-only election.

There are three bases, not two, and the third is the one people file wrong returns over. Section 1015(a) states the general rule and then its exception in one sentence: the basis is the donor's, "except that if such basis (adjusted for the period before the date of the gift as provided in section 1016) is greater than the fair market value of the property at the time of the gift, then for the purpose of determining loss the basis shall be such fair market value." Read quickly that sounds like a choice between two numbers. It is not. Each number governs a different question, and a sale price sitting between them answers neither.

Regulation 1.1015-1(a)(2) works it out in a single example: "A acquires by gift income-producing property which has an adjusted basis of $100,000 at the date of gift. The fair market value of the property at the date of gift is $90,000. A later sells the property for $95,000. In such case there is neither gain nor loss. The basis for determining loss is $90,000; therefore, there is no loss. Furthermore, there is no gain, since the basis for determining gain is $100,000."

Publication 551 states the same result as a test the reader can apply: "If you use the donor's adjusted basis for figuring a gain and get a loss, and then use the FMV for figuring a loss and have a gain, you have neither gain nor loss on the sale or disposition of the property." So the honest summary is that a gift of depreciated property creates a dead zone between the two figures in which the disposition is simply not a taxable event, and the built-in loss is destroyed for both people: the giver could have sold and claimed it, the recipient cannot.

Business property is an exception to the loss side. Publication 551, verbatim: "If you hold the gift as business property, your basis for figuring any depreciation, depletion, or amortization deduction is the same as the donor's adjusted basis plus or minus any required adjustments to basis while you hold the property." The depreciation basis is the donor's figure even where fair market value at the gift was lower.

The holding period comes across with the basis. Section 1223(2) includes in the recipient's holding period the period the property was held by the other person, "if under this chapter such property has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in his hands as it would have in the hands of such other person." Regulation 1.1223-1(b) gives the gift as its own worked illustration. The practical effect is that a recipient who sells the next week still has long-term capital gain if the giver had held the asset for more than a year. Note the condition, though: the tacking rule is expressed in terms of the recipient taking the same basis as the transferor, so it follows the carryover figure rather than the substituted fair-market-value figure.

Gift tax paid can raise the basis, and the version everyone quotes is the wrong one. Section 1015(d)(1)(A) increases the basis "(but not above the fair market value of the property at the time of the gift) by the amount of gift tax paid with respect to such gift." That is the general form of the rule, and it is the version most summaries stop at. For any modern gift, section 1015(d)(6)(A) narrows it: for a gift made after December 31, 1976, the increase is only the portion of the tax that bears "the same ratio to the amount of tax so paid as— (i) the net appreciation in value of the gift, bears to (ii) the amount of the gift," and section 1015(d)(6)(B) defines net appreciation as the excess of the gift's fair market value over the donor's adjusted basis immediately before it. So only the appreciation-proportionate share of the gift tax is added, capped at the tax actually paid and still never above fair market value at the gift. Section 1015(d)(3) handles split gifts by summing both halves.

In practice this almost never bites. With the lifetime exclusion at $15,000,000, a reportable gift ordinarily consumes exclusion and produces no gift tax at all, so there is nothing to add. It belongs on the page because it is the step a reader will find described somewhere as routine, and it is not.

Transfers between spouses are outside this section, and getting this backwards invents a tax problem that does not exist. Section 1015(e) is unambiguous: for property acquired by gift in a transfer described in section 1041(a), "the basis of such property in the hands of the transferee shall be determined under section 1041(b)(2) and not this section." A transfer to a spouse, or to a former spouse incident to divorce, carries the transferor's basis with no dual-basis loss haircut and no dead zone. Publication 551 states the same rule in its own section on property transferred from a spouse.

One further limb the heading promises. Section 1015(b) covers property acquired by a transfer in trust that is not a gift, bequest, or devise: the basis is the grantor's, "increased in the amount of gain or decreased in the amount of loss recognized to the grantor on such transfer." That is a different transaction from an ordinary gift and is why the section's title mentions transfers in trust separately.

How this sits against the rule at death. A gift moves basis; death resets it. That contrast is the sharpest planning consequence in this area and it is taught in full on the page for the step-up in basis, which owns date-of-death valuation and the disappearing gain. The point to carry away from this page is the narrower one: section 1015 is the reason a gift of appreciated property is a transfer of the tax bill as well as the asset, and section 1015(a)'s loss rule is the reason a gift of depreciated property destroys a deduction rather than transferring it.

The mechanics reduce to four questions asked in order: what did the giver pay, what was the property worth when it was given, what did the recipient sell it for, and was any gift tax paid on the transfer.

Where value at the gift was at or above the giver's basis, only the first question matters. The recipient takes the giver's adjusted basis for every purpose, and gain is the sale price minus that figure.

Where value at the gift was below the giver's basis, both bases are live and the answer depends on where the sale price falls. Publication 551's own example is the clearest statement of it, and its numbers are used here rather than invented ones because the illustration is the IRS's. Verbatim: "You received an acre of land as a gift. At the time of the gift, the land had an FMV of $8,000. The donor's adjusted basis was $10,000. After you received the land, no events occurred to increase or decrease your basis. If you sell the land for $12,000, you'll have a $2,000 gain because you must use the donor's adjusted basis ($10,000) at the time of the gift as your basis to figure gain. If you sell the land for $7,000, you'll have a $1,000 loss because you must use the FMV ($8,000) at the time of the gift as your basis to figure a loss."

And the third case, in the publication's own words: "If the sales price is between $8,000 and $10,000, you have neither gain nor loss. For instance, if the sales price was $9,000 and you tried to figure a gain using the donor's adjusted basis ($10,000), you would get a $1,000 loss. If you then tried to figure a loss using the FMV ($8,000), you would get a $1,000 gain."

So on those facts: sell at $12,000 and there is a $2,000 gain; sell at $7,000 and there is a $1,000 loss; sell anywhere from $8,000 to $10,000 and there is nothing to report. The $2,000 of built-in loss that existed at the moment of the gift is not transferred and not preserved. It is gone.

A hypothetical on the gain side, to show the size of what travels. Suppose Teodoro's aunt bought shares for $12,000 many years ago and gifts them to him when they are worth $70,000. He takes a $12,000 basis. He holds them for two more years and sells at $100,000. His gain is $100,000 minus $12,000, or $88,000, all of it long-term because her holding period tacks onto his. Only $30,000 of that growth happened on his watch. Had his aunt instead sold the shares herself and gifted the cash, the same $58,000 of pre-gift appreciation would have been taxed on her return at her rates, which is the real question behind most gift-versus-sell decisions: not whether the gain is taxed, but whose return it lands on and in which year.

Where carryover basis works in the recipient's favor

• The gift itself is not income. Nothing is taxed until the recipient disposes of the property, so the timing is theirs.
• The giver's holding period tacks on, so an asset gifted and sold immediately can still produce long-term capital gain rather than short-term.
• Where the recipient is in a lower capital gains bracket than the giver, moving the asset before the sale can lower the tax on the same gain. The kiddie tax and the assignment-of-income doctrine both constrain how far that goes.
• Where value at the gift is at or above the giver's basis, there is one basis and one clean answer.

The costs and the traps

• The recipient inherits the whole embedded gain, including decades of appreciation they had no part in, and finds out at sale rather than at the gift.
• A gift of depreciated property destroys the loss. The giver cannot deduct it because they no longer own the asset, and the recipient cannot deduct the part that accrued before the gift.
• The dead zone between the two bases catches people preparing returns, because both intuitive answers produce a number and the correct answer is zero.
• Basis has to be documented, and a donor's records for an asset bought thirty years ago frequently do not exist. Where the facts cannot be obtained, section 1015(a) lets the Secretary substitute a value determined administratively.
• Gift tax paid adds only its appreciation-proportionate share to basis, and for almost every donor there is no gift tax to add.
• The basis rule and the transfer tax rule are separate systems. A gift can be entirely free of gift tax and still hand over a large future income tax bill.