Carryover Basis
Carryover basis is the rule (IRC §1015) where a gifted asset's cost basis in the recipient's hands equals the donor's basis at the time of the gift, plus any gift tax paid attributable to appreciation. The donor's holding period also carries over, so an asset gifted on day 364 of its holding period becomes long-term in the recipient's hands the next day.
Carryover basis is the structural opposite of step-up at death (§1014). The two rules together define the planning game for highly-appreciated assets: hold appreciated assets to step them up at death (eliminating the gain entirely), and gift either depreciating assets or (sometimes) cash to children during life. Gifting an appreciated asset transfers the gain to the recipient, who pays tax on the eventual sale at their (often lower) marginal rate but loses the §1014 elimination opportunity.
The holding-period carryover is non-obvious but important. A donor who gifts a stock held for 11 months gives the recipient an asset that becomes long-term in 31 days, not in 13 months — the 11-month tenure carries over. This matters for sale-timing planning: a recipient receiving a near-long-term gift can wait the residual short period and unlock LT rates rather than restarting the clock.
The rule has a special carve-out for losses: if the donor's basis exceeds the asset's fair-market-value at the time of gift, the recipient takes a dual basis — the donor's basis for gain calculations and the FMV for loss calculations. A subsequent sale at a price between FMV and basis produces no gain and no loss. This dual-basis rule prevents shifting unrealized losses to a taxpayer with better loss-utilization (e.g., a high-bracket parent gifting depreciated stock to a low-bracket child for the child to harvest the loss).
| Gift (carryover) | Inheritance (step-up) | |
|---|---|---|
| Recipient basis | Donor's original basis | FMV at date of death |
| Holding period | Carries over | Always long-term |
| Tax on appreciation | Recipient eventually pays | Eliminated entirely |
| Donor / decedent gift-or-estate-tax cost | Annual exclusion + lifetime exemption | Lifetime exemption only |
| Best for | Depreciated assets, low-bracket recipients | Highly-appreciated assets |
Gifted-asset lots in synthetic data should carry the carryover-basis flag and the donor's original acquisition date (for holding-period determination). Test scenarios include the dual-basis case (donor basis > FMV at gift), the gifted-on-the-cusp case (gifted near the long-term threshold), and the gift-tax-paid case (gift exceeds annual exclusion, gift tax paid by donor adds to recipient's basis).
Common pitfalls
- Re-clocking the holding period at gift instead of carrying it over — produces wrong short-vs-long determinations.
- Forgetting the dual-basis rule when the donor's basis exceeds FMV at gift — recipient cannot deduct losses that would benefit the donor's tax position.
- Failing to add gift-tax-paid to the recipient's basis — the §1015(d) basis adjustment for paid gift tax is non-trivial on large gifts.
- Treating gifts to a non-grantor trust as gifts that step up at the grantor's eventual death — assets gifted to a non-grantor trust have carryover basis; they are not in the grantor's estate and do not step up.
Examples
Parent owns 100 shares of AAPL acquired 2018 at $40 ($4,000 basis), now $200 ($20,000 FMV). Parent gifts to child. Child's basis: $4,000. Child's holding period: from 2018 (long-term). Child sells at $250: $25,000 proceeds − $4,000 basis = $21,000 LT capital gain on child's return.
Parent owns shares with $10,000 basis, current FMV $7,000 (depreciated). Parent gifts to child. Child's gain basis: $10,000. Child's loss basis: $7,000 (FMV at gift). Child later sells at $8,500: between the two bases, so neither gain nor loss. Sells at $11,000: $1,000 gain (using gain basis). Sells at $5,000: $2,000 loss (using loss basis).