Basis Rules for Acquired Property

How you acquire property determines its tax basis. Understanding these rules is essential for advising clients on estate planning, gift strategies, and family transactions.

Inherited Property: Stepped-Up Basis

Under IRC Section 1014, property acquired from a decedent receives a stepped-up basis equal to the property's fair market value (FMV) at the date of death.

Valuation Options

Alternate Valuation Date Requirements:

• Must file estate tax return (Form 706)
• Must reduce both estate value AND estate tax liability
• Once elected, applies to ALL estate assets (cannot cherry-pick)

Key Features of Inherited Basis

Example: Father purchased stock for $20,000. At his death, the stock is worth $100,000. His daughter inherits the stock with a stepped-up basis of $100,000. If she sells for $105,000, she recognizes only $5,000 of gain.

Assets That Do NOT Receive Step-Up

• IRAs and 401(k)s - subject to income tax when distributed
• Annuities - taxable portion remains subject to income tax
• Income in Respect of a Decedent (IRD) - items that would have been taxable to decedent

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Gifted Property: Carryover Basis Rules

Property received as a gift generally takes a carryover basis-the donor's adjusted basis carries over to the donee.

General Rule: Carryover Basis for Gains

When the FMV at gift date equals or exceeds the donor's basis:

Donee's Basis = Donor's Adjusted Basis

The donee's holding period includes the donor's holding period (tacked).

Exception #1: Double Basis Rule (Loss Property)

When FMV at gift date is LESS than donor's basis, a special "double basis" rule applies:

Example: Andrea's basis is $10,000. She gifts property to Sam when FMV is $8,000.

• Sam sells for $11,000: Gain = $11,000 - $10,000 = $1,000 gain (uses donor's basis)
• Sam sells for $7,000: Loss = $7,000 - $8,000 = $1,000 loss (uses FMV at gift)
• Sam sells for $9,000: No gain or loss (in the gap between bases)

Holding Period for Loss Property: When the donee uses FMV as basis (for a loss), the holding period starts at the date of the gift.

Exception #2: Gift Tax Paid Increases Basis

When the donor pays gift tax on appreciated property, the donee's basis may be increased:

Basis Increase = Gift Tax Paid x (Net Appreciation / Taxable Gift)

Where:

• Net Appreciation = FMV at gift - Donor's Adjusted Basis
• Taxable Gift = FMV - Annual Exclusion ($19,000 in 2025)

Example: Joe gifts property worth $250,000 (basis $100,000) and pays $100,000 gift tax.

• Net Appreciation = $250,000 - $100,000 = $150,000
• Taxable Gift = $250,000 - $19,000 = $231,000 (using the 2025 annual exclusion)
• Basis Increase = $100,000 x ($150,000 / $231,000) = $64,935
• James's Basis = $100,000 + $64,935 = $164,935

Important: The basis increase cannot exceed FMV at the time of the gift.

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Section 267: Related Party Transactions

Section 267 disallows loss deductions on sales or exchanges between related parties.

Who Are Related Parties?

How Section 267 Works

1. Seller's loss is permanently disallowed - cannot deduct the loss
2. Buyer gets dual basis (like loss property gifts):
   • Seller's basis for gains
   • FMV for losses
3. Buyer may use disallowed loss to offset future gains on that property

Example: Jack sells stock to his brother Pete. Jack's basis = $120,000; FMV = $40,000.

• Jack's $80,000 loss is disallowed (related party)
• Pete's basis: $120,000 for gains, $40,000 for losses
• If Pete sells for $55,000: No gain or loss (in the gap)
• If Pete sells for $130,000: Gain = $130,000 - $120,000 = $10,000 (the disallowed loss offsets)

CFP Exam Tip: Section 267 applies only to losses, not to gains. If Jack sold to Pete at a gain, the gain would be recognized normally.

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Section 1041: Divorce Property Transfers

Section 1041 provides that transfers of property between spouses, or between former spouses incident to divorce, are treated as gifts for tax purposes.

Key Rules

"Incident to Divorce" Definition

A transfer is incident to divorce if:

1. Transfer occurs within 1 year of marriage ending, OR
2. Transfer is related to cessation of marriage AND occurs within 6 years of marriage ending under divorce decree

Planning Implications

The recipient spouse inherits the tax liability. When dividing assets in divorce:

• A $100,000 stock with $20,000 basis has $80,000 built-in gain
• That built-in gain transfers to the recipient spouse
• This should be factored into property settlement negotiations

Example: Wife transfers rental property (FMV $300,000, basis $100,000) to Husband as part of divorce settlement.

• No gain recognized by Wife at transfer
• Husband's basis = $100,000 (carryover)
• If Husband sells for $350,000, he recognizes $250,000 gain

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Community Property Step-Up Rules

IRC Section 1014(b)(6) provides a significant advantage for community property states: both halves of community property receive a stepped-up basis when one spouse dies.

Community Property States (2025)

Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin

Full (Double) Step-Up vs. Half Step-Up

Example: Married couple in California bought stock for $100,000 (community property). At first spouse's death, stock is worth $1,000,000.

• Community Property: Surviving spouse's basis = $1,000,000 (full step-up)
• If Joint Tenancy in non-CP state: Surviving spouse's basis = $550,000 (only half stepped up)

"Opt-In" Community Property Trusts

Several non-community property states (Florida, Tennessee, Kentucky, South Dakota, Alaska) now allow married couples to create community property trusts to potentially qualify for the double step-up.

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Summary: Basis Rules at a Glance