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February 17, 2008 - I am planning to sell shares of stock that I received as a gift instead of by purchase. Is there a difference in the tax treatment?

In the event of a sale, you will have to determine your gain or loss, and for this you will need to know your "basis." For most property you buy yourself, the basis is simply your cost. For property received as a gift, however, special basis rules apply.

The general rule is that you receive the same basis in the property that the donor had in it. Many taxpayers are unaware of this rule and believe their basis to be the value of the gift when they receive it.

Example. Lyle buys stock for $1,000 and gives it to his niece Ellen when it's worth $8,000. Ellen later sells it for $11,000. Ellen's basis in the stock is only $1,000-the same basis Lyle had. Thus, she must report $10,000 of gain on the sale.

Note, if Ellen had sold the property for just $6,000, she would still have to report a gain (of $5,000 on her $1,000 basis), even though the property declined in value in her hands. She would only be able to report a loss if she were to sell it for less than $1,000.

Loss property. Special rules apply for property which has gone down in value in the hands of the donor. For such property, at the time of the gift, the donor's basis (cost) will be higher than the value of the property. In this case, you must keep track of two figures for basis purposes. To measure gain on a later sale, the general carryover basis rule applies and your basis is the same that the donor had. But to measure loss on a later sale, your basis is limited to the (lower) value of the property at the time of the gift.

Example (1). Karen buys stock for $12,000 and gives it to her nephew Ed when it's worth $8,000. Ed later sells it for $6,000. To measure loss, Ed's basis in the stock is only $8,000-the value of the stock on the date of the gift. Thus, Ed has only a $2,000 loss on the sale.

Example (2). The facts are the same as in Example (1), except that Ed sells the stock for $15,000. To measure gain, Ed's basis is $12,000, the same basis Karen had. Thus, Ed's gain is $3,000.

Under these rules, if a donee of loss property sells it for an amount in between the property's date of gift basis and (lower) value, there will be no gain or loss on the sale.

Did the donor pay gift tax? If the value of the gift is more than $12,000 (the gift tax annual exclusion for 2007 and 2008), the donor may have paid federal gift taxes on it. If this is the case and the property had appreciated in value in the donor's hands, you will be able to increase your basis. The rule is you add to your basis that portion of the gift tax paid which is allocable to the increase in value at the date of gift.

Getting basis information. It's important to get the basis information you need from the donor. If you can't establish basis, IRS can impose a zero basis, in which case you will have to report the entire sale price as gain.

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