If property has appreciated as of the date of the gift, how is the gift tax paid by the donor treated?

When considering how gift tax paid by the donor is treated concerning appreciated property, the correct understanding lies in how the gift tax affects the donee's basis in the property received. When property is gifted, the basis (the value used to determine gain or loss for tax purposes) for the donee in that property is generally affected by the amount of gift tax paid.

In this instance, if the donor pays gift tax on the appreciation of the property, that amount is effectively added to the recipient's basis in the property. This rule is in place to ensure that the donee is not penalized for the appreciation that occurred before the transfer and that the tax liability is appropriately aligned with the true value received. Essentially, it helps maintain an equitable tax treatment regarding the increase in value of the asset, which the donee would eventually realize as a capital gain if they were to sell the property in the future.

This treatment ensures that the combined basis of the original property value and the additional amount from the gift tax provides a fair basis when determining any future gain or loss on the property by the donee.