Revenue Ruling 82-13: Donor’s Gain on Net Gifts

A “net gift” is an arrangement where the recipient of the gift (the donee) agrees to pay the resulting federal gift tax. This obligation normally falls on the person giving the gift (the donor). This strategy is often used by individuals who wish to transfer significant assets, such as real estate or stock, but may not have the available cash to cover the gift tax liability. By shifting the tax payment to the donee, the donor can complete the transfer without needing to sell other assets to raise funds.

The Net Gift Transaction Explained

A net gift is a transfer of property where the transaction is explicitly conditioned on the donee paying the gift tax. This is a binding agreement that becomes part of the gift’s terms. Without this condition, the legal obligation to pay the tax would remain with the donor.

The value of the gift for tax purposes is effectively reduced by the amount of the gift tax the donee pays. This technique is particularly useful for donors holding valuable but illiquid assets. It allows them to pass on the asset intact without having to sell a portion of it to cover the tax.

Calculating the Applicable Gift Tax

Calculating the gift tax in a net gift scenario involves an interdependent formula because the tax paid by the donee reduces the value of the gift itself. The Internal Revenue Service (IRS) provides a specific formula to resolve this circular calculation, as outlined in Revenue Ruling 75-72: True Tax = Tentative Tax / (1 + Rate of Tax).

To apply this, one must first determine the “tentative tax.” This is the tax that would be due on the full, gross value of the gift before accounting for the donee’s tax payment. This involves taking the property’s fair market value, subtracting the annual gift tax exclusion ($19,000 for 2025), and applying the relevant tax rates.

Consider a donor who makes a gift of property valued at $1,100,000 and has already used their entire lifetime gift tax exemption. Assuming a 40% tax rate and after applying the $19,000 annual exclusion, the taxable gift is $1,081,000. The tentative tax would be 40% of this amount, or $432,400. Using the formula, the true tax the donee must pay is calculated as $432,400 / (1 + 0.40), which equals $308,857.14.

The donor is required to report this transaction to the IRS by filing Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return. On this form, the donor shows the fair market value of the gift and then subtracts the gift tax paid by the donee to arrive at the final net taxable gift.

Income Tax Consequences for the Donor

As clarified in Revenue Ruling 82-13, a net gift can create income tax for the donor. The IRS views the transaction as a “part gift, part sale.” The “sale” portion is the economic benefit the donor receives by being relieved of their gift tax obligation, and this relief from a debt is treated as an amount realized from the disposition of property.

A taxable capital gain occurs if the gift tax paid by the donee is greater than the donor’s adjusted basis in the transferred property. The formula is: Gain = Gift Tax Paid by Donee – Donor’s Adjusted Basis. This principle was affirmed by the Supreme Court in the 1982 case Diedrich v. Commissioner.

Continuing the previous example, assume the donor’s adjusted basis in the $1,100,000 property was $200,000. The gift tax paid by the donee was $308,857.14. The donor’s recognized capital gain would be $308,857.14 minus $200,000, which equals $108,857.14. The donor must report this gain on their income tax return. If the gift tax paid by the donee is less than the donor’s basis, no income is recognized.

Determining the Donee’s Basis

The tax implications of a net gift extend to the recipient, specifically concerning their tax basis in the property. Basis is used to calculate the donee’s own capital gain or loss if they later sell the asset. Under IRS regulations, the donee’s basis is the greater of two amounts: the donor’s adjusted basis in the property at the time of the gift, or the amount of gift tax the donee paid.

This rule ensures that the portion of the transaction considered a “sale” is reflected in the new owner’s basis. This differs from a standard gift, where the donee typically just carries over the donor’s basis.

Using the ongoing numerical example, the donor’s adjusted basis was $200,000, and the gift tax paid by the donee was $308,857.14. Since the gift tax paid is the larger of the two figures, the donee’s new basis in the property is $308,857.14. If the donee were to sell the property for its fair market value of $1,100,000, their taxable capital gain would be $791,142.86.