How to Determine the Cost Basis of Gifted Stock
Determining the cost basis of gifted stock or other needed information for tax purposes can be confusing. Oftentimes, a well-meaning family member, like grandma, will buy stock for a loved one when they are a small child and give it to them when they are an adult. Sometimes, the gifting of the actual stock does not occur until twenty, thirty years later. Who is thinking of tax liability several years, if not decades, in the future! Then the receiver of the gifted stock may not sell it for months or years later as well. The good news is you may not need as much information as you think. With some careful planning, both the giver and receiver of the gift of stock can keep the information they both will need to determine their tax liability.
Gift Tax Liability
Givers of a gift of stock need to determine the fair market value of the stock at the time the gift is given, not the cost basis. The gift tax exclusion for tax year 2020 remains the same as 2019: $15,000. This exclusion applies to an unlimited number of people each year. And, one of the best things is if the amount is under the $15,000 per person, it does not even need to be reported. If you do give over the excluded amount, you do need to report it. However, you do not have to pay taxes unless you give more than the lifetime exemption limit. For 2020, the lifetime gift tax exemption is $11.58 million. Married couples get double that amount to $23.16 million.
Example. Anna purchased 100 shares of ABC stock for $10 a share in 1991 for her granddaughter, Candace, on her first birthday. Anna kept the stock in her name and gave it to Candace this year on her 30th birthday. At the time she gave Candace the 100 shares of ABC stock, the stock was valued at $50 a share.
This means the value of Anna’s gift to Candace for gift tax purposes is $5,000 ($50 share price at the time of gift x 100 shares of gifted stock). The cost basis, the amount Anna paid for the stock when she purchased it, is not important because it is included in the $5,000. Anna did not sell the stock. She gave it away. If she had sold it, she would need to know her cost basis, so she would not be taxed on those funds twice. However, since she gave the shares to Candace, she does not need her cost basis. Candace will need Anna’s cost basis to determine her tax liability. Anna just needs to determine the fair market value, the price she could have received if she had sold it, on the day she gave it to Candace.
Even better news for Anna is because the gift is below the $15,000 individual annual exclusion, she does not even need to report it. As far as Anna is concerned, she can give the shares to Candace without any tax implications. Done.
If, however, the fair market value of the shares at the time Anna gifted them to Candace was $200 a share, Anna would need to report the $20,000 ($200 a share x 100 shares) on her tax return. She would not owe any taxes on the gift at this time unless she exceeded the $11.58 million lifetime exemption. The $5,000 ($20,000 stock gift - $15,000 individual annual exclusion) would be applied towards Anna’s lifetime exemption.
Income Tax Liability
The receiver, Candace, Anna’s granddaughter, in the example above, does not have to worry about gift tax liability. Gift taxes only apply to the giver, her grandmother. The receiver does not have to worry about taxes until they decide to sell the stock shares. When the receiver sells the gifted stock shares, they will need to know their cost basis to determine their income tax liability. This is where things can get complicated. The receiver’s cost basis is the giver’s cost basis.
Example. Anna purchased 100 shares of ABC stock for $10 a share in 1991 for her granddaughter, Candace, on her first birthday. Anna kept the stock in her name and gave it to Candace this year on her 30th birthday. At the time she gave Candace the 100 shares of ABC stock, the stock was valued at $50 a share. Candace held the shares for a few months and sold all of them at $45 a share.
If Candace had purchased the stock herself, it would have been subject to short-term capital gains tax because she only held them for a few months. But with the gift of stock shares, it is the giver’s holding time that governs. Because Anna held the stock for over a year, Candace would owe the lower long-term capital gains rate on any gain. This means Candace would owe long-term capital gains on $3,500 calculated as $4,500 (100 shares x $45 per share = $4,500) - $1,000 (Anna’s cost basis: 100 shares x $10 per share = $1,000). If Candace sold the shares at $7 a share, $3 less than the share price paid by Anna, she would report a capital loss at the difference between her sell price and Anna’s cost basis.
However, when Anna gifted the stock to Candace its fair market value was $8 a share and Candace sold it a few months later for $6 a share, she would have a short-term capital gains loss of $2 a share ($8 fair market value of the stock shares when gifted - $6 stock share sell price). This is because if the gift of stock is given at a loss, it is the fair market value on the date the stock was given and the receiver’s holding period that are used to determine your tax liability. If the stock is sold for more than the giver’s cost basis, then the giver’s original cost basis and holding period transfers to the receiver. One important thing to note is that if the stock is sold by the receiver for a price somewhere between the fair market value of the stock when it was given and the giver’s cost basis, no gain or loss can be recognized.
The Bottom Line
If you have already sold the gifted stock, you will need to determine the giver’s cost basis of gifted stock, the fair market value on the day when the stock was given to you, and your capital gain or loss when you sold the stock.
Determining your tax implications and information you need if you are giving or selling gifted stock can be confusing. But it does not have to be! If you are considering giving the gift of stock or selling your gifted stock shares, schedule an appointment today with the accounting and tax preparation professionals at Gudorf Tax Group. Taxes may be owed that could easily be avoided with some careful tax planning. Regardless of your situation, do not let the frustration of taxes affect the joy you get from giving or receiving.