How do gift tax rules affect cost basis and future capital gains?

Gifting transfers ownership of property without full payment and triggers two separate but related tax consequences: the gift-tax reporting/limit rules that can require Form 709, and the cost-basis rules that determine the recipient’s capital gains when they later sell the asset. These rules are designed so gifts avoid double taxation but can create surprises if records are missing or the donor’s basis differs greatly from current market value (FMV).

Key rules you need to know

  • Annual exclusion and Form 709: If a donor gives more than the annual exclusion amount to a single recipient in a calendar year, the donor must file IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, even if no gift tax is due because of the lifetime exemption. See IRS Topic 701 and Form 709 instructions for current filing thresholds and procedures (IRS). IRS Form 709 and Topic 701.

  • Lifetime exemption: Gifts above the annual exclusion reduce the donor’s lifetime estate-and-gift exemption. That lifetime exemption amount is indexed and has changed over time; for example, it was $12.92 million in 2023. Always confirm the current exemption and threshold amounts on the IRS website before planning large gifts (IRS).

  • Basis carryover (general rule): In most lifetime gifts, the recipient takes the donor’s adjusted basis (the donor’s cost plus any allowable adjustments) and the donor’s acquisition date carries over for long-term/short-term holding period purposes. This carryover basis matters when the recipient later sells the asset because capital gains are calculated using that original basis (IRS Publication 551).

  • Special dual-basis rule (losses vs gains): If the FMV at the gift date is less than the donor’s basis, the tax code uses a dual or split-basis rule for the recipient: for determining gain, use the donor’s basis; for determining loss, use the FMV at the date of gift. If the recipient later sells between the FMV and the donor’s basis, neither a deductible loss nor a taxable gain is recognized. See IRS Publication 551 for the details.

  • Gifts to spouses and noncitizen spouses: Gifts between U.S. citizen spouses are generally unlimited and not subject to gift tax. Special higher limits apply to gifts to noncitizen spouses; check current IRS guidance for the annual dollar limit (IRS Topic 709/709 instructions).

  • Gifts to charity: Donating appreciated assets to a qualified charity is treated differently — the donor may be able to claim a charitable deduction for the FMV (subject to rules), and the charity typically takes a stepped-up basis equal to FMV when it later sells the asset. See IRS guidance on charitable contributions for specifics.

Practical examples (applied)

Example 1 — Stock gift with carryover basis:
A donor originally bought 100 shares for $10,000 (basis $100/share). Years later, the shares are worth $20,000 and the donor gives them to a child. The child’s basis generally is the donor’s $100/share basis and uses the donor’s acquisition date. If the child later sells at $30/share, capital gain is calculated on the difference between $30 and $10 (the original basis) per share.

Example 2 — Gift where FMV is below donor basis (split-basis):
Donor’s basis: $50,000. FMV at gift date: $30,000. Recipient later sells for $40,000. Because $40,000 is between FMV ($30k) and donor’s basis ($50k), the sale produces no taxable gain and no deductible loss under the dual-basis rule.

Example 3 — Real estate and improvements:
When gifting real estate, the recipient inherits the donor’s basis adjusted for capital improvements, depreciation, and any previous casualty losses. Good records of purchase price, improvement receipts, and depreciation schedules are essential. The recipient will have the donor’s holding period for determining long-term vs. short-term gain.

Recordkeeping checklist (donor and recipient)

Donor responsibilities:

  • Keep original purchase documents, closing statements, receipts for improvements, depreciation records if rental property, and records of any adjustments to basis.
  • If you exceed the annual exclusion for any recipient, prepare and file Form 709 in the year of the gift (the donor is responsible for filing).
  • Track lifetime gift totals against the estate-and-gift lifetime exemption and note any use of exemption on Form 709.

Recipient responsibilities:

  • Obtain a written statement from the donor showing the donor’s adjusted basis and the gift date FMV. If the donor won’t or can’t provide records, assemble as much corroborating documentation as possible (brokerage statements, closing docs, old tax returns showing depreciation, etc.).
  • When selling, match lots carefully and retain trade confirmations and 1099-B forms from brokerages; brokerages report sales to the IRS and often include basis data for lots acquired by purchase but not for gifts—so your paperwork matters.

Brokerage and cost-basis reporting for securities

Brokerage firms report realized gains and basis to the IRS on Form 1099-B. However, brokerage systems are designed for purchases and sales they record; when shares are received as gifts, the recipient should:

  • Tell the receiving brokerage the donor’s acquisition date and basis for each lot transferred, and provide supporting statements.
  • Consider specific-lot identification when selling to control which basis applies to sold shares and to time gains or losses. If you do not identify lots, the default sale method may be FIFO or the broker’s default, which can lead to higher taxes.

For more on tracking lots and family transfers, see our guide on Managing Basis and Lots in Family-Transfer Transactions.

Planning strategies and professional tips

  • Maximize the annual exclusion each year: Small, recurring gifts keep money out of your taxable estate and avoid eating into the lifetime exemption.

  • Use the lifetime exemption carefully: When you exceed the annual exclusion, you consume part of your lifetime exemption. Large estate-gift planning should be coordinated with your estate attorney and CPA.

  • Consider gifting appreciated securities directly versus selling and gifting cash: Donors who give appreciated stock to family or to charity can shift future capital-gains tax to the recipient (or avoid it if donated to charity), so always evaluate whether the recipient has the means to pay the tax when they sell.

  • Gift timing and step-up alternatives: In many cases, holding appreciated assets until death can produce a step-up in basis for heirs (inherited property typically receives a step-up to fair market value at death). That can be preferable to gifting during life depending on goals. Compare the estate-tax and income-tax trade-offs with your advisor.

  • Keep records when gifting property with depreciation: For rental property, the recipient may take on depreciation recapture exposure when selling; accurate depreciation history is necessary to compute taxable amounts.

Common mistakes to avoid

  • Not filing Form 709 when required; remember that the donor, not the recipient, is responsible for filing.

  • Assuming market value at gift equals recipient basis: In most gifts the donor’s basis carries over. The market value only becomes the recipient’s basis for loss-determination in the split-basis situation.

  • Poor documentation: Missing closing statements, missed improvement receipts, or incomplete brokerage lot records can make it hard to prove basis to the IRS and can lock in higher taxes.

  • Forgetting special gift rules: Certain gifts (e.g., future interests, some tuition or medical direct payments, gifts to noncitizen spouses) have special rules and reporting thresholds.

Action steps — what to do this year

  1. Confirm current annual exclusion and lifetime exemption with the IRS before making large gifts (limits change annually). See IRS Topic 701 and Form 709 instructions.
  2. Use the annual exclusion fully by gifting up to the limit to each intended recipient in cash, securities, or other property.
  3. Create a gifting file: donor purchase records, closing statements, improvement receipts, depreciation schedules, and a dated statement of FMV at gifting.
  4. If transferring securities, transfer them in-kind between brokerages and provide lot-level basis information to the receiving broker.
  5. Consult a CPA or estate planning attorney before gifting property with substantial appreciation or complex basis history.

Useful internal resources

Professional perspective

In my practice helping clients with gifting and estate transitions, the biggest value comes from good documentation and early coordination between tax preparers, financial advisors, and estate attorneys. Small annual gifting can reduce future estate exposure without triggering immediate tax headaches — but handing over an asset without paperwork often creates larger tax costs for your loved ones.

Professional disclaimer

This article is educational and not tax, legal, or financial advice. Rules and dollar thresholds change; consult a qualified tax advisor or estate attorney for tailored advice and to confirm current numbers and filing requirements (IRS resources such as Form 709 instructions and Publication 551 provide official guidance).

Authoritative sources