When an asset is received as a gift, what happens if the fair market value exceeds the donor's adjusted basis?

When an asset is received as a gift, the recipient typically takes on a basis known as carryover basis. This means that the recipient's basis in the gifted asset is the same as the donor's adjusted basis, which is the original cost of the asset adjusted for any applicable deductions, such as depreciation.

If the fair market value of the asset at the time of the gift exceeds the donor's adjusted basis, this can create a potential gain or loss scenario for the recipient if they decide to sell the asset later. The recipient will use the donor's adjusted basis for determining the gain or loss upon disposition. Therefore, the concept of carryover basis ensures that any unrealized appreciation in the value of the asset does not trigger a taxable event at the time of the gift.

In contrast to the correct answer, a zero basis would imply that the recipient has no investment in the asset, which is not the case with gifts. Reporting the asset as income is also incorrect because gifts are not considered taxable income to the recipient. Lastly, the fair market value at the time of the gift does not automatically become the new basis; rather, the adjusted basis from the donor carries over. The carryover basis effectively preserves the tax characteristics of the gift until a future transaction