Carryover Basis on Gifted Real Estate

When you receive a gift of real property, your cost basis is typically the carryover basis—the donor’s original purchase price and improvements, not the property’s fair market value on the date you received it. However, if the property was worth less than the donor’s basis at gift, a special dual-basis rule applies, and any future loss is capped by the lower amount.

How carryover basis works in a gift

When you receive a gift of real estate, the Internal Revenue Service treats you as stepping directly into the donor’s economic shoes. Your basis is the donor’s adjusted basis at the time of the gift—that is, the original purchase price plus any capitalized improvements minus any depreciation the donor claimed. The gift itself carries no basis step-up to fair market value.

This is fundamentally different from an inheritance, where a beneficiary typically receives a basis equal to the property’s fair market value on the decedent’s date of death. Gifts are more tax-friendly to the donor in that respect (no capital gains tax owed at the time of transfer) but carry a tax cost forward to the recipient.

The donor’s holding period is also tacked onto yours. If the donor bought in 2015 and gifted to you in 2024, your holding period runs from 2015 for long-term capital gains purposes. This can be a significant advantage if you immediately sold after receiving the gift.

The dual-basis rule for loss property

The IRS applies a special exception when the property’s fair market value at the time of gift is lower than the donor’s basis. In these cases, the recipient has two separate basis figures.

For gains: Your basis for computing a gain is the donor’s original basis. If you later sell at a price above the donor’s basis, you recognize a gain measured against that higher figure.

For losses: Your basis for computing a loss is the fair market value on the date of gift. If you sell below that FMV amount, your loss is capped by the FMV-to-sale-price decline.

For breakeven sales: If the sale price falls between the FMV and the donor’s original basis, neither a gain nor a loss is recognized.

Example of dual-basis calculation

Suppose your aunt bought a rental property in 1995 for $200,000. By 2024, she had claimed $80,000 in depreciation, bringing her adjusted basis to $120,000. At that time, the property’s fair market value had fallen to $100,000 due to neighborhood decline. She gifts it to you.

• Your gain basis: $120,000 (donor’s adjusted basis)
• Your loss basis: $100,000 (FMV at gift)

Scenario 1: You sell in 2025 for $150,000.

• Comparison to gain basis: $150,000 − $120,000 = $30,000 gain recognized

Scenario 2: You sell in 2025 for $95,000.

• Comparison to loss basis: $100,000 − $95,000 = $5,000 loss recognized

Scenario 3: You sell in 2025 for $110,000.

• Price is above loss basis ($100,000) but below gain basis ($120,000)
• No gain or loss recognized

Gift tax and basis—a critical distinction

A common misconception is that if the donor paid gift tax on the transfer, that amount is added to your basis. It is not. The donor’s gift tax] liability is separate from your cost basis. If your aunt exceeded the annual exclusion and filed a gift tax return, that does not increase your basis in the property. The gift tax is purely a matter between the donor and the IRS.

The only exception is in the rare case of a gift of property from a non-resident alien—special rules under Section 1015(d) can allow a limited step-up to the extent gift tax was paid. For typical U.S. resident gifts, ignore gift tax when calculating basis.

Depreciation recapture and carryover basis

If the property is a rental or business asset, depreciation claimed by the donor remains a recapture item in your hands. The depreciation recapture rules mean that when you sell, a portion of your gain is taxed as ordinary income rather than capital gain.

Specifically, if the donor depreciated a residential rental and you later sell at a gain, unrecaptured Section 1250 depreciation is taxed at a maximum 25% rate (higher than the preferential capital-gains rates). The depreciation already claimed by the donor counts toward your recapture obligation.

This is one reason gifts of depreciated property are sometimes less valuable than they initially appear. A recipient who thought they received a low-cost rental property might discover that the donor’s historical depreciation causes a chunk of the gain to be taxed at ordinary rates.

Holding period and long-term gains status

One silver lining: your holding period includes the donor’s. If your uncle owned the property for 15 years before gifting it to you, and you hold it for an additional six months before selling, your total holding period is over 15 years. This ensures you qualify for long-term capital gains rates even if you immediately resell.

This automatic tacking of holding period is unique to gifts. In a purchase, your holding period starts from your acquisition date. In a taxable exchange, holding periods are separate. In a gift, you step backward in time.

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