 Hello, and welcome to this session in which we will discuss gift tax basis. In other words, we need to learn how to compute the tax basis for a gift. Well, what's unique about a gift? Well, you don't pay for a gift. When someone gives you a gift, you don't invest any money in it. They're giving it to you without any consideration in return. You're not paying them anything. So the question becomes, what is your basis in that gift? Is it zero? Well, it cannot be zero. You have to have a basis. Why do you need the basis? Well, let's just make sure we understand why we need the basis. Because when you sell it in the future, you have to compare the amount realized or consideration received versus the basis to find out whether you have a gain or a loss. Also, when you have this asset, you might have to depreciate the asset. Well, I need to know my basis in order to depreciate the asset. Therefore, in this session, we would learn about how to determine your tax basis when you receive a property in a gift transaction. To establish the basis of a gift property, you must know the property adjusted basis to the donor. Who is the donor? The donor is the rich uncle or aunt or grandpa or grandma. So the donor is the person, the generous person that's going to give you the gift. Think of donor as employer and think of the donor as an employee, the person that's receiving the gift. So first, you have to know the adjusted basis. Also, you have to know the fair market value at the time you were giving the gift. And also, you have to know if there's any taxes paid on the property. And we will see why you need to know this. So you need to know three things first. The basis, specifically not the basis, when we say basis adjusted basis, the fair market value when they gave you that gift, and if they paid any taxes on that property. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today, no obligation, no credit card required. Let's take a look at the general rule first, then we'll look a little bit more into the specifics. For gift property, the general rule is the donor basis or the donor adjusted basis is carried over to the donor. So whatever their basis were, the basis will transfer to you. That's the general rule. We're going to see an exception to this. Also, you would increase the basis by the amount of gift tax paid by the donor that's attributable to the increase in the property value. So if this property increased in value and as a result of that increase, the donor paid the tax, well, your basis will be increased by a proportion of that tax. Don't worry, we'll look at an example. Just know if the donor paid taxes, your basis will be increased a little bit. We'll look at an example with numbers. So the general rule applies anytime the fair value of the gift at the time of the gift is equal or greater than the donor basis. So I'm going to, here you have to pay attention. So this general rule that their basis, the donor basis transfer to the donor basis when, when, when, when the gift, when the gift that you gifted has a fair market value greater than the adjusted basis. Let's work an example, just not work an example, give you an example. For example, if someone gave you 100 shares of Apple stock, their basis is $65. That's their basis. And at the time of the gift, the stock price was 95. Well, guess what? That's great. The fair value is greater than the basis. So this general rule would apply. Simply put, they're giving you a gift and that gift already appreciated. It went up in value. So they're not giving you something that lost value. They're giving you something that increased in value. So the fair value is greater than the adjusted basis. So the general rule, let me write it here one more time, the basis to the donor equal to the basis of the donor plus in case the donor paid any tax attributable to the increase in property value, we would look at numbers soon about this example. Let's look at a simple example that we would look at an example with tax implication. John received a piece of land as a gift from his friend Jay. Great. Jay is the generous person. At the time of the gift, the land has an adjusted basis of 45. We know the adjusted basis and the fair market value of 60. Three months later, John sold that land. So when John sold the land, how much profit they would realize? Well, we have to determine what's John's basis. Determine John's basis of the land and the amount recognized from the sale. Well, John's basis, since the land had a fair market value greater than the adjusted basis, John's basis will be the same as Jay, which is how much? 45. Well, so the John's basis in the land is 45. Now John sold it for 65. Well, if you sold it for 65 and you have a basis of, we're considering a basis of 45, guess what? You have a recognized gain of 20. Let's change a scenario a little bit. Assume that Jay paid a gift tax of 5,000. Let's ignore the annual execution for gift. We're not going to get into that. Just if you are told that the donor also paid $5,000 in taxes as a gift tax. Now, you have to understand that portion of that $5,000 is attributed to the increase in the fair market value. So you have to find out of that $5,000 how much is attributed to the fair market value. Think about it. Who's the donor? Jay. When Jay's basis worth 45, when he gifted it, it went up to 60. So there's a $15,000 increase in value. Well, here's what's going to happen. If there's a $15,000 increase in value, we're going to take the increase in value divided by the amount gifted. So we're going to take 65 minus 45. So there was an increase of 15,000 in market value divided by 60. And if we took 15 divided by 60, we need to find this ratio. So simply put, the asset increased by 25% for Jay. Now Jay paid in total 5,000 in taxes. So guess what? Of that 5,025% of it is attributed to the increase in the value. As a result, it's going to give us 1,225. This 1,225 is added to the basis. It's added to the basis. Simply put, the basis is 45 plus 1,220, 1,250. Therefore, John's basis is 46,250. Now, in the real world, this doesn't, this does not happen. They may throw something at you at the CPA exam. I highly doubt it because now, gift taxes, to pay gift taxes, you have to have a lot of money, like millions and millions. Therefore, they don't cast it very heavily. But the point is, you need to know, they might throw you one questions from their database. So know that part of the taxes, will it be increased to the basis in proportion to the increase in the fair value? Just know this. Exception to the general rule. Now, we talked about the general rule. And we said the general rule is when the fair value is greater than the adjusted basis. When the fair value is greater than the adjusted basis, easy. The basis of the donor equal to the basis of the donning. So whatever the basis of the donor was, transferred. Now, when the fair value of the property at the time of the gift is less than the donor basis, now we're looking at fair value of the gift is less than the adjusted basis. The dony basis now, what's the, what's the dony basis? Well, we don't know. It's going to depend on the future selling of the property. And whether the property result in a gain or a loss to the dony. So now we're going to look at the exception. It's very simple rules. I'm going to show you the rules. Please follow with me. This following rule prevent taxpayer from shifting losses among family members to friend who received the greatest benefit gift. So simply put what happened is, if you have a loss, what you do is you give that property to someone who needs the loss and they will benefit from it. That's what they want to avoid. If the property, if the property is subsequently sold at a price lower than the fair value. So now they donated the property that's lower than the the fair value is lower than the adjusted basis. Now, if later on the dony sold that property lower than the fair value, well, then the fair value is the basis. So in other words, the last basis is the basis fair market value at the time of the gift. So it becomes the basis becomes the fair value. Simply put, let me show you a line. Let's assume we have a line here. We have the basis. Okay. And now when we gifted this, when we gave the gift, gift was the fair market value was below the fair market value was below the basis. Now what you did is you sold the dony sold the big sold the asset below the fair market value, whatever that number is, even below. And what's what's going to happen, your basis becomes the fair market value, your basis becomes the fair market value. So if the selling price is less than the fair market value, use the fair market value. Okay, now let's change the scenario. Same thing. Some a donor gifted the property with a fair market value less than the adjusted basis. Now when the dony, let's see what what situation of the property subsequently sold for for a price higher than the dony. Now the dony waited on that property and the property went up in value. So now it's above the basis. Remember, they donated it at fair value. It was below basis. Now when they sold it, it was above the basis. What do we use as the basis? Guess what? The basis. Notice it's the line that's closest to you. Notice when you sold it below fair value, fair market value was the line closest to you. When you sold it above basis, the basis is the line to you. So in other words, the gain basis is the donor basis as the time of the gift. It's the basis. So if the selling price is greater than the adjusted basis, use the adjusted basis as the basis. Now the third scenario is what? What do you think the third scenario is? What if the dony sold the asset? Let me change a different color with a different color. Sold the sold this gifted property here someplace between the basis and the fair value. Well, good news. Guess what? There is no gain and no loss under those circumstances. So if you sold it for whatever the price you sold it for, we're going to look at numbers. The basis will be equal to that price. Therefore, if the property subsequently sold by the dony at a price between the donor basis and the fair value, the dony uses the selling price as the basis. Well, if the selling price is the basis, selling price equal the basis. So if I said my selling price is 10,000 and my basis is 10,000, I have no gain and no loss. Use the selling price as the basis. Now it's better to work with numbers. We'll work with numbers. Don't worry about this. Now let's talk about the depreciation basis. It's important to know that the dony's basis for the gifted property, for the depreciation basis, is always the lesser of, for the depreciation purpose, the adjusted basis, the donor's adjusted basis, or the fair value of the property received at the time of the gift, the lower of these two. Don't worry. We're going to look at numbers and we'll see how it works. Jimmy received the car on his birthday as his birthday gift from his friend, generous friend. At the time of the gift, the car had an adjusted basis of 25. So we have an adjusted basis equal to 25K and the fair market value of 21. So now we need the exception rule because the fair value was less than the adjusted basis. After five months, Jimmy decided to sell the car to unrelated party. Now just forget about it. It doesn't have to be car or anything. Think of this as stocks because car is, you know, some people confuse a personal property. They gave you 25,000, 21,000 worth of stocks with an adjusted basis of 21, just because I don't want to confuse you with personal property. After five months, Jimmy decided to sell the car or the stocks to unrelated party, determine the basis for the car or for the asset. Well, if he sells the car for 19, let's go back and show you what I showed you earlier, that line. Remember the line that I showed you, I said we have the basis and here we have numbers. The basis is 25,000. The fair value, the fair value was 21. Now we sold the car at 19. What are we going to be considering the basis? You guessed it, the fair value. It's the closest thing to the basis. If we sold the car for 23, if we sold the car for 23, right here, no gain and no loss, whatever the car, the stocks, the asset, if we sold the asset for 25,500, which is here, the basis will be 25. So that's the solution. Now we can look at it. At the time of the gift, the car had a fair value of 21, which is less than the donors. Therefore, the car depends on the future selling price. If Jimmy sold the car for 19, lower than the fair value, then the fair value will be the basis and we would incur a loss. If we would incur a loss of 2000, which I already told you this. If the car was sold for 23, it's in between. Therefore, we would have no gain and no loss. If Jimmy sells the car or the asset or the stocks for 25,500, it's above the basis. Well, guess what? The basis will be the basis will be the original basis, 25,000 will be the basis. And as a result, we will have a gain of 500. Now let's talk about the holding period of a gift. We need to know what's the holding period, because that's going to determine whether we have a long-term or a short-term gain or loss. The donate holding period for the gift property is determined as follow. Let's follow. When the donor adjusted basis is carried over to the donate, the holding period for the donate is considered to have started with the donor. So remember, if we have the general rule, donor basis equal to the donate basis, then also the holding period starts with the donor, whatever the donor holding period was. And the holding period could be, the donor could have bought this asset the stock a long time ago or recently. It doesn't matter. The donor holding period will transfer. When the fair value of the property at the time of the gift determines the donor's basis, the donate holding period start at the day after the property was gifted. If we're using the fair market value of the property at the time of the gift, then we have the, then the holding period start the day after the property was gifted. So it's a different rule when the fair value of the property at the time of the gift determine the donor basis. So if the fair value is the basis, then the holding period start the day after the property was gifted. When the subsequent selling price of the property determines, when the subsequent selling price of the property determined the Donis basis, the holding period is irrelevant because the Donis recognized no gain and no loss for the sale of the transaction. Again, let's take a look at an example. On June 17, Alex received a property valued at 9,500 as a gift. Bob acquired the property 20x1. At the time of the gift, Bob's basis of the property is 12,000. So we have the basis of 12. At the time of the gift, again we're dealing with the exception rule 9.5,000. Bob's basis in the property is 12, and Alex sold the property at 413,000. So Alex sold the property right here. Alex sold the property at 13,000. Well, if Alex sold the property for 13,000, the basis is 12, determine Alex's basis for the gifted property and the amount and the nature of the gain. Well, at the time of the gift, the property had a fair value 9,000, which is lower than the 12, which is, we have the exception. Alex's basis depend on the property future selling price, given that the Alex sold the property for 13, Bob's basis to the property to Alex who would recognize a gain of 1,000, which is the difference between 13 and 12. He sold it at 13. There's a $1,000 gain. In addition, the holding period starts March 12, 20x1 on the date which Bob acquired the property because we're using the basis. As a result, the gain recognized as long term as the property was held more than a year. Remember x1 to x5, then sold it in x6. So the original basis is March 12x1, which is long term. Assume now that the property was sold for 8,000. Okay, let's go back and draw the scenario here. We have, let's look at the numbers basis of 12. The basis were 12. The fair market value was 9 at the time of the gift. Now we sold it at 8. Now we sold it at 8. Okay, so that's what happened. Alex sold the property for 8, which is less than the fair market value at the time of the gift. The fair value of the property at the time of the gift determines Alex's basis. So the fair market value is the basis. Accordingly, Alex should recognize a loss because it's the closest to the, the closest line is fair market value, a loss of $1,500. Alex holding period for the property start on the day after the date was gifted, which is June 18, 20x5, because it was gifted June 17, June 18, the holding period start. June 18, 20x5, it was sold, when was it sold? I believe in 2006, what, when was it sold? Sold May 14 towards less than a year. We're looking at short term here. We're looking at short term because it was sold in May 14, 20x6. So this is basically a good explanation of the gift tax. What should you do now? Whether you are a CPA candidate, EA candidate, or an accounting students go to Farhat lectures and work MCQs that's going to help you reinforce. You need to be tested about this. Invest in yourself, invest your time to get this under control so you will do better on the exam. Study hard. The CPA exam is worth it.