Bryant - Course 4. Tax Planning. 5. Basis

Question 1

What is the Original Basis?

Answer 1

In most cases, the original basis of property is its cost. Cost is the amount paid for the property in cash or the Fair Market Value (FMV) of other property given in the exchange. Any costs of acquiring the property and preparing the property for use are included in the cost of the property.

Capital additions increase the basis. IRC Section 263(a) generally requires taxpayers to capitalize an amount paid to acquire, produce, or improve tangible property. Repairs, such as fixing a roof leak or painting a room, are not considered capital improvements and, thus, are not accounted for in determining basis.

Reductions, like depreciation, reduce the basis.

Question 2

Ellen paid $12,000 and borrowed $48,000 from the local savings and loan company to purchase for a home she will use as her personal residence. Three years later, she paid $10,000 to add a room onto the house, paid $625 to have the house painted, and $800 for built-in bookshelves.
As of January 1 of the current year, Ellen has reduced her mortgage to $44,300. What is the basis for Ellen’s house?
* $48,000
* $55,100
* $70,800
* $71,425

Answer 2

$70,800

Most property is acquired by purchase and its initial basis is the cost of the property. Capital additions increase the basis.

The basis on Ellen’s home is computed as follows:
$12,000 (payment) + $48,000 (mortgage) + $10,000 (capital addition [room]) + $800 (capital addition [bookshelves]) = $70,800

Question 3

List things that would increase basis

Answer 3

Capital improvements:
* Putting an addition on your home
* Replacing an entire roof
* Paving your driveway
* Installing central air conditioning
* Rewiring your home

Assessments for local improvements:
* Water connections
* Sidewalks & Roads

Casualty losses:
* Restoring damaged property

Legal fees:
* Cost of defending and perfecting a title

Zoning costs

Question 4

List things that would decrease basis

Answer 4

• Depreciation
• Certain vehicle credits
• Section 179 deduction
• Casualty or theft loss deductions and
• insurance reimbursements
• Nontaxable corporate distributions
• Exclusion from income of subsidies for energy
• conservation measures

Question 5

What is the adjusted basis?

Answer 5

The adjusted basis of property is the original basis plus purchase-related costs or capital additions, less depreciation (if applicable).

Adjusted basis also depends on how the property is acquired (e.g., by purchase, gift, or inheritance).

Most property is acquired by purchase and its initial basis is the cost of the property.

However, if the property is acquired from a decedent, its basis to the estate or heir is its FMV either at the date of death or, if the alternate valuation date (AVD) is elected, six months from the date of death. There are certain rules for determining the adjusted basis. Once the initial basis is determined, it may be adjusted upward or downward reflecting added capital or return of investment through tax breaks.

Question 6

What is Original Issue Discount (OID)?

Answer 6

Original Issue Discount (OID) is the excess of a debt instrument’s stated redemption price at maturity over its issue price (acquisition price for a stripped bond or coupon). Zero-coupon bonds and debt instruments that pay no stated interest until maturity are examples of debt instruments that have OID.

Generally, a debt collection is not a sale or an exchange. However, if a debt instrument is retired, amounts received by the holder are treated as being received in an exchange. Debt instruments include bonds, debentures, notes, certificates, and other evidence of indebtedness. Although Congress has provided that retirement of debt instruments be treated as exchanges, Congress is unwilling to allow taxpayers to convert large amounts of potential ordinary interest income into capital gain by purchasing debt instruments at a substantial discount.

Question 7

On January 1 of the current year, the Orange Corporation issues $500,000 of 11%, 20-year bonds for $480,000.
Calculate the amount of original issue discount.
* $0
* $220
* $2,000
* $4,400

Answer 7

$0

There is no original discount (i.e., $0) since the discount of $20,000 ($500,000 - $480,000) is less than $25,000 (0.0025 x $500,000 x 20).

Question 8

When does carryover basis occur?

Answer 8

Carryover basis occurs when a taxpayer receives an asset and takes the same basis as the property had in the hands of the transferor. This occurs primarily in the case of gifts.

Question 9

What is the basis of appreciated property received as a gift?

Answer 9

The basis of appreciated property received as a gift is generally the same as the donor’s basis (i.e., carryover basis).

Question 10

For assets that are gifted at a loss, what is the basis?

Answer 10

In situations involving assets that are gifted at a loss (i.e., below the adjusted basis of the property), we need to adopt a ‘wait-and-see approach until the asset is sold. After the sale, the gain/loss and holding period can be determined.

There are three possible scenarios:
* Scenario #1:
Gift of loss property and the final sale price is above the original basis of the donor. In this case, the donee (gift recipient) will use the donor’s original basis to calculate the gains AND will inherit the donor’s holding period.

• Scenario #2:
  Gift of loss property & the final sale is below the FMV on the date of the gift. The donee will use the FMV on the date of the gift as the basis AND the holding period will begin on the date of the gift.
• Scenario #3:
  Gift of loss property & the final sale is in between the donor’s original basis and the FMV on the date of the gift. There will be no loss or gain and the holding period is a non-factor.

Question 11

In general, the basis of appreciated property received as a gift is the _ ______??_______.

• FMV on the date of the gift
• donor’s adjusted basis
• stepped-up basis
• annual gift exclusion

Answer 11

donor’s adjusted basis

The basis of appreciated property received as a gift is generally the donor’s adjusted basis.

Question 12

What is the Effect of Gift Tax on Basis?

Answer 12

If the donor pays a gift tax on the transfer of property, the donee’s basis may be increased. This increase occurs only if the fair market value (FMV) of the property exceeds the donor’s basis on the date of the gift. The increase in the donee’s basis is equal to a pro-rata portion of the gift tax that is attributable to the unrealized appreciation in the property.

The amount of the addition to the donee’s basis is determined as follows:
Gift tax paid ×((FMV at time of gift − Donor’s basis)/(FMV at time of gift − Annual Exclusion))

Question 13

Ruben and Sandra are married and live in Louisiana, a community property state. They jointly own real property with an adjusted basis of $300,000. When the property has an FMV of $500,000, Ruben dies leaving all of the property to Sandra.
What is Sandra’s adjusted basis in the property?
* $550,000
* $300,000
* $500,000
* $400,000

Answer 13

$500,000

Because Sandra and Ruben reside in a community property state, both Sandra’s portion and Ruben’s portion of the property get a step up in basis to $500,000.

Question 14

Patrick inherits property having an $80,000 FMV on the date of the decedent’s death. The decedent’s basis in the property is $47,000. The executor of the estate does not elect the alternate valuation date.

What is Patrick’s basis for the property?

Answer 14

Patrick’s basis for the property is $80,000.

Question 15

Dianna inherits property having a $60,000 FMV at the date of the decedent’s death. The decedent’s basis in the property is $72,000. The alternate valuation date is not elected.

What is Dianna’s basis for the property?

Answer 15

Dianna’s basis for the property is $60,000.

Question 16

John and Mary are husband and wife (not a community property state) and jointly own stock with a FMV of $200,000 and a basis of $100,000. John dies and half of the FMV is included in his gross estate.

What is Mary’s basis in the stock?

Answer 16

Mary’s basis in the stock after John’s death is $150,000. (Her $50,000 basis in her half plus $100,000 (the FMV of the stock used for John’s gross estate)).

Question 17

Describe the alternate valuation date (AVD)

Answer 17

The basis of property received from a decedent is generally the fair market value (FMV) of the property at the date of the decedent’s death or an alternate valuation date (AVD). This provision can result in either a step-up (increase) or step-down (decrease) in basis but is frequently described as the stepped-up basis rule.

Instead of using the FMV on the date of death to determine the estate tax, the executor of the estate may elect to use the FMV on the alternate valuation date.

The AVD is generally six months after the date of death.

If the alternate valuation date is elected, the basis for all the assets in the estate is their FMV on that date unless the property is distributed by the estate to the heirs or is sold before the alternate valuation date.
If the alternate valuation date is used, property distributed or sold after the date of the decedent’s death and before the alternate valuation date has a basis equal to its FMV on the date of distribution or the date on which it is disposed.
If the estate is small enough that an estate tax return is not required, the value of the property on the alternate valuation date may not be used.

This means that the aggregate value of the assets determined by using the alternate valuation date may be used only if the total value of the assets has decreased during the six-month period.

Question 18

Helmut inherits all the property owned by an individual who died in March when the FMV of the property was $5.8 million. Six months after the date of death, the property had a $5.95 million FMV. The property is distributed to Helmut in December.

What is Helmut’s basis in the property?

Answer 18

Use of the alternate valuation date is not permitted because the value of the gross estate has increased.

Therefore, his basis in the property is $5.8 million, the FMV on the date of death.

Question 19

Marilyn inherits all the property owned by an individual who dies in April when the property has a $100,000 FMV. The value of the property six months later is $90,000.

What is Marilyn’s basis in the property?

Answer 19

Because of the size of the estate, no estate tax is due.
The alternate valuation date may not be used, and Marilyn’s basis for the property is $100,000.

Note that Marilyn would not want the alternate valuation date to be used because her basis would be $90,000 instead of $100,000.

Question 20

Why would an executor elect to use the alternate valuation date?

Answer 20

An executor may elect to use the alternate valuation date to reduce the estate taxes owed by the estate.

However, the income tax basis of the property included in the estate is also reduced for the heirs who inherit the property.

Question 21

What are the income tax implications of the stepped-up basis?

Answer 21

In the case of an estate that is large enough to pay estate taxes, the stepped-up basis reduces the overall tax burden.

In the case of estates below the estate tax limits or only marginally taxable, the stepped-up basis provides a significant income tax benefit at little or even no estate tax costs.

Question 22

In determining which assets a sick or elderly person should sell or gift for estate tax purposes, the income tax benefits of the stepped-up basis should be considered.
Generally, assets with a low basis and a high value should be kept until death while assets with a low value and high basis ought to be disposed of first.
* True
* False

Answer 22

True

Question 23

What happens if the decedent and the decedent’s spouse own property in community property law state?

Answer 23

If the decedent and the decedent’s spouse own property under community property laws, one-half of the property is included in the decedent’s estate and its basis to the surviving spouse is its fair market value (FMV).

The Internal Revenue Code also provides that the surviving spouse’s one-half share of the community property is adjusted to the FMV. In effect, the surviving spouse’s share of the community property is considered to have passed from the decedent.

Question 24

Matt and Jane, a married couple, live in Texas, a community property state, and jointly own land as community property that cost $110,000. The land has an $800,000 FMV when Jane dies, leaving all her property to Matt.

What is Matt’s basis for the property?

Answer 24

His basis for the entire property is $800,000.

Question 25

What happens if the decedent and the decedent’s spouse own property in a common-law state?

Answer 25

In a common-law state, only one-half of the jointly owned property is included in the decedent’s estate and is adjusted to its FMV. The survivor’s share of the jointly held property is not adjusted.

Question 26

Barry and Maria, a married couple, live in Iowa, a common-law state, and jointly own land that cost $200,000. The property has a $700,000 FMV when Barry dies, leaving all his property to Maria.
What is Maria’s basis for the land?

Answer 26

Her basis for the land is $450,000 [$100,000 + (0.50 x $700,000)].

Question 27

What is Original Basis?

Answer 27

Original Basis: In most cases, the basis of property is its cost. Any costs of acquiring the property and preparing the property for use are included in the cost of the property.

Question 28

Define Original Issue Discount

Answer 28

Original Issue Discount is defined as “the excess (if any) of the stated redemption price at maturity over the issue price.”

Question 29

What is Carryover Basis?

Answer 29

Carryover Basis: is the basis in the hands of a transferee that is the same as the basis of the transferor.

Question 30

Pete wants to make a gift of either ABC common stock (basis of $44,000 and FMV of $50,000) or XYZ common stock (basis of $73,000 and FMV of $50,000) to his nephew. Pete and his nephew have the same tax rate. Which of the following reasons suggest that Pete should give the ABC stock to his nephew? (Select all that apply)
* Pete should give the ABC stock to his nephew because the nephew’s basis for determining a gain or loss is $44,000 plus a portion of any gift tax Pete pays.
* Pete should give the ABC stock to his nephew because the nephew’s basis for determining a gain or loss is $73,000 plus a portion of any gift tax Pete pays.
* The nephew’s basis for XYZ common stock is $50,000 to determine a loss and $73,000 to determine a gain.
* If the nephew sells XYZ stock for less than $73,000 but greater than $50,000, no gain or loss is recognized and thus some of the potential loss is not used.

Answer 30

• Pete should give the ABC stock to his nephew because the nephew’s basis for determining a gain or loss is $44,000 plus a portion of any gift tax Pete pays.
• The nephew’s basis for XYZ common stock is $50,000 to determine a loss and $73,000 to determine a gain.
• If the nephew sells XYZ stock for less than $73,000 but greater than $50,000, no gain or loss is recognized and thus some of the potential loss is not used.
  Pete should give the ABC stock to his nephew because the nephew’s basis for determining a gain or loss is $44,000 plus a portion of any gift tax Pete pays. The nephew’s basis for XYZ common stock is $50,000 to determine a loss and $73,000 to determine a gain. If the nephew sells XYZ stock for less than $73,000 but greater than $50,000, no gain or loss is recognized and thus some of the potential loss is not used. Furthermore, the nephew’s basis for the XYZ stock is not increased if Pete has to pay a gift tax on the $35,000 ($50,000 FMV- $15,000 present interest gift tax exclusion) taxable gift.

Question 31

Robert gave property with a basis of $1,300 to Sally when it had a fair market value (FMV) of $1,100. Sally later sold the property for $2,000 resulting in a recognized gain of:
* $0
* $200
* $700
* $900

Answer 31

$700

When Sally sells at a gain she can use up to Robert’s original basis as her basis. $2,000 - $1,300 = $700.

Question 32

Rocky purchases stock of ABC Corporation for $19,000. He pays a commission of $300 to purchase the shares. Rocky later sells the stock. In computing his gain or loss, what is Rocky’s original basis?
* $19,300
* $19,000
* $18,700
* $19,150

Answer 32

$19,300

Rocky’s basis is $19,300 ($19,000+$300). The original cost basis is calculated by using the initial purchase price plus any additional cost incurred to obtain the investment.

Question 33

How is the gain or loss from the disposition of the property determined?

Answer 33

Whenever property is disposed of by sale, gift, trade, or inheritance, a potential tax consequence exists.
The gain or loss from the disposition of the property is determined by comparing the sale price to the adjusted basis of the property.

A person’s original basis in an asset is determined by the way it was acquired:
* Through purchase,
* In trade, or
* Received as a gift or inheritance.

The original basis of the property is adjusted by deductions, such as depreciation, or by additions, such as capital improvements.

Question 34

Define amount realized.

Answer 34

The amount realized from a sale or other disposition of property is the sum of any money received plus the FMV of all other property received.

Question 35

Amount Realized & Gain Calculation Example:
Anna exchanges land subject to a liability of $20,000 for $35,000 of stock owned by Mario. Mario takes the property subject to the liability. The amount realized by Anna is $55,000 ($35,000 + $20,000 liability assumed by Mario). If Anna’s adjusted basis for the land exchanged is $42,000, what is her realized gain?

Answer 35

Her realized gain is $13,000 ($55,000 amount realized - $42,000 adjusted basis).

In the above example, Anna receives stock with a $35,000 FMV and is relieved of a $20,000 debt. Mario’s taking the property subject to the debt is equivalent to providing Anna with cash of $20,000. Thus, the amount realized by Anna is $55,000.

Question 36

What does the recovery of basis doctrine state?

Answer 36

The recovery of basis doctrine states that taxpayers are allowed to recover the basis of an asset without being taxed because such amounts are a return of capital that the taxpayer has invested in the property.

If a taxpayer receives a $12,000 return of capital distribution from a corporation when the taxpayer’s basis for its investment in the corporation’s stock is $10,000, the first $10,000 received represents a recovery of basis and only the $2,000 excess amount is treated as a gain realized on a sale or exchange of the stock investment.

In many cases, basis is recovered in the form of a deduction for depreciation, cost recovery, or a casualty.

Question 37

What is adjusted basis?

Answer 37

Adjusted basis is the new basis after additions or deductions to the original basis have been made. The initial adjusted basis of property depends on how the property is acquired (e.g., by purchase, gift, or inheritance). Most property is acquired by purchase and therefore its initial basis is the cost of the property. However, if property is acquired from a decedent, its basis to the estate or heir is its fair market value (FMV) either at the date of death or, if the alternate valuation date is elected, six months from the date of death. There are certain rules for determining the adjusted basis. Once the initial basis is determined, it may be adjusted upward or downward.

Capital additions (also called capital expenditures) are expenditures that add to the value or prolong the life of the property or adapt the property to a new and different use. Capital additions increase the basis. Capital recoveries, such as the deductions for casualty losses, cost recovery, and depreciation, reduce the basis.

Question 38

What is the equation to determine a property’s adjusted basis?

Answer 38

A property’s adjusted basis can be determined by the following equation:

• Initial basis
• • Capital additions (e.g., new loading dock for a building)
• • Capital recoveries (e.g., depreciation deduction)
• = Adjusted basis

Question 39

All realized gains and losses are recognized for tax purposes.
* False
* True

Answer 39

False

Although most realized gains are recognized, some realized losses are not. For example, losses on the sale or exchange of property held for personal use cannot be recognized.

Question 40

To calculate adjusted basis, you take the initial basis, _ ______??_______ the capital additions and _ ______??_______ capital recoveries.
* add; add
* add; subtract
* subtract; subtract
* subtract; add

Answer 40

A property’s adjusted basis can be determined by the following equation:
Initial basis
+ Capital additions (e.g., new loading dock for a building)
- Capital recoveries (e.g., depreciation deduction)
= Adjusted basis

Question 41

What is the amount of gain or loss that is actually reported on the tax return called?

Answer 41

The amount of gain or loss that is actually reported on the tax return is called the recognized gain or loss.

In some instances, gain or loss is not recognized due to special provisions in the tax law (e.g., a gain or loss may be deferred or a loss may be disallowed).

Question 42

Are realized losses on the sale or exchange of assets held for personal use recognized for tax purposes?

Answer 42

Losses are generally deductible if they are in carrying on a trade or business, in an activity engaged in for profit, and casualty & theft losses.
Realized losses on the sale or exchange of assets held for personal use are not recognized for tax purposes. Therefore, a taxpayer who incurs a loss on the sale or exchange of a personal-use asset does not fully recover the basis.

Question 43

Ralph purchases a personal residence for $60,000. Deductions for depreciation are not allowed because the asset is not used in a trade or business or held for the production of income. If Ralph sells the house for $55,000,

What is the realized loss?
Is it deductible?

Answer 43

The realized loss of $5,000 is not deductible, and he recovers only $55,000 of his original $60,000 basis.

Question 44

Peggy purchases an asset by paying cash of $40,000 and signs a note payable to the seller for $60,000. She also assumes a lien against the property in the amount of $2,000.
What is her basis for the asset?

Answer 44

Her basis for the asset is $102,000 ($40,000 + $60,000 + $2,000).

Question 45

Describe Uniform Capitalization Rules

Answer 45

The Tax Reform Act of 1986 (TRA) created one set of capitalization rules applicable to all taxpayers and all types of activities. These uniform capitalization rules apply principally to inventory.

The uniform capitalization rules also affect property other than inventory if the property is:
* used in a taxpayer’s trade or business or
* in an activity engaged in for profit.

Taxes paid or accrued in connection with the acquisition of property are included as part of the cost of the acquired property.

Taxes paid or accrued in connection with the disposition of property reduce the amount realized on the disposition.

Question 46

Describe the Capitalization of Interest

Answer 46

Under the uniform capitalization rules, interest must generally be capitalized on debt(s) equal to expenditures that produce real property or certain tangible personal property.

The interest paid or incurred during the production period must be capitalized if the property produced is designated property.

Designated property is any of the following:
* Real property.
* Tangible personal property with a class life of 20 years or more.
* Tangible personal property with an estimated production period of more than 2 years.
* Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million.
* Property a taxpayer produces.

A taxpayer produces property if they construct, build, install, manufacture, develop, improve, create, raise, or grow it.

Question 47

If stock sold or exchanged is not adequately identified, what method must be used to identify the stock?

Answer 47

In most cases, the adjusted basis of property is easily identified with the property that is sold. However, problems occur when the property is homogenous in nature. An example of a potential setback in identification occurs when an investor owns several blocks of common stock of the same corporation, purchased on different dates at different prices. Regulations require the taxpayer to identify the particular stock that is sold or exchanged. Investors need to be careful to provide specific instructions on which securities should be sold. If the stock sold or exchanged is not adequately identified, the first-in, first-out (FIFO) method must be used to identify the stock. With the FIFO method, the stock sold or exchanged is presumed to come from the first lot or lots acquired.

Question 48

If an investor does not specify securities to be sold, the LIFO (last-in, first-out) method will be used.
* False
* True

Answer 48

False

If an investor does not specify when securities are sold, the FIFO method will be used. With this method, the stock sold or exchanged is presumably from the first acquired lots. While LIFO is a bona-fide accounting method for inventory valuation, LIFO does not technically exist for the sale of capital assets (this is a subset of specific identification method).

Question 49

Often, taxpayers who own personal-use assets convert these assets to an income-producing use or for use in a trade or business. When this conversion occurs, the property’s basis must be determined.

The basis for computing depreciation is the lower of what 2 things?

Answer 49

The basis for computing depreciation is the lower of:
* the fair market value (FMV) or
* the adjusted basis of the property at the time that the asset is transferred from personal use to an income-producing use or for use in a trade or business.

This rule prevents taxpayers from obtaining the benefits of depreciation to the extent that the property has declined in value during the period that it is held for personal use.

Question 50

Olga owns a boat that originally cost $2,000 and is used for personal enjoyment. At a time when the boat has a $1,400 FMV, Olga transfers the boat to her business of operating a marina.
What is the basis for depreciation?

Answer 50

The basis for depreciation is $1,400 because the FMV is less than Olga’s adjusted basis at the time of conversion to business use. The $600 decline ($2,000 - $1,400) that occurred while Olga used the boat for personal use may not be deducted as depreciation.

If the boat’s FMV is more than $2,000, the basis for depreciation is $2,000 because the FMV is higher than its adjusted basis at the time the asset is transferred to business use.

Question 51

Susanna purchased a personal residence for $50,000 and subsequently converted the property to rental property. At the time of the conversion, the property had a $46,000 FMV. Assume that depreciation of $20,700 has been deducted when the property is sold for $21,000.
What is the basis of the property at the time of the sale?
What is her gain/loss on the sale?

Answer 51

The basis of the property at the time of the sale is $25,300 ($46,000 - $20,700).

Thus, her loss on the sale is $4,300 ($21,000 - $25,300).

Question 52

Susanna purchased a personal residence for $50,000 and subsequently converted the property to rental property. At the time of the conversion, the property had a $46,000 FMV. Assume that depreciation of $20,700 has been deducted when the property is sold for $31,000.
What is the basis of the property at the time of the sale?
What is her gain/loss on the sale?

Answer 52

The basis of the property is $29,300 ($50,000 - $20,700) and her gain is $1,700 ($31,000 - $29,300).
Note that the adjusted basis at the time of conversion is used here because the property is sold at a gain.

Without the rule for determining basis of personal-use property converted to business property, taxpayers would have an incentive to convert non-business assets that have declined in value to business use before selling the asset to convert non-deductible losses into deductible losses.

Question 53

Craig owns a personal-use asset with a basis of $80,000 and a $50,000 FMV. If he sells the asset for its FMV, the $30,000 loss ($50,000 - $80,000) is not deductible because losses on the sale of personal-use assets are not deductible.

If Craig converts the asset to business use and then immediately sells the asset for $50,000,
What is the realized gain/loss?

Answer 53

If Craig converts the asset to business use and then immediately sells the asset for $50,000, no loss is realized because the basis of a business-use asset for purposes of determining loss is $50,000.

Question 54

Describe Allocation of Basis

Answer 54

When property is obtained in one transaction and portions of the property are subsequently disposed of at different times, the basis of the property is allocated to the different portions of the property. Gain or loss is computed at the time of disposal for each portion. If an individual purchases a 20-acre tract of land and later sells the entire tract, an allocation of basis is not needed. However, if the taxpayer divides the property into smaller tracts of land for resale, the cost of the 20-acre tract must be allocated among the smaller tracts of land.
The allocation is based on the fair market value (FMV) of the various tracts of land.

Question 55

What is the formula for Allocation of Basis Calculation?

Answer 55

To determine the basis of the individual lot, use the following formula:

Total Cost of the Tract × (FMV of the Lot / FMV of the Tract)

Question 56

Several years ago, Dionne, a developer, purchased a tract of land at an original cost of $700,000. The land was subdivided into 25 building lots of equal sizes.
This afternoon, Alice the appraiser determined that the current FMV of the entire tract is $1,500,000 and the FMV of the individual lot that Dionne is putting up for sale is $67,500.
Determine the basis that Dionne will use for the sale of the individual lot that is going to be sold.
* $28,000
* $50,000
* $22,750
* $31,500

Answer 56

$31,500

To determine the basis of the individual lot, use the following formula:

Total Cost of the Tract × (FMV of the Lot/FMV of the Tract)
$700,000 × ($67,500/$1,500,000) =$700,000 × 0.045 =$31,500
Therefore, there is a $31,500 basis for the lot being sold.

Question 57

What happens to common costs incurred on an asset?

Answer 57

Common costs incurred to obtain or prepare an asset for service must be capitalized and allocated to the basis of the individual assets.

Question 58

Common Costs & Basis Calculations:
Priscilla acquires three machines for $60,000, which have fair market values (FMVs) of $30,000, $20,000 and $10,000, respectively. Costs of the delivery amount to $2,000 and costs to install the three machines amount to $1,000.
The total installation and delivery costs of $3,000 are allocated to each of the three machines based on their FMVs.

What is the allocation of the $3,000 of common costs?
What is the basis for each of the three machines?

Answer 58

The allocation of the $3,000 of common costs occurs as follows:
* Machine 1: ($30,000 (FMV)/($30,000 + $20,000 + $10,000) ×$3,000 =$1,500
* Machine 2: ($20,000 (FMV)/($30,000 + $20,000 + $10,000) ×$3,000 =$1,000
* Machine 3: ($10,000 (FMV)/($30,000 + $20,000 + $10,000) ×$3,000 =$500

The basis for each of the three machines is as follows:
* Machine 1: $30,000 (FMV) + $1,500 (Common Cost Allocation) =$31,500
* Machine 2: $20,000 (FMV) + $1,000 (Common Cost Allocation) =$21,000
* Machine 3: $10,000 (FMV) + $500 (Common Cost Allocation) =$10,500

Question 59

Describe Nontaxable Stock Dividend Received

Answer 59

If a nontaxable stock dividend is received, a portion of the basis of the stock on which the stock dividend is received is allocated to the new shares received from the stock dividend. The cost basis of the previously acquired shares is then reduced by the amount of the basis that is allocated to the stock dividend shares. If the stock received as a stock dividend is of the same type as the stock owned before the dividend, the total basis of the stock owned before the dividend is allocated equally to all shares now owned.

Question 60

Wayne owns 1,000 shares of Bell Corporation common stock with a $44,000 basis. Wayne receives a nontaxable 10% stock dividend and now owns 1,100 shares of common stock.
What is the basis for each share of common stock?

Answer 60

The basis for each share of common stock is now $40 ($44,000 ÷ 1,100).

Question 61

If the stock received as a stock dividend is not of the same type as the stock owned before the dividend, what is the allocation based on?

Answer 61

If the stock received as a stock dividend is not of the same type as the stock owned before the dividend, the allocation is based on relative fair market value (FMV).

Question 62

Stacey owns 500 shares of Montana Corporation common stock with a $60,000 basis. She receives a nontaxable stock dividend payable in 50 shares of preferred stock. At the time of distribution, the common stock has a $40,000 FMV ($80 x 500 shares) and the preferred stock has a $10,000 FMV ($200 x 50 shares). After the distribution, Stacey owns 50 shares of preferred stock.

What is the basis or the preferred stock?
What is the basis of the common stock?

Answer 62

After the distribution, Stacey owns 50 shares of preferred stock with a basis of $12,000 [($10,000 ÷ $50,000) x $60,000].

Thus, $12,000 of the basis of the common stock is allocated to the preferred stock and the basis of the common stock is reduced from $60,000 to $48,000.

Question 63

Two years ago, Jose purchased 100 shares of common stock in Blue in Green Co., for $5,280. Last year, Blue in Green declared a stock dividend of 1 share of its common stock for each 10 shares held. This year, Blue in Green’s common stock split 2-for-1 at a time when the FMV was $80/share.
What is Jose’s basis in each of his shares of the Blue in Green Co. stock if both distributions were tax-free?
* $80 per share
* $52.80 for 100 shares, $0 for all additional shares
* $24 per share
* $48 for $110 shares, $0 for all additional shares

Answer 63

$24 per share

$5,280 ÷ (100 + 10 + 110 shares) = $24 per share

Question 64

List the 3 courses of action a recipient of stock rights has

Answer 64

Stock rights represent rights to acquire shares of a specific corporation’s stock at a specific exercise price when certain conditions are met. The exercise price is usually less than the market price when the stock rights are issued. Stock rights may be distributed to employees as compensation and they are often issued to shareholders to encourage them to purchase more stock.

A recipient of stock rights generally has three courses of action.
* The stock rights can be sold or exchanged, in which case the basis allocated to the stock rights, if any, is used to determine the gain or loss.
* The stock rights may be exercised, and any basis allocated to the rights is added to the purchase price of the acquired stock.
* The stock rights may be allowed to expire, in which case no loss is recognized, and any basis allocated to the rights is reallocated back to the stock.

Question 65

What is the basis of the stocks rights if the fair market value (FMV) of nontaxable stock rights received is less than 15% of the FMV of the stock?

Answer 65

If the fair market value (FMV) of nontaxable stock rights received is less than 15% of the FMV of the stock, the basis of the stocks rights is zero unless the taxpayer elects to allocate the basis between the stock rights and the stock owned before distribution of the stock rights. If the FMV of a nontaxable stock right received is equal to or greater than 15% of the FMV of the stock, the basis of the stock owned before the distribution must be allocated between the stock and the stock rights.

Question 66

How does the decision to allocate basis affects the gain or loss realized?

Answer 66

The decision to allocate basis affects the gain or loss realized on the sale or disposition of the stock rights because the basis of the rights is zero unless an allocation is made. Furthermore, the basis of any stock acquired by exercising the rights is affected whether a portion of the basis is allocated to the rights or not. The basis of the stock acquired by exercising the stock rights is the amount paid plus the basis of the stock rights exercised.

Question 67

Tina owns 100 shares of Bear Corporation common stock with a $27,000 basis and a $50,000 FMV. She receives 100 nontaxable stock rights with a total FMV of $4,000. Because the FMV of the stock rights is less than 15% of the FMV of the stock (0.15 x $50,000 = $7,500), the basis of the stock rights is zero unless Tina elects to make an allocation.

If Tina elects to allocate the basis of $27,000 between the stock rights and the stock, what is the basis of the rights?
What is the basis of the stock?

Answer 67

If Tina elects to allocate the basis of $27,000 between the stock rights and the stock, the basis of the rights is $2,000 ([$4,000 ÷ $54,000] x $27,000).

The basis of the stock is $25,000 ([$50,000 ÷ $54,000] x $27,000).

Question 68

Tom bought 80 shares of stock for $4,000. Later, when the FMV of the stock was $10,000, Tom gave the stock to his son. No gift taxes were required. His son later sold the stock for $12,000. What is his son’s gain or loss?
* $8,000 gain
* $2,000 gain
* $6,000 gain
* $2,000 loss

Answer 68

$8,000 gain

The son’s basis in the gifted property will be $4,000 so he will recognize a gain of $8,000. The donor’s holding period will also carry over.

Question 69

Brad receives a $14,000 return of capital distribution from a corporation, when the tax basis for the investment is $10,000. What amount is treated as a gain realized on a sale or exchange of the stock investment.
* $14,000
* $10,000
* $4,000
* $24,000

Answer 69

$4,000

If a taxpayer receives a $14,000 return of capital distribution from a corporation when the taxpayer’s basis for its investment in the corporation’s stock is $10,000, the first $10,000 received represents a recovery of basis and only the $4,000 excess amount is treated as a gain realized on a sale or exchange of the stock investment.

Question 70

This year, Alice made a gift of property to Bill. The property had a basis to Alice of $45,000 and a fair market value of $75,000 at the time of the gift. The gift was fully taxable so Alice had to pay a gift tax on the transfer of $1,400. Alice made full use of the annual exclusion when paying the gift tax. What is Bill’s basis in the property?
* $40,000
* $70,100
* $45,700
* $30,000

Answer 70

$45,700

When the FMV is greater than the donor’s basis at the time of the gift; the donee normally takes a carryover basis.
When the donor pays a gift tax (only on appreciated property), the portion of the gift tax allocable to the appreciation is added to the basis.
$45,000 +[$1,400 X {($75,000 - $45,000) / $60,000}]
Note that $60,000 represents the value of the taxable gift. (FMV of $75,000 - $15,000 annual exclusion).

Question 71

If a donee receives a gift with an FMV below the adjusted basis of the donor, and eventually sells the gifted property for an amount that is GREATER than the adjusted basis of the donor, _ ______??______ is used to calculate the gains.
* the gift tax basis
* the donor’s adjusted basis
* the sale price
* the FMV on the date of the gift

Answer 71

the donor’s adjusted basis

When loss property is gifted and the final sale price is above the original basis of the donor’s adjusted basis, the donee (gift recipient) will use the donor’s adjusted basis to calculate the gains AND will inherit the donor’s holding period.

Question 72

For an Original Issue Discount (OID) to be zero on a $250,000, 15-year, zero-coupon corporate bond, the purchase price must be greater than _ ______??______.
* $231,250
* $187,500
* $62,500
* $240,625

Answer 72

$240,625

To find the purchase price at which an OID would be zero, the following formula is used to determine the amount of the maximum discount:
(0.0025 x face value of the bond x bond term)

In this case, the calculation is as follows:
(0.0025 x $250,000 x 15) = $9,375

Therefore, the bond must sell for greater than $240,625 ($250,000 - $9,375) for the OID to be considered zero.

Question 73

When determining basis of a personal residence, which of the following will increase basis?
* Complete replacement of a roof
* Replacing several damaged shingles
* Installation of a new window
* Painting the exterior of the home

Answer 73

Complete replacement of a roof

A new roof is considered a capital addition which increases basis. The remaining items are categorized as repairs and are not accounted for in determining basis.

Question 74

Kieran purchases an apartment building for $800,000 to use as a rental property. The land has a $280,000 FMV and the building has a $520,000 FMV.
What is Kieran’s basis for the apartment building?
* $520,000
* $240,000
* $800,000
* $338,000

Answer 74

$520,000

If more than one asset is acquired in a single purchase transaction the IRS considers this a basket purchase. With a basket purchase, the cost must be apportioned to the various assets acquired. The allocation is based on the relative fair market value (FMV) of the assets.

In Kieran’s case, the purchase is a basket purchase because it involved a building and land. The basis for the apartment building is $520,000.

Question 75

If a stock that is sold or exchanged is not adequately identified, the _ ______??______ _ must be used to identify the stock.
* first-in, first-out (FIFO) method
* specific identification method
* last-in, first-out (LIFO) method
* hybrid method

Answer 75

first-in, first-out (FIFO) method

If the stock sold or exchanged is not adequately identified, the first-in, first-out (FIFO) method must be used to identify the stock.

With the FIFO method, the stock sold or exchanged is presumed to come from the first lot or lots acquired.

Question 76

In the current year, Clifford makes one gift of property with a $37,500 basis to Jimmy when the property has a $88,000 FMV. Clifford pays a gift tax of $22,500.
Calculate Jimmy’s basis for the property for determining both gain and loss.
* $37,500
* $88,000
* $66,875
* $53,503

Answer 76

$53,503

Since the donor, Clifford, paid gift tax on the transfer of property, the donee’s basis increases because the fair market value (FMV) of the property exceeds the donor’s basis on the date of the gift.

The following formula is used to determine the amount to be added on to the donee’s basis:
Gift tax paid ×(FMV at time of gift − Donor’s basis)/(FMV at the time of gift − Annual exclusion)
$22,500 ×(($88,000 − $37,500)/($88,000 − $17,000)) =
$22,500 ×($50,500/$71,000) =
$22,500 ×0.7113 =$16,003
$16,003 + $37,500 (original basis) = $53,503

Question 77

Several years ago, Rhonda bought an original, signed vinyl record of her favorite 80s songwriter, Donald McMichael, for $75. When the musical medium shifted to MP3s, the value of the record dropped to $25 and Rhonda gifted it to her friend, Josie. This year, a vinyl record revival occurred and Josie sold the Donald McMichael album for $65.
Calculate the gain or loss on Josie’s record sale.
* $10 loss
* $50 gain
* $0
* $40 gain

Answer 77

$0

The record sale is subject to the ‘double-basis’ rule, and, as a result, there will be no gain or loss to Josie.

When the final sale of a gifted loss property is in between the donor’s original basis and the FMV on the date of the gift, there will be no loss or gain and the holding period is a non-factor.

Since Josie’s sale price ($65) fell in between Rhonda’s original purchase price ($75) and the FMV on the date of the gift ($25), there is $0 recognized on the sale.

Question 78

Which of the following items will decrease basis?
* Assessments for local improvements
* Certain vehicle credits
* Capital improvements
* Legal fees

Answer 78

Certain vehicle credits

Assessments for local improvements, legal fees, and capital improvements increase basis.

Question 79

The basis of property received from a decedent is ________________________. (Select all that apply)
* the decedent’s original basis
* the fair market value (FMV) of the property at the date of death
* the FMV on the alternate valuation date
* the FMV on a date determined by the executor of the estate

Answer 79

the fair market value (FMV) of the property at the date of death
the FMV on the alternate valuation date

Question 80

Suzu Inc. is a general contracting firm. This year, Eli, the business owner, purchases a pickup truck for $40,000 and pays sales taxes of $3,000 and a title for $750.
Based on this information, calculate the basis of Suzu Inc.’s new pickup truck.
* $42,250
* $43,000
* $40,000
* $43,750

Answer 80

$43,750

Cost basis for the pickup is $40,000 + $3,000 (sales tax) + $750 (title) = $43,750