When someone receives a gift, the recipient of the gift is not responsible for reporting the value of any gifts as income. Rather, it is the gift-giver, or donor of the property, who is required to pay gift taxes if the value of the gift exceeds the annual gift tax exclusion.
Taxes become an issue for the gift’s recipient when gifted property is sold. The gift’s recipient is deemed to have owned the property for as long as the donor owned it, and also takes the donor’s cost basis (the original value of the property). This is true for gifts made while the donor is alive.
For example, suppose your mother purchased a home for $50,000 fifty years ago, and the property is now worth $150,000. If she gives the property to you as a gift during her lifetime, you take her cost basis of $50,000. When you sell the property, you will have a long term capital gains of $100,000 ($150,000 minus $50,000).
Different rules apply to inherited property. When the transfer is deemed to have occurred at the donor’s death, the recipient of the property receives a step-up in basis to the value of the property on the date of death. This can result in significant tax savings when the property is sold.
Taking the example above, suppose that instead of giving you the property during her life, your mother holds on to the property, which passes to you when your mother dies. In this situation, your cost basis would be the value of the property on the date of your mother’s death. If you sell the property right away, you will not have have to pay any capital gains taxes.
Property that is transferred by transfer on death deed occurs at the donor’s death. Therefore, the beneficiary of such property should get a step-up in basis on the property just as if it had passed through probate. The benefit of having a transfer on death deed is that the property would pass by operation of law, bypassing the costs and time associated with a probate proceeding.