“Income” in the tax sense does not always coincide with the definition of income for other purposes. Consider a $500 graduation gift. Though clearly one’s bank statement balance would be increased by receipt of this gift, the tax law does not consider it to be income. Conversely, consider the winner of a vacation to Hawaii who gives the vacation to his friend. The winner (but not the friend) must still report the entire value of the trip as income.

Internal Revenue Code § 61(a) is the linchpin to taxability of these, and all other items of income. That section succinctly declares “Except as otherwise provided…gross income means all income from whatever source derived…” Treasury Reg. § 1.61-1(a) embellishes the Code section by thoughtfully adding “income may be realized in any form, whether in money, property, or services.”

The gift does not constitute income because it falls within the exception “Except as otherwise provided.” Congress has determined that gifts should not be taxed as income. Code § 102 thus provides that “Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.” The vacation prize is taxable to the winner since it clearly constitutes an accession to wealth, taxable under Code § 61(a), and no exception applies. The fact that the winner immediately transferred the prize to a friend is immaterial. The friend, however, will not be taxed, since it constitutes a gift to him.

Generally no tax is imposed on appreciated property until it is sold, since
Congress probably considers it inappropriate to impose tax on “paper” gains. Thus, although Code § 61(a) imposes tax on “gains derived from dealings in property,” Code § 1001(a) provides that no gain is realized until property is sold. Realized gain is generally the difference between the purchase and sale price of the property. Code § 1001(c) provides that realized gain is subject to tax “except as otherwise provided.” One example of a realized gain not being subject to tax is where the proceeds from the sale of a home are reinvested in a new home. Code § 1034 permits the entire gain to be “rolled over,” or deferred. To be sure, the entire gain may eventually be taxed, since the purchase price of the new home is reduced by the amount of unrecognized gain for tax purposes. This mechanism sets the stage for a taxable event when the “new” home is sold. However, the deferral becomes permanent if the taxpayer dies owning the “new” home, since his heirs will inherit the property with a “stepped up” basis.