Basis in Assets: What it Means and Why it’s Important for Gifts and Inheritances

By: Bradley R. Coppedge, esq.

“Basis” is defined by Black’s Law Dictionary (6th ed.) as “The value assigned to an asset for the purpose of determining gain (or loss) on the sale or transfer or in determining value in the hands of a donee”. Stated in layman’s terms, your basis in an asset is the threshold for determining if any tax is due when the asset is subsequently sold.

The terms we will review to understand basis are Cost-Basis, Adjusted Basis, Carry-Over Basis and Stepped-Up Basis.

A person’s basis in an asset is initially his “cost-basis” in a purchased asset, i.e., the amount that was paid for an asset. Assuming there has been no depreciation claimed on tax returns (which would reduce basis), nor any significant capital improvements to the asset (which would increase basis), a person’s cost basis will remain as the basis until the asset is sold. (On the other hand, if the basis has been increased or decreased it is referred to as “Adjusted Basis”.)

If an asset is gifted during life to a third party, the person receiving the gift (the “donee”) takes what is known as a “carryover basis”, such that the donee’s basis is the same as that of the donor, whether that is the cost basis or adjusted basis. This is generally the rule for any asset gifted during life.

If an asset is instead inherited by a person upon another’s death, the recipient receives a “stepped up basis” such that the recipient’s basis becomes the value of the asset on the date of the decedent’s death. As such, capital gains taxes are only due upon a subsequent sale to the extent the sales price exceeds the stepped-up basis.

A common area where problems arise with basis are when elderly parents decide that they want to start making gifts. Oftentimes, the thought the person has is “if I gift it now, we won’t have as much to deal with at probate”. First, as I’ve pointed out in several prior articles, “probate” is not something to worry yourself over, at least in Georgia and Alabama. It is not a burdensome process where you have a properly prepared Last Will and Testament. Second, making such a gift can result in taxes subsequently being paid that could have been avoided.

Example: Mom, a widow, had a house that she and her husband paid $70,000 back in the late 1970s. Due to market increases and its prime location, it is now worth $400,000. Mom’s “basis” in the house is her original cost basis of $70,000 (with certain exceptions depending on when Dad died and what it was worth then). So if Mom gifts the house to her children prior to her death, the children take her carryover basis of $70,000. When they go to sell it after her death for $400,000, there is incurred $330,000 of capital gain, on which capital gain tax will be paid. If, on the other hand, she had bequeathed the house to the children at her death, the children would have received a stepped-up basis of $400,000, resulting in no capital gain when the children subsequently sold it!

Always make sure to seek counsel of your tax or estate planning attorney or other financial adviser before making gifts of appreciated assets, in order to make sure you are aware of the tax consequences of the same, so that you do not end up with a tax surprise.