Can You Avoid Capital Gains by Gifting?

Capital gains represent the profit realized from selling an asset, such as real estate, stocks, or other investments, that has increased in value. This gain is the difference between the sale price and the original purchase price, often called the cost basis. When an asset sells for more than its initial cost, a capital gain occurs, typically subject to taxation. The tax rate varies depending on how long the asset was held, distinguishing between short-term and long-term gains.

Gifting assets involves transferring ownership of property from one individual, the donor, to another, the recipient, without receiving comparable payment. This is a common strategy in personal financial planning, allowing individuals to transfer wealth during their lifetime. Gifting assets has distinct tax considerations that differ from those associated with selling assets outright. Understanding these implications benefits both the donor and the recipient.

Donor’s Capital Gains When Gifting

When an individual gifts an appreciated asset, the act of giving does not trigger a capital gain for the donor. The donor does not incur capital gains tax at transfer, even if the asset has significantly increased in value. The potential for capital gains tax liability transfers with the asset to the recipient, along with the donor’s original cost basis. This allows the donor to avoid the immediate tax event that would occur if the asset were sold.

This contrasts with selling the asset, where the donor would immediately realize appreciation and owe capital gains tax. For example, if a donor purchased stock for $10,000 and it is now valued at $50,000, gifting these shares does not result in a $40,000 taxable gain for the donor. The appreciation and original basis carry over to the recipient.

The donor does not “avoid” a capital gain they would have realized by selling; instead, the potential for that gain is deferred and shifted. This means the donor does not pay capital gains tax at the time of the gift, but the built-in gain persists within the asset. This dictates where and when capital gains tax liability may arise.

Cost Basis of Gifted Property

The cost basis of gifted property determines future capital gains or losses. When property is received as a gift, the recipient takes on the donor’s adjusted basis, known as a “carryover basis.” The recipient’s starting point for calculating gain or loss upon a subsequent sale is the amount the donor originally paid for the asset, plus any capital improvements. For instance, if a donor bought stock for $100 and gifted it, the recipient’s basis would be $100, regardless of the market value at the time of the gift. This carryover basis applies to various assets, including real estate and securities.

However, a special rule applies when the fair market value (FMV) of the gifted property at the time of the gift is less than the donor’s adjusted basis. This “double basis rule” or “split basis rule” establishes two different bases for the recipient: one for calculating a gain and another for calculating a loss. This rule prevents the transfer of unrealized losses, ensuring the recipient cannot claim a loss they did not personally incur.

For calculating a capital gain, the recipient uses the donor’s adjusted basis. If the recipient sells the asset for more than the donor’s original cost, the gain is computed using that basis. For example, if the donor’s basis was $100,000, and the FMV at the time of the gift was $70,000, selling the property for $120,000 results in a $20,000 gain ($120,000 sale price – $100,000 donor’s basis).

Conversely, for calculating a capital loss, the recipient uses the fair market value of the property at the time of the gift. If the asset sells for less than this lower FMV, a loss is recognized based on that value. Using the previous example, if the recipient sells the property for $60,000, the loss would be $10,000 ($60,000 sale price – $70,000 FMV at gift). This prevents the recipient from claiming a loss based on the donor’s higher original cost when the asset declined in value.

A unique scenario arises if the sale price falls between the donor’s adjusted basis and the fair market value at gift. In this range, the recipient recognizes neither a gain nor a loss. For example, if the donor’s basis was $100,000 and the FMV at the time of the gift was $70,000, and the recipient sells the property for $85,000, there is no taxable event. No gain is recognized because the sale price ($85,000) is less than the gain basis. No loss is recognized because the sale price ($85,000) is more than the loss basis.

Recipients should obtain and retain accurate basis information from the donor, including original purchase price, purchase date, and any improvements. They also need the fair market value at the time of the gift if the property declined in value. Without this documentation, determining taxable gain or deductible loss upon a future sale can be difficult. The carryover basis rule, with its double basis modification, shows gifting does not erase embedded gains or transfer losses for immediate tax benefit.

Recipient’s Tax Obligation Upon Sale

When the recipient sells a gifted asset, their tax obligation for capital gains or losses becomes clear. The gain or loss is calculated by subtracting the determined cost basis (established by carryover or double basis rules) from net sale proceeds. If the sale price exceeds the applicable basis, a capital gain results; if less, a capital loss occurs. This calculation uses the basis information carried over from the donor.

The recipient’s tax obligation depends on the asset’s holding period. The recipient generally includes the donor’s holding period when determining their own, known as “tacked-on basis.” This combined holding period classifies the gain or loss as short-term or long-term. Short-term capital gains apply to assets held for one year or less, taxed at ordinary income rates. Long-term capital gains apply to assets held for more than one year, typically benefiting from lower tax rates.

For example, if a donor held stock for six months and then gifted it, and the recipient sells it seven months later, the total holding period is 13 months. Even if the recipient held it for less than a year, the gain or loss is long-term due to the tacked-on holding period. This can affect tax liability, as long-term rates are often more favorable.

The recipient pays capital gains tax, realizing the profit from the sale. This can result in a tax bill for the recipient, especially if the gifted property appreciated since the donor’s original purchase. For instance, if a property gifted with a carryover basis of $100,000 sells for $500,000, the recipient is responsible for capital gains tax on the $400,000 gain.

While some homeowners may qualify for an exclusion of capital gains on the sale of a primary residence (up to $250,000 for single filers and $500,000 for married couples), this exclusion does not automatically transfer to a gifted home recipient. The recipient must meet ownership and use tests, typically living in the home as their primary residence for at least two of the five years preceding the sale. Gifting an appreciated primary residence may not be as beneficial unless the recipient occupies the property for the required period.

Gift Tax Implications

Gift tax is a federal levy on the transfer of money or property without receiving full value, separate from capital gains tax. Unlike capital gains, which apply to profit from a sale, gift tax applies to the act of giving the gift itself. The donor, not the recipient, is generally responsible for gift tax.

The Internal Revenue Service (IRS) provides an annual gift tax exclusion, allowing individuals to give a specific amount of assets to as many people as they wish each year without triggering gift tax reporting or reducing their lifetime exemption. For 2025, this annual exclusion is $19,000 per recipient. A donor can give $19,000 to multiple individuals without gift tax implications. Married couples can combine their exclusions, allowing them to give up to $38,000 per recipient in 2025.

Gifts exceeding the annual exclusion generally require the donor to file federal gift tax return Form 709. Filing this form does not necessarily mean gift tax is owed. Instead, the excess amount above the annual exclusion reduces the donor’s lifetime gift tax exemption.

The lifetime gift tax exemption is a cumulative amount an individual can gift during their lifetime, or leave as part of their estate, without incurring federal gift or estate taxes. For 2025, the lifetime gift tax exemption is $13.99 million per individual. Married couples can double this amount to $27.98 million. If total taxable gifts made over a donor’s lifetime exceed this exemption, gift tax may become due.

Even if no gift tax is immediately due because the lifetime exemption covers the excess gift, filing Form 709 is required for gifts above the annual exclusion. This form tracks the portion of the lifetime exemption used. Certain transfers, like direct payments for tuition or medical expenses to an educational or medical institution, do not count against the annual exclusion or lifetime exemption.