September 29, 2010

Dear Carrie,

Am I right to assume that, for determining gift tax liability, the value of a gift of stock is the cost basis?

A Reader

Dear Reader,

I’m glad you asked this question because gifts of stock can raise a lot of tax issues. That’s because there are different ways of valuing stock depending on whether it’s for gift tax or capital gains tax purposes.

While your question is specifically about gift tax valuation, I’m going to expand my answer a bit. The gift tax liability applies only to a donor who gives more than $13,000 to any one person in a given year. (The recipient of a gift never has to pay a gift tax.) But the valuation for capital gains tax liability at the time of a sale is of particular importance to the lucky person receiving the gift.

Valuing stock for gift tax purposes

The simple answer to your question is no, the value of a gift of stock for determining gift tax liability is NOT the donor’s cost basis, but rather the fair market value of the stock at the time the gift is given. So let’s say you purchased 100 shares of XYZ stock at $50 a share. Your cost basis is $5000. Now the stock is $80 a share and you want to give it as a gift. The value of your gift for gift tax purposes would be $8,000.

Current gift tax law allows you to give up to $13,000 to any number of individuals each year without paying a gift tax or even reporting the gifts. If you give over that amount to any individual, you must report the gift on your tax return, but you don’t have to pay any gift tax until you give away more than the lifetime limit of $1,000,000based on the amount given above and beyond $13,000 per year per person. So in this example, there would be no gift tax liability. However, if the stock happened to be $150 a share, the value of the gift would be $15,000. You’d then have to report it and $2,000 would be applied toward your $1,000,000 lifetime exclusion.

Valuing a gift of stock for capital gains tax treatment

The good news for the recipient of a gift of stock is that there’s no tax on the gift itself. It’s when the recipient decides to sell the stock that the issue of valuation comes up. And this is where things get a bit more complicated.

In general, when valuing a gift of stock for capital gains tax liability at the time of sale, it’s the donor’s cost basis and holding period that rules. As an example, let’s say you receive a gift of stock from your grandfather. He bought it for $10 a share and it’s worth $15 a share on the day you receive it. If you then sell the stock, whether for a gain or a loss, your cost basis will be the same as your grandfather’s: $10 per share. Sell it at $25 and you’ll pay tax (at the short or long-term rate, depending on how long he owned the stock) on a gain of $15 a share; sell it at $8 and your capital loss will be $2 a share.

But now let’s say the stock your grandfather bought for $10 a share was only $5 a share on the day you received it. If the stock continues to go down and you decide to sell it, the fair market value on the date you receive the stock and your holding period (which also begins on the date you received it) is used to determine your loss. So if you sell the stock for $3 a share, your capital loss will be $2 a share and your holding period will be measured from the transfer date. However, if the stock price rises above $10, then the original cost basis and original holding period transfers over to you. For example, if the stock in this case rose to $15, you would report a $5 gain and your holding period would be measured from when your grandfather first bought the stock. There is one important exception: If you sell the stock at a price somewhere between your grandfather’s $10 basis and the $5 fair market value, no gain or loss is recognized.

Determining fair market value

The concept of “fair market value” comes into play whether you’re looking at gift or capital gains tax liability, so it’s important to know how this is determined. Since stock prices can go up or down on any given day, the fair market value of a gift of stock is the average between the high and low share prices on the date the gift is given.

As you can see, while the answer to your question is pretty straightforward, there’s a lot more to be aware of when it comes to gifts of stock. As always, it’s a good idea to talk to your tax advisor. And, one last pointtry not to let IRS rules and regulations spoil the pleasure you can get from both giving and receiving!