CAN I EXCHANGE PROPERTY THAT WAS GIVEN TO ME?

We recently received a call from a client we will call Carolyn.  Two years ago Carolyn’s aunt gave her a vacation home, and Carolyn has been renting it out since then.  Carolyn is considering exchanging the home for another rental. 

 

Assuming the house has not increased in value since Carolyn’s aunt gave it to her, does Carolyn have gain?  In other words, how do you compute gain for someone who has received property by gift?  Very generally, the rule is that the donee (Carolyn) has the same basis in the property that the donor (her aunt) had.  So if Carolyn’s aunt’s basis in the property was $150,000 then Carolyn’s basis would also be $150,000.  If the fair market value of the property as of the day her aunt gave it to Carolyn was $325,000, and the property’s value has not changed since then, Carolyn would have taxable gain of about $175,000 ($325,000-$150,000) if she sold it without doing an exchange. 

 

This is very different from what would happen if Carolyn had inherited the property from her aunt.  If Carolyn had inherited the property, she would receive it with a step up in basis and would therefore have a basis equal to the fair market value of the property as of the date she inherited it.  Accordingly, Carolyn would have no gain if she sold the house for $325,000 and would therefore have no reason to do an exchange. 

 

It’s important to understand the difference between the potential gain when selling property that you received by gift and property that you received by inheritance.  Although there is a step up in basis when inheriting property, that tax benefit is not available to those who receive property as a gift during the donor’s lifetime. 

 

Calculating basis in gifted property can be complicated and calculations may change depending on whether the fair market value is greater or less than the basis at the time of transfer.  The IRS has some helpful resources addressing these differences at https://www.irs.gov/publications/p551/ar02.html#en_US_201412_publink1000257001.

We always recommend that you also talk to your tax advisor about your particular situation.

 

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