How is gift tax allocated to the recipient's basis calculated?

The way gift tax is allocated to the recipient's basis is crucial for understanding the tax implications of receiving a gift. When a gift is made, the recipient's basis in the asset is generally determined by your original cost, adjusted for any gift tax that is applicable.

Thus, when calculating the recipient's basis, you take into account the fair market value of the gift at the time it is given and any gift tax paid on that amount. The correct choice emphasizes the difference between the market value and the original cost, which is essential for calculating the basis accurately. If the fair market value at the time of the gift exceeds the donor's basis in the asset, the gift tax effectively increases the recipient's basis.

This means that the recipient may have a higher basis if the donor has paid gift tax, allowing for more favorable tax treatment when the recipient eventually sells the asset. Understanding this aspect ensures proper calculation of capital gains when a gifted asset is sold in the future, which is why the approach of using the difference between market value and original cost is pivotal.

Other options do not accurately capture how basis adjustments due to gift tax are calculated, focusing instead on elements that do not reflect the correct methodology for determining the basis of gifted property.