Basis

The basis of an asset is the price paid to acquire the asset. When someone sells an asset, he or she must pay income tax on the amount of the selling price in excess of the basis. The buyer receives the asset at a stepped-up basis, equal to what the buyer paid to acquire the property.

When an asset passes to heirs at death, the asset is subject to estate tax on the fair market value of the property regardless of the original basis. The asset receives a new basis equal to the fair market value of the asset. The estate pays no capital gains tax even though the asset is transferred with a basis higher than it had when it became part of the estate. The recipient receives the asset with a basis equal to the stepped-up fair market value.

When someone receives an asset as a gift, the basis of the asset becomes the donor's basis increased by any gift tax paid on the net appreciation at the time of the gift. The donor pays no capital gains tax, but these transactions can turn into tax disasters for the recipient of the gift if he or she sells the asset. The asset, in most cases, has a basis lower than the selling price and the seller (the recipient of the gift) is responsible for paying capital gains taxes on the difference between the selling price and the original basis of the asset.