Legal Definitions - carryover basis

"Carryover basis" is a tax concept used to determine the original cost of an asset for tax purposes when that asset has been received as a gift. When an individual sells an asset, they typically calculate their taxable profit (known as a capital gain) by subtracting their original purchase price (their "basis") from the sale price. However, if an asset was received as a gift, the recipient did not purchase it and therefore does not have their own original purchase price.

Under the carryover basis rule, the recipient of a gifted asset must use the original donor's purchase price as their own basis. This means that any increase in the asset's value from the time the donor first acquired it until the recipient sells it will be considered a capital gain for the recipient. This rule ensures that the capital gains tax liability associated with the asset's appreciation is not avoided simply because the asset was transferred as a gift.

• Example 1: Gifting Real Estate

  Imagine a grandmother, Eleanor, bought a small vacation cabin in 1995 for $70,000. In 2020, when the cabin was appraised at $250,000, Eleanor decided to gift it to her grandson, David. In 2023, David sells the cabin for $300,000. Under the carryover basis rule, David's basis for the cabin is Eleanor's original purchase price of $70,000. When David sells the cabin for $300,000, his capital gain is calculated as $300,000 (sale price) - $70,000 (carryover basis) = $230,000. David would owe capital gains tax on this $230,000, even though the cabin was already worth $250,000 when he received it.

• Example 2: Gifting Investment Shares

  Consider a scenario where a father, Mr. Henderson, purchased 500 shares of "Global Innovations Corp." stock in 2010 for $20 per share, totaling $10,000. In 2022, when the shares were valued at $75 per share ($37,500 total), Mr. Henderson gifted them to his daughter, Maria. In 2024, Maria sells all 500 shares for $90 per share, totaling $45,000. Maria's basis for these shares is the carryover basis from her father, which is $10,000 (500 shares * $20/share). When Maria sells the shares for $45,000, her capital gain is $45,000 (sale price) - $10,000 (carryover basis) = $35,000. She is responsible for capital gains tax on this $35,000.

• Example 3: Gifting a Valuable Collectible

  Suppose an avid collector, Ms. Rodriguez, acquired a rare first-edition book in 1990 for $2,000. In 2018, when the book was appraised at $15,000, Ms. Rodriguez gifted it to her mentee, Alex. In 2023, Alex decides to sell the book at a specialized auction, where it fetches $20,000. Alex's basis for the book is the carryover basis from Ms. Rodriguez, which is her original purchase price of $2,000. When Alex sells the book for $20,000, his taxable capital gain is $20,000 (sale price) - $2,000 (carryover basis) = $18,000. This illustrates how the original owner's cost is "carried over" to the recipient for the purpose of calculating capital gains tax.