Jamie is terminally ill and does not expect to live much longer. Pondering the consequences of her estate, she decides how to allocate her property to her nephews. She makes a gift of depreciated property (i.e., adjusted basis exceeds fair market value)

Question

to Will, a gift of appreciated property (i.e., fair market value exceeds adjusted basis) to Jim, and leaves appreciated property to Sam in her will. Each of the properties has the same fair market value. From an income tax perspective, which nephew is her favorite?

Answer 1

Jamie appears to like Sam best. Sam receives the most beneficial tax treatment by receiving a stepped-up basis (i.e., fair market value on the date of Jamie's death) in the inherited property. Therefore, he would recognize less gain than Jim. Further, he would not have to deal with the dual basis issue like Will if he decided to sell the property. Because Jim receives a gift of appreciated property, he will realize gain equal to the amount of appreciation if he decides to sell. This is because his basis (i.e., carryover) is equal to Jamie's adjusted basis.

Jamie appears to be indifferent about Will. A gift of depreciated property receives a loss basis to Will of the lower of the adjusted basis or the fair market value on the date of the gift. This eliminates a possible loss deduction for Jamie and also prevents Will from taking a loss deduction for the decline in value while Jamie owned the property. On the other hand, Will's gain basis is equal to Jamie's adjusted basis for the property (and is greater than Sam's basis). Therefore, if the property appreciates while owned by Will, he will have recognized gain on the sale only if the property appreciates to a fair market value in excess of Jamie's adjusted basis for the property.