Question: I am contemplating giving to my daughter stock which has decreased in value below my purchase price. Is my daughter entitled to a tax loss if she sells the property?

Answer:  The unrealized loss existing at the time of the gift cannot be deducted by your daughter if she sells the property. A better tax result will be enjoyed if you instead sell the property and take the loss personally and then gift the sale proceeds to your daughter.

The well recognized general rule is that the tax basis in property received as a gift by a donee is the same as the tax basis in the property in the hands of the donor. However, some tricky issues arise with respect to the tax basis of gifted property which has depreciated in value in the hands of the donor. A determination of whether or not a loss can be recognized depends on the value of the property at the time of the gift.

The starting point is determining the market value of the gifted property as of the date of the gift. A taxpayer must compare the tax basis in the property at the time of the gift to the property’s market value. In the case of stock, tax basis is generally the purchase price paid for the gifted stock. If the gifted property has a lesser value than the donor’s tax basis in the property at the time of the gift, the donee’s tax basis will be the property’s market value. If the property has appreciated in value, the donee’s tax basis is the same as the donor’s tax basis. As a result, the donee may have a differing tax base depending on whether the property is sold for a gain or a loss.

Consider what happens if Allison purchases stock for $10,000 and then gifts the stock to her daughter Ella at a time when the stock has a market value of $7,000. Allison’s basis in the stock is $10,000, the amount she paid to acquire the property. Ella’s basis in the property is $7,000, the lesser of Allison’s basis of $10,000 and the market value of the stock at the time of the gift which is $7,000. If Ella in turn sells the stock for $6,000, the difference between the $6,000 sale price and Ella’s tax basis of $7,000 will entitle Ella to a tax loss of $1,000. Allison’s unrealized $3,000 loss cannot be deducted by Ella.

In the case of appreciated property, the gain will be based on the donor’s basis. If Allison’s stock is worth $11,000 at the time of the gift and Ella sells that property when received, Ella will report a gain of $1,000, the difference between the $11,000 sale price and her tax basis in the property which is the same as Allison’s tax basis.  

Suppose instead the first scenario applies where the stock is worth $7,000 at the time of the gift and appreciates in value to $8,000 after it is gifted to Ella and Ella then sells the stock.  For tax purposes, there is no gain to report since the sale price of $8,000 is less than Ella’s $10,000 tax basis for gain purposes. There is also no loss to report because the sale price of $8,000 is more than Ella’s tax basis for loss purposes of $7,000.

While gifting property is an effective tool for transfer tax purposes, the income tax aspects of gifting must be taken into account as well.  Many people are well aware of the basis reset rule at death whereby the tax basis of the property of a decedent becomes the market value of the property as of the date of the decedent’s death. Giving the tendency of property to appreciate in value over time, this basis step-up rules encourages taxpayers to retain appreciating property until death to avoid income tax when property is sold after the decedent’s death. In a case, where property has depreciated in value, the resetting of the tax basis at death will not be beneficial as the tax basis upon death will be decreased to the market value as of the date of death.

As seen above, no real income tax benefit is enjoyed if the property is gifted when the property’s market value is less than the donor’s tax basis at the time of the gift. The better approach in your case would be to sell the property during your lifetime to take full advantage of the tax loss and then gift the sale proceeds to your daughter.

Please contact Bruce Bell with any questions at (312) 648-2300 or e-mail at [email protected].