Tax 3-3 Analyze a situation to calculate the adjusted basis of property.

Question 1

Basis

A taxpayer’s basis in an asset generally will be tied to the cost of the asset if the asset was purchased, also known as _____ _____.

cost basis

substituted basis

stepped-up basis

(3-3, pg 22)

Answer 1

cost basis

Question 2

Basis

When an asset is received as a gift, the taxpayer’s basis generally will be tied to the basis that the donor had in the asset prior to the gift, also known as _____ _____.

cost basis

substituted basis

stepped-up basis

(3-3, pg 22)

Answer 2

substituted basis

Question 3

Basis

When an asset is received as an inheritance, the heir’s basis in the asset generally will be its fair market value on the date of death, also known as _____ _____.

cost basis

substituted basis

stepped-up basis

(3-3, pg 22)

Answer 3

stepped-up basis

Question 4

Adjustments in Basis

A taxpayer is required to _____ (include in basis rather than deduct as an expense) certain costs associated with the acquisition of an asset. For example, sales taxes, freight costs, setup and installation costs, and legal or other professional fees incurred with respect to the acquisition of a capital asset must be included in the basis of the asset and recovered through depreciation, if the asset is depreciable.

(3-3, pg 22)

Answer 4

capitalize

Also, capitalized costs include “improvements,” which are amounts paid that increase the value or significantly prolong the useful life of an asset. An “improvement” is distinguished from a “repair,” which merely maintains the asset in an ordinary efficient operating condition.

Question 5

Adjustments in Basis

The basis of an asset acquired by gift is generally the donor’s basis. However, there is one situation where the fair market value on the date of the gift is used.

If the fair market value on the date of the gift is less than the donor’s basis in the asset, the donee’s basis in the asset for purposes of determining a loss on the sale of the asset will be the asset’s fair market value on the date of the gift.

However, the basis for determining gain on the sale will still be the donor’s basis. If the asset is sold at a price between the fair market value on the date of the gift and the donor’s basis, then…

(3-3, pg 23)

Answer 5

no gain or loss will be recognized.

Question 6

Adjustments in Basis

Donor’s adjusted basis: $10
FMV on date of gift: $5

Sale at $3 generates a…

(3-3, pg 23)

Answer 6

$2 loss using the FMV on date of gift

Question 7

Adjustments in Basis

Donor’s adjusted basis: $10
FMV on date of gift: $5

Sale at $14 generates a…

(3-3, pg 23)

Answer 7

$4 gain using donor’s basis

Question 8

Adjustments in Basis

Donor’s adjusted basis: $10
FMV on date of gift: $5

Sale at $6, $7, $8, or $9 generates a…

(3-3, pg 23)

Answer 8

no gain or loss

Question 9

Adjustments in Basis

When an asset is received as an inheritance, the heir’s basis in the asset is generally the fair market value on the date of death. This is commonly referred to as a “stepped-up basis.” Realize, however, that the basis may also be“stepped-down” to fair market value in the case of an asset that has _____ value since purchase.

(3-3, pg 23)

Answer 9

lost

The executor of the decedent’s estate may elect to value the property for estate tax purposes as of an “alternate valuation date,” usually six months after the date of death. If the executor makes this election, the heir’s basis in the property will be the property’s fair market value on the alternate valuation date.

Question 10

The term _____ basis refers to the original basis in the property, increased by any adjustments such as acquisition expenditures or improvements and reduced by any adjustments to basis, such as depreciation deductions taken and the Section 179 deduction.

(3-3, pg 24)

Answer 10

adjusted

If the asset is sold, the sales price is compared to this adjusted basis amount to calculate the ultimate gain or loss from the sale.

Question 11

Adjusted Basis

Adam Smith purchased a computer for exclusive use in his consulting business. The computer had a cost of $2,200, and Adam paid $45 for delivery and an additional $125 for setup charges.

His adjusted basis is calculated as follows:

(3-3, pg 24)

Answer 11

$2,200 Cost Basis
+ $45 Capitalized Costs
+ $125 Capitalized Costs
= $2,370 Adjusted Basis

Question 12

Adjusted Basis

Adam Smith purchased a computer for exclusive use in his consulting business. The computer had a cost of $2,200, and Adam paid $45 for delivery and an additional $125 for setup charges and his new adjusted basis is $2,370.

Assume that Adam took a first-year cost recovery (depreciation) deduction of $474. His adjusted basis in the computer after the first year would be computed as follows:

(3-3, pg 24)

Answer 12

$2,370 Adjusted basis
- $474 cost recovery
= $1,896 Adjusted basis

Question 13

Adjusted Basis

4. The basis of an asset acquired by inheritance is
5. the greater of the decedent’s adjusted basis or the fair market value on the date of death.
6. the lesser of the decedent’s adjusted basis or the fair market value on the date of death.
7. the decedent’s adjusted basis.
8. the fair market value on the date of death.

(LO 3-3)

Answer 13

4. the fair market value on the date of death.

The basis of an asset acquired by inheritance is generally the fair market value on the date of death.

Question 14

Adjusted Basis

5. Two years ago, Jeff Welker purchased a parcel of raw land on which he could construct a new building for his hardware business. He paid $60,000 for the land and incurred $800 in legal fees associated with the title search. He also paid an attorney $2,000 to draft the contract for the purchase of the land. Property taxes on the land have totaled $1,200 annually.

What is Jeff’s adjusted basis in the land?

$60,000

$60,800

$62,800

$65,200

(LO 3-3)

Answer 14

$62,800

$60,000 Cost Basis
+ $800 Capitalized Costs
+ $2,000 Capitalized Costs
= $62,800 Adjusted Basis

The adjusted basis is the $60,000 cost increased by the capitalized costs (the title search and legal fees of $2,800).

Question 15

Adjusted Basis

6. Two years ago, Jerry Walker purchased new office equipment for use in his hardware business. The cost of the equipment was $18,000, and freight, delivery, and installation costs totaled $2,200. He received a first-year cost recovery deduction of $2,887 and a second-year cost recovery deduction of $4,947

What is Jerry’s adjusted basis in the equipment?

$10,166

$12,366

$18,000

$20,200

(LO 3-3)

Answer 15

$12,366

  $18,000 Cost Basis
\+ $2,200 Purchase Costs
- $2,887 1st Year Recovery Deduction
- $4,947 2nd Year Recovery Deduction 
= $12,366 Adjusted Basis

The cost basis of $18,000 is increased by the $2,200 of freight and installation costs. This is decreased by the first two years of cost recovery deductions of $7,834.

Question 16

Adjusted Basis

7. Two years ago, Stan James received a gift of 100 shares of common stock from his parents. The fair market value of the stock on the date of the gift was $80 per share. His parents had purchased the stock four years earlier at $60 per share. Stan sold this stock for $102 per share last week. What was Stan’s per share basis in the stock when it was sold?

$60

$80

$102

(LO 3-3)

Answer 16

$60

If the fair market value on the date of the gift is greater than the donor’s adjusted basis, the donor’s adjusted basis ($60 per share) is used as the recipient’s basis.

Question 17

Adjusted Basis

8. Terry’s uncle gave him 100 shares of Abacus Inc. common stock. The fair market value of the stock on the date of the gift was $180 per share. Terry’s uncle had purchased the stock three years earlier at $210 per share. Terry sold his holdings of the stock for $200 per share three weeks ago.

What was Terry’s gain or loss on the sale of the stock?

$0

($1,000)

$2,000

(LO 3-3)

Answer 17

$0

When the fair market value on the date of the gift is less than the donor’s basis in the asset, and the sale price is between the fair market value on the date of the gift and the donor’s basis, there is no gain or loss recognized.

Question 18

Adjusted Basis

18. Three years ago, Mary Gibson received a gift of 100 shares of public utility stock from her aunt. The fair market value of the stock on the date of the gift was $20 per share. Her aunt had purchased the stock six years earlier at $6 per share. Mary sold this stock for $24 per share last week.

What was Mary’s basis in the stock when she sold it?

$6 per share

$20 per share

$24 per share

(LO 3-3)

Answer 18

$6 per share

If the fair market value on the date of a gift is greater than the donor’s adjusted basis, the donee takes the donor’s basis.

Question 19

Adjusted Basis

23. Four years ago, Mark Lesser received a gift of 500 shares of common stock from his grandfather. The fair market value of the stock on the date of the gift was $335 per share. His grandfather had purchased the stock three years earlier at $425 per share. Mark sold this stock for $200 per share last week.

What was Mark’s basis in the stock when he sold it?

$200 per share

$335 per share

$425 per share

(LO 3-3)

Answer 19

$335 per share

When the fair market value on the date of the gift is less than the donor’s basis in the asset, and the sale price is less than the fair market value on the date of the gift, then the donee’s basis is the fair market value on the date of the gift.

Question 20

Adjusted Basis

Two years ago, Sam Jones received a gift of 100 shares of common stock from his parents. The fair market value of the stock on the date of the gift was $10 per share. His parents had purchased the stock four years earlier at $3 per share. Sam sold this stock for $12 per share last week.

What was Sam’s tax basis in the stock when he sold it?

(LO 3-3)

Answer 20

Tax basis = $300 $3 (donor’s basis) × 100 (shares) = $300

Question 21

Adjusted Basis

Four years ago when Jerry Dunes moved into the mountain cabin, his uncle gave him 100 shares of Quantum Inc. common stock. The fair market value of the stock on the date of the gift was $20 per share. Jerry’s uncle had purchased the stock 16 months earlier at $30 per share. Jerry sold his holdings of the stock for $25 per share three weeks ago.

What was Jerry’s gain or loss on the sale of the stock?

(LO 3-3)

Answer 21

Neither gain nor loss has to be recognized if the donee sells the property for a value between the FMV on the date received and the donor’s cost—if the FMV on the date received is less than the donor’s basis.

Question 22

Adjusted Basis

Five years ago, Bill Johnston received a gift of 100 shares of ABC common stock from his parents. The fair market value of the stock on the date of the gift was $12 per share. His parents had purchased the stock four years earlier at $7 per share. Bill sold this stock for $13 per share last week.

What was Bill’s tax basis in the stock when he sold it?

(LO 3-3)

Answer 22

$7/share—the gain basis of an asset acquired by gift generally is the donor’s adjusted basis.

Question 23

Practice Test 2

Adjusted Basis

20. Several years ago, Jack Mitchell purchased a duplex to use as a rental property. The cost of the duplex was $79,500. He paid an attorney $800 to draft the legal documents related to the purchase. He paid $7,500 for improvements in the first year, and this year paid $1,900 for various repairs to the property. He claimed a first-year cost recovery deduction of $3,000.

What is Jack’s adjusted basis in the duplex?

$85,900

$82,900

$84,800

$87,800

$87,800

(LO 3-3)

Answer 23

$84,800

  $79,500 Cost Basis
\+ $800 Capitalized Costs
\+ $7,500 Capitalized Costs
- $3,000 1st Year Recovery Deduction	
= $84,800 Adjusted Basis

The cost of the duplex of $79,500 is increased by the capitalized costs. The capitalized costs would include $800 for the attorney’s fees and $7,500 for improvements. This amount would be reduced by the cost recovery deduction of $3,000, to leave an adjusted basis of $84,800. The repairs of $1,900 represent a current deduction and therefore do not impact the basis of the property.

Question 24

Practice Test 2

Adjusted Basis

21. Billy Joseph received 100 shares of stock from his uncle, Ray Washington. Ray purchased the stock eight years ago for $12 per share. The fair market value on the date of Ray’s death was $9 per share, and the fair market value six months after the date of death was $10 per share.

Assume that Billy inherited the stock and that the administrator did not elect the alternate valuation date. What is Billy’s per-share basis in the acquired stock?

$9.00

$9.50

$10.00

$12.00

(LO 3-3)

Answer 24

$9.00

The basis of property acquired by inheritance is simply the fair market value on the date of the decedent’s death. In this case, that value was $9 per share.

Question 25

Practice Test 2

Adjusted Basis

22. Billy Joseph received 100 shares of stock from his uncle, Ray Washington. Ray purchased the stock eight years ago for $12 per share. The fair market value on the date of Ray’s death was $9 per share, and the fair market value six months after the date of death was $10 per share.

Assume instead that the administrator elected the alternate valuation date. What is Billy’s per-share basis in the acquired stock?

$9.00

$9.50

$10.00

$12.00

(LO 3-3)

Answer 25

$10.00

The basis of property acquired by inheritance where the administrator elects the alternate valuation date is the fair market value on that alternate valuation date. Thus, in this situation the fair market value of $10 as of the alternate valuation date would be Billy’s basis in the acquired property.

Question 26

Practice Test 2

Adjusted Basis

23. Billy Joseph received 100 shares of stock from his uncle, Ray Washington. Ray purchased the stock eight years ago for $12 per share.

Billy received the stock as a gift from Uncle Ray two years ago, when the fair market value of the stock was $15 per share, and he sold the stock this year for $19 per share.

What was Billy’s per-share basis in the stock?

$12

$15

$19

the basis cannot be determined

(LO 3–3)

Answer 26

$12

In the case of an asset received as a gift, if the fair market value on the date of the gift is greater than the donor’s adjusted basis, the recipient has a carryover basis. In this case, Uncle Ray had purchased the stock for $12 per share and had gifted it to Billy when the fair market value was $15 per share. Billy subsequently sold the stock for $19 per share. Thus, the carryover basis from Uncle Ray would be $12 per share.

Question 27

Practice Test 2

Adjusted Basis

24. Billy Joseph received 100 shares of stock from his uncle, Ray Washington. Ray purchased the stock eight years ago for $12 per share.

Billy received the stock as a gift from Uncle Ray two years ago, when the fair market value was $8 per share, and he sold the stock this year for $6 per share.

What was Billy’s per-share basis in the stock?

$6

$8

$12

the basis cannot be determined

(LO 3–3)

Answer 27

$8

When the fair market value on the date of the gift is less than the donor’s basis in the asset, the donee’s basis in the asset for purposes of determining a loss is the asset’s fair market value on the date of the gift. In this situation, the $8 per-share value on the date of the gift would be Billy’s basis.

Question 28

Practice Test 1

Adjusted Basis

9. Four years ago, Janice Miller purchased a duplex for investment purposes at a cost of $120,000. Legal fees for acquisition were $2,000. Prior to renting the property, Janice paid $8,000 to tear down a wall, renovate, and transform two bedrooms into a master suite. She has since taken cost recovery deductions in the amount of $19,500 and paid $2,000 in property taxes.

What is Janice’s current adjusted basis in the duplex?

$90,500

$100,500

$108,500

$110,500

$120,000

(LO 3-3)

Answer 28

$110,500

  $120,000 Cost Basis
\+ $2,000	Capitalized Costs
\+ $8,000	Capitalized Costs
- $19,500 1st Year Recovery Deduction
= $110,500 Adjusted Basis

The adjusted basis is the original cost basis of $130,000 (including the legal fees and improvements that must be capitalized), reduced by the cost recovery deductions. The property taxes paid are a current deduction, and thus do not impact the adjusted basis.