Carryover basis

The carryover basis rule applies to gifts: when you receive an asset as a gift, your cost basis is the same as the donor’s original cost basis, not the fair market value at the time of the gift. If your parent bought stock for $100 and gifted it to you when it was worth $500, your basis is $100—not $500. You inherit all embedded gains and all embedded losses. Carryover basis contrasts sharply with step-up in basis, which applies to inherited assets.

How carryover basis works

Suppose your parent buys Apple stock for $100 and gifts it to you when it is worth $500. Your cost basis is $100, not $500. If you sell at $600, your capital gain is $500 ($600 - $100), and you owe tax on the full $500 gain.

This is fundamentally different from inheritance. If your parent dies holding the same $500 stock, you receive a step-up in basis to $500. You can sell immediately with zero tax.

The carryover basis rule incentivizes parents to wait—hold until death, and let heirs receive the step-up, rather than gift during life and lock in carryover basis.

Why carryover basis exists

Carryover basis prevents donors from avoiding tax through gifts. Without it, a parent could gift appreciated stock to a child, the child could sell it, and the parent would avoid the capital gains tax. Carryover basis ensures the original owner’s embedded gains follow the asset.

For losses: carryover works in reverse

If an asset is gifted at a loss (bought at $500, gifted when worth $100), carryover basis applies to losses too. Your basis is $500. You could later sell at $300, realizing a $200 loss.

However, the IRS disallows losses on gifted assets if the asset is sold for less than the fair market value at the time of gift. In this case, your basis is $100 (fair market value at gift), not $500 (original basis). This prevents donors from transferring losses to beneficiaries to shelter their income from tax.

Contrast with inherited assets

The step-up on inherited assets is a major tax advantage. This is one reason wealthy individuals sometimes hold appreciated assets until death rather than gift them.

Gift tax and carryover basis

Do not confuse carryover basis with gift tax. Carryover basis is about income tax on future gains. Gift tax is a separate federal tax paid by the donor (if applicable) at the time of the gift, depending on the size of the gift and the donor’s lifetime exemption.

Example: Parent gifts $5 million of appreciated stock to a child. The parent may owe gift tax on the $5 million (using their lifetime gift tax exemption). The child receives carryover basis, not step-up, so they inherit the parent’s original embedded gains.

Planning implications

Because of carryover basis, large gifts of appreciated assets are less tax-efficient than bequests. A parent might consider:

1. Holding appreciated assets until death (to trigger step-up on heirs).
2. Making gifts of appreciated assets before they appreciate (so the basis is closer to fair market value).
3. Using charitable giving to transfer appreciated assets without triggering capital gains tax (and receiving a deduction).

See also