Section 2: Income & Assets Unit 6: Calculating Basis of Assets

Question 1

The cost basis of an asset may include:

Answer 1

• Sales taxes charged during the purchase
• Freight-in charges and shipping fees
• Installation costs and testing fees
• Delinquent real estate taxes that are paid by the buyer of a property
• The cost of any major improvements to the property
• Legal and accounting fees for transferring an asset
• The cost of extending utility service lines to the property and impact fees
• Legal fees or court costs perfecting title to a property
• Legal fees for obtaining a decrease in an assessment levied against property to pay for local improvements; and/or zoning costs and the capitalized value of a redeemable ground rent.

Question 2

Ambrosio purchases a new vehicle for $15,000. The sales tax on the vehicle is $1,200. He also pays a delivery charge to have the car shipped from a dealership in another state to his home. The delivery charge is $210. What is his basis in the vehicle?

Answer 2

Therefore, Ambrosio’s basis in the vehicle is $16,410 ($15,000 + $1,200 +
$210).

Question 3

Leonardo sets up a computer system and designs a custom website for Lindsay’s restaurant business. In return, Lindsay gives Leonardo a delivery van that he plans to use for his own business and depreciate. The fair market value of both Leonardo’s services and the delivery van is $70,000. Lindsay’s basis in the delivery van was $45,000. What amount of income should Leonardo report for this bartering transaction and what is his depreciable basis in the delivery van?

A. $70,000 income; $70,000 depreciable basis.
B. $70,000 income; $45,000 depreciable basis.
C. $0 income and no depreciable basis.
D. $45,000 income; $70,000 depreciable basis.

This question is answered correctly on the first attempt by 51% of students.

Answer 3

Correct Answer Explanation for A:

If compensation for personal services is paid in property, its fair market value at the time of receipt is gross income, which becomes the basis in the property. Since the delivery van’s FMV at the time of the barter exchange is $70,000, Leonardo must recognize $70,000 of income and the property’s depreciable basis is also $70,000.

Question 4

3. Question ID: 95399827 (Topic: Basis of Assets - General)
   Gerard owns 100 shares of Sustainable Fisheries, Inc. stock, which he purchased five years ago for $1,500. On May 1, Sustainable Fisheries issues a stock dividend of 50 additional shares. Gerard sells 60 shares on December 28. What is his adjusted basis in the 60 shares that he sold?

A. $600
B. $2,250
C. $900
D. $500

Answer 4

Correct Answer Explanation for A:

Gerard’s basis in the original stock was $1,500 for 100 shares, so his original basis per share was $15 ($1,500/100). The addition of 50 shares means Gerard’s adjusted basis per share decreased to $10 per share ($1,500/150). Therefore, his basis in the 60 shares he sold in December is $600 ($10 adjusted basis per share × 60).

Question 5

Kenji purchased 75 silver coins as an investment on January 1, 2023. The coins cost $23 each, plus an additional sales tax of $67. On November 10, 2023, Kenji sold all the coins to a collector for $1,900. What is his net gain and how it is taxed?

Answer 5

His net gain is $108 ($1,900 - $1,792 basis). Kenji’s basis in the silver coins is $1,792 ([$23 × 75 coins] + $67). Kenji has a $108 short-term capital gain, because he held the coins for less than a year. The short-term gain will be taxed at his ordinary income tax rate.

Question 6

4. Question ID: 94849644 (Topic: Basis of Assets - General)
   Maura was granted 50 nonqualified stock options by her employer, Yancey Corporation, on June 8, 2023, to purchase stock in the company. At the date of the grant, the company was privately-held and the FMV of the stock was not readily determinable. The option price was $10 a share. Yancey Corporation completed an initial public offering (IPO) on November 1, and Maura exercised her options on December 15, 2023. The stock’s FMV on the exercise date was $32 a share. Maura immediately sold the stock upon exercise and received gross proceeds of $1,600. How should Maura report this transaction on her tax return?

A. Ordinary income of $1,100
B. Capital gain of $1,600
C. Dividend income of $1,600
D. Capital gain of $1,100

Answer 6

Correct Answer Explanation for A:

The difference between the option price ($10/share) and the FMV ($32/share) is included in Maura’s taxable compensation ($22 × 50 shares = $1,100) and thus is taxable as ordinary income. For more information and examples of stock options, see IRS Tax Topic 427, Stock Options.

Question 7

Leticia pays a total of $1,050 for 100 shares of Azure Cola, Inc., plus an additional broker’s
commission of $50. This means her initial cost for the 100 shares is $1,100 ($1,050 original cost + $50
broker’s commission). This equals $11 per share ($1,100 ÷ 100 shares). At a later point in time, Leticia
receives a stock dividend of 10 shares without any tax implications. What is her basis per share now?

Answer 7

Her original basis of
$1,100 must now be divided over 110 shares (the initial 100 shares plus the additional ten-share
dividend). Her basis per share decreases to $10 ($1,100 ÷ 110).

Question 8

Irwin buys 100 shares of Cortex Technology, Inc. for $50 per share. His cost basis is $50 × 100 shares or $5,000. Six months later, Cortex Technology, Inc. declares a 2-for-1 stock split, and Irwin receives 100 additional shares of stock. What is his new basis per share?

Answer 8

Therefore, his new basis in each individual stock is $25 = ($5,000 ÷ [100 + 100]). His total basis in the shares remains $5,000.

Question 9

5. Question ID: 94849575 (Topic: Basis of Assets - General)
   When calculating the basis of stock or other securities held for investment, which of the following costs would NOT be included in a stock’s basis?

A. Direct costs of purchase.
B. Interest paid on a margin loan.
C. Recording fees.
D. Broker’s commissions.

Answer 9

Correct Answer Explanation for B:

The basis of stocks or bonds is generally the purchase price plus the costs of purchase, such as broker’s commissions and recording or transfer fees. In most cases, the cost basis of an investment is the original purchase price upon acquisition. However, interest incurred on a margin loan would not be included in the basis of securities. Instead, investment interest expense is a tax deduction.

Note: Investment interest expense is the interest paid on money borrowed to purchase taxable investments. This includes interest incurred on margin loans for buying stock in a brokerage account. This deduction is limited to the amount of net investment income.

Question 10

6. Question ID: 94849694 (Topic: Basis of Assets - General)
   On May 11, 2023, the Barberry Corporation granted 800 incentive stock options to their top sales executive, Julie, with an option price of $15. On December 31, 2023, Julie exercised all of her stock options when the market price per share was $23. Once she exercised her options, she decided to hold onto the stock for investment purposes. What is the basis of her stock and how much should be included on Julie’s Form W-2 as income for the year?

A. Basis $12,000; income $6,400.
B. Basis $12,000; income $12,000.
C. Basis $12,000; income $0.
D. Basis $0; income $0.

Answer 10

Correct Answer Explanation for C:

For incentive stock options, (ISOs) the basis in the stock is the actual price per share paid upon exercise of the options. In this case, the executive’s basis is 800 × $15 = $12,000. The bargain element attributable to the difference between the exercise price and the value at the date of exercise ([$23 - $15] × 800 shares = $6,400) is not recognized until the stock is sold. However, the taxpayer may need to make an adjustment for alternative minimum tax (AMT) purposes for the bargain element. When the stock is later sold, she will recognize gain equal to the difference between her basis and the net proceeds of the sale.

For more information on how to report taxable stock options, see IRS Topic No. 427 Stock Options.

Question 11

7. Question ID: 94849689 (Topic: Basis of Assets - General)
   During the current year, Ishmael purchased a new utility van for his package delivery business. The van is used 100% for business. He reports his income and loss on Schedule C. His costs were as follows:

Cost of the van: $64,000.
Sales tax on the van: $3,850.
Title transfer charges: $700.
Installation of special equipment: $1,500.
Personal property taxes on the van: $2,000 (DMV registration fees).
What is Ishmael’s depreciable basis in this utility van?

A. $72,050
B. $66,200
C. $68,550
D. $70,050

Answer 11

Correct Answer Explanation for D:

The answer is calculated as follows: $64,000 cost of van + $3,850 sales tax + $700 transfer charges + $1,500 installation charges = $70,050.

The basis of property is generally its cost. Sales tax paid in acquisition of property is treated as a cost of the property. Delivery charges, installation, and testing also are included as part of the cost of property. Personal property taxes, however, are not treated as a cost of the property. The DMV fees would be deductible as a current business expense on Schedule C, and not included in the basis of the van.

Question 12

8. Question ID: 94849662 (Topic: Basis of Assets - General)
   Hyun purchases an empty parking lot for $90,000 at a county property auction. He plans to use the property for investment purposes. He pays $20,000 in cash and finances the remaining $70,000 with a bank loan. The lot has a $12,000 lien against it for unpaid property taxes that were owed by the previous owner. Hyun agrees to pay the delinquent property taxes as a condition of the sale. Which of the following statements is correct?

A. His basis in the property is $102,000.
B. His basis in the property is $32,000.
C. His basis in the property is $90,000, and he can deduct the property taxes on his Schedule A as property taxes paid.
D. His basis in the property is $78,000.

Answer 12

Correct Answer Explanation for A:

Hyun’s basis in the property is determined as follows: ($90,000 + $12,000 = $102,000). Hyun cannot deduct the delinquent property taxes as a current expense, because the property taxes were not his liability (they were assessed on the previous owner and owed by the previous owner). Any obligations of the seller that are assumed by the buyer increase the basis of the asset, and are not currently deductible. Since Hyun did not own the property when the taxes accrued but agreed to pay them as a condition of the sale, he should add the property tax payment to his basis in the property.

Question 13

3. Question ID: 95850157 (Topic: Basis of Assets - Divorce)
   Harold and Bethany finalized their divorce this year. A month after the divorce was final, Harold transferred 1,000 shares of stock with a $50,000 basis to Bethany as part of the divorce settlement. The stock’s value increased to $60,000 during their divorce proceedings, and this was the value of the stock when it was transferred to Bethany. What are the tax implications for this transfer?

A. Bethany must recognize a gain of $10,000 on the transfer.
B. Harold must recognize a gain of $10,000 on the transfer.
C. Harold may recognize a loss of $10,000 on the transfer.
D. Neither Harold nor Bethany recognizes any gain or loss on the transfer.

Answer 13

Correct Answer Explanation for D:

Neither Harold nor Bethany recognizes any gain or loss on the transfer. Bethany’s basis in the stock would remain the same as Harold’s ($50,000).

When property is transferred from one spouse to another during a divorce, typically, there are no tax implications for this transfer. For property transfers to qualify as “incident to a divorce,” the transfer generally must occur within one year after the date the marriage ends.

For more information about spousal transfers during a divorce, see Publication 504, Divorced or Separated Individuals.

Question 14

4. Question ID: 94849614 (Topic: Basis of Assets - Divorce)
   Stephanie and Roger, a married couple, purchased a home together seven years ago for $180,000. They both lived in it until January 12, 2023, when they legally separated, and Roger moved out. The court granted Stephanie sole ownership of the home as part of their divorce settlement. Their divorce became final on September 1, 2023. The fair market value of the home was $442,000 when ownership was transferred to Stephanie. She sold the house on December 26, 2023, for $451,000. What is Stephanie’s taxable gain on this transaction?

A. $21,000
B. $271,000
C. $0
D. $9,000

Answer 14

Correct Answer Explanation for A:

Special rules apply to divorced taxpayers. Stephanie meets the “ownership and use” tests, and the basis in the property remains the same. Transfers related to a divorce are generally nontaxable, and the fair market value of the property at the time of the divorce has no bearing on the taxable outcome. The gain is figured as follows:

Original cost: $180,000
Sale price: $451,000
Total realized gain: $271,000
Sec. 121 exclusion for single filers: ($250,000)
Taxable gain she must report on her tax return: $21,000 in long-term capital gains
Since she owned the property for longer than one year, the taxable portion of Stephanie’s gain would be reported as a long-term capital gain. Because she is no longer legally married in the year of the sale, she will be filing single, and her maximum section 121 exclusion is $250,000, not $500,000.

Question 15

1. Question ID: 95850159 (Topic: Basis of Gifted Assets)
   In general, what is the basis of property received as a gift?

A. The basis of gifted property is usually zero.
B. The fair market value (FMV) at the time of the gift.
C. The adjusted basis of the property just before the donor made the gift.
D. The original cost basis of the property, without any adjustments.

Answer 15

Correct Answer Explanation for C:

The basis of property received as a gift is generally the donor’s adjusted basis just before making the gift. This is known as a “transferred basis.”

Question 16

4. Question ID: 94849512 (Topic: Basis of Gifted Assets)
   Bonnie receives an acre of land as a gift from her brother. Her brother’s basis in the land is $50,000, which is how much he originally paid for it. The land’s fair market value on the date of the gift is $40,000. A couple of years later the value of the land further lowers in value and Bonnie sells the gifted land for $35,000. What is her basis in the land for calculating her own gain or loss on the sale?

A. $35,000
B. $0
C. $40,000
D. $50,000

Answer 16

Correct Answer Explanation for C:

Since Bonnie sold the property at a loss, her basis in the land for calculating the loss is $40,000, because it is the lower of her brother’s adjusted basis and the fair market value on the date of the gift. See IRS Publication 551, Basis of Assets, for more information on how to calculate the basis of gifted property.

Question 17

6. Question ID: 94849640 (Topic: Basis of Gifted Assets)
   Murray purchased a first edition of an Ernest Hemingway novel in the 1920s for $25. Decades later, Murray gave the book to his grandson, Maximus. At the time of the gift, the book had an appraised value of $1,325. Nine months later, Maximus sold the book for $1,650. What is the amount and character of Maximus’ gain from the sale of the first edition book?

A. $1,625 long-term capital gain.
B. $1,300 long-term capital gain.
C. $1,625 ordinary gain.
D. $325 short-term capital gain.

Answer 17

Correct Answer Explanation for A:

Maximus has a $1,625 long-term capital gain ($1,650 – transferred basis $25). The holding period is long term, because the holding period of his grandfather is “tacked-on” to Maximus’ holding period.

Question 18

1. Question ID: 94849764 (Topic: Basis of Inherited Property)
   Jennifer inherited 1,000 shares of stock from her grandmother, who died on February 1, 2023. Her grandmother had originally paid $10 per share when she purchased the stock several years prior. The fair market value of that stock on February 1 was $13 per share. Nine months later, on November 1, Jennifer sold all the stock for $14 a share. No estate tax return was filed for her grandmother’s estate. What is the amount and nature of Jennifer’s gain?

A. $1,000 in long-term capital gain.
B. $1,000 in short-term capital gain.
C. $4,000 in long-term capital gain.
D. $4,000 in short-term capital gain.

Answer 18

Correct Answer Explanation for A:

She has $1,000 in long-term capital gain. Her cost basis of the stock is the fair market value of that stock as of the date of the decedent’s death. Since the FMV of the stock was $13 on the date of her grandmother’s death, then her basis would be $13,000 ($13 x 1,000 shares) Therefore, if Jennifer sells all the stock for $14 a share and on the date of death the value was $13 a share, then she would pay tax on $1 a share ($14,000 sales price - $13,000 stepped-up basis). Since the stock was inherited, it would automatically be treated as long term capital gains.

Question 19

2. Claudine owns a piece of land that she purchased several years ago for $250,000. The land is now
   worth $750,000. During the year, she borrows $500,000 from a bank to improve the property. She uses
   $260,000 of the loan to demolish two existing buildings on the property and clear the land for the
   construction of a stockyard and horse stable, which will begin next year. What is Claudine’s basis in
   the land after the demolition is completed?
   A. $250,000
   B. $460,000
   C. $510,000
   D. $750,000

Answer 19

2. The answer is C. Claudine’s basis in the land is calculated as follows: $250,000 (cost basis) +
   $260,000 (demolition costs) = $510,000. The loan amount is irrelevant because the act of borrowing
   alone does not increase the basis; the amount spent on the improvement of the property increases its
   basis.

Question 20

5. The basis of inherited property is generally:
   A. The adjusted basis to the decedent.
   B. The fair market value of the property on the date of the decedent’s death.
   C. The purchase price that the decedent paid.
   D. Determined nine months after the death of the decedent.

Answer 20

5. The answer is B. The basis of inherited property is generally the FMV of the property on the date
   of the decedent’s death, regardless of what the deceased person paid for the property or the tax basis
   in the property in the hands of the decedent right before death.

Question 21

13. Which of the following is added to a property’s basis instead of deducted on the tax return?
    A. Casualty loss.
    B. Personal property tax based on the value of a car.
    C. Investment interest expense.
    D. The cost of demolishing a building.

Answer 21

13. The answer is D. Demolition costs are not deductible. They must be added to the basis of the land
    on which the building was located. The costs increase the basis of the land, and not the basis of any
    subsequent building that may be constructed on the property at a later date.

Question 22

14. Which of the following is not added to the basis of property?
    A. Legal and accounting fees for transferring the title.
    B. Points on a loan.
    C. Sales tax.
    D. Freight-in charges.

Answer 22

14. The answer is B. Points related to a loan used to acquire property may be deductible in the year
    they are paid or amortizable over the term of the loan. Points are a type of mortgage interest. They are
    not added to the basis of the property.