REG CPA Exam: How to Calculate the Tax Basis of Property Received as a Gift or as an Inheritance from a Decedent

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Introduction

Overview of the Importance of Understanding the Tax Basis of Property Received as a Gift or Inheritance

In this article, we’ll cover how to calculate the tax basis of property received as a gift or as an inheritance from a decedent. The tax basis of property received as a gift or inheritance plays a crucial role in tax planning and compliance. Understanding how to determine and calculate this basis is essential for several reasons:

Determination of Gain or Loss: The tax basis is the starting point for calculating the gain or loss when the property is sold. This gain or loss, in turn, affects the amount of tax owed. If the basis is calculated incorrectly, it can lead to overpayment or underpayment of taxes, both of which have significant financial implications.
Estate and Gift Tax Implications: The way the basis is determined can impact estate and gift taxes. Properly understanding these rules ensures compliance with tax laws and helps in effective estate planning, potentially minimizing tax liabilities.
Accurate Record-Keeping: Maintaining accurate records of the basis of property is essential for tax reporting. Without precise documentation, taxpayers may face challenges in justifying their calculations during audits or inquiries by the IRS.

Relevance to the REG CPA Exam

The REG (Regulation) section of the CPA exam covers a wide range of topics related to federal taxation, ethics, and business law. One of the key areas tested is the calculation of the tax basis for various types of property, including property received as a gift or inheritance. Here’s why this topic is particularly relevant:

Core Concept in Taxation: Calculating the tax basis is a fundamental skill in taxation. Mastery of this concept is essential for answering many exam questions correctly, as it underpins numerous scenarios and problems presented in the REG exam.
Application in Real-World Scenarios: The REG CPA exam aims to test candidates on practical knowledge that they will apply in their professional careers. Understanding how to calculate the tax basis of gifted or inherited property is directly applicable to real-world tax situations, making it a critical area of study.
Complex Rules and Regulations: The IRS rules governing the tax basis of property received as a gift or inheritance are complex and nuanced. The REG exam tests candidates’ ability to navigate these complexities, ensuring they can apply the rules correctly in various situations.
Preparation for Professional Practice: For aspiring CPAs, a thorough understanding of tax basis calculations prepares them for advising clients, handling tax filings, and ensuring compliance with tax laws. This knowledge is invaluable for a successful career in public accounting, taxation, and financial advisory services.

By focusing on the importance and relevance of understanding the tax basis of property received as a gift or inheritance, candidates can better prepare for the REG CPA exam and enhance their ability to apply these principles in their professional practice.

Definition of Tax Basis

Explanation of Tax Basis

The tax basis of an asset, also known simply as “basis,” is a critical concept in the field of taxation. It refers to the original value of an asset for tax purposes, which is used to determine the amount of gain or loss realized upon the sale or other disposition of that asset. The basis can be thought of as the starting point for measuring any subsequent financial transactions involving the asset.

The initial basis of an asset is generally the amount paid for it, which includes the purchase price, sales tax, shipping and handling fees, installation charges, and any other costs directly related to acquiring the asset. However, the basis can be adjusted over time due to various factors, such as improvements made to the property, depreciation, and other capital expenses.

For property received as a gift or inheritance, the rules for determining the basis are different and more complex. These specific rules will be discussed in greater detail in later sections of this article.

Importance of Tax Basis in Determining Gain or Loss on the Sale of Property

The tax basis is of paramount importance because it directly impacts the calculation of gain or loss when the property is sold. Here’s how it works:

Calculation of Gain or Loss: The gain or loss on the sale of property is determined by subtracting the tax basis from the amount realized (usually the sale price) from the transaction.

Gain: If the amount realized exceeds the tax basis, the difference is a taxable gain.
Loss: If the tax basis exceeds the amount realized, the difference is a deductible loss. For example, if you sell an asset for $100,000 and the tax basis is $70,000, the gain is $30,000 ($100,000 – $70,000). Conversely, if the asset is sold for $60,000, the loss is $10,000 ($70,000 – $60,000).

Tax Liability: The calculation of gain or loss is crucial for determining the tax liability associated with the sale. A higher basis reduces the gain and therefore the tax owed, while a lower basis increases the gain and the associated tax. This is why understanding and accurately determining the basis is essential for effective tax planning and compliance.
Impact on Deductions and Credits: The tax basis also affects eligibility for certain tax deductions and credits. For example, the basis is used in calculating depreciation deductions for business assets. An incorrect basis can lead to inaccuracies in these deductions, potentially resulting in penalties or lost tax benefits.
Estate Planning and Gift Tax Considerations: Properly understanding the tax basis is essential in estate planning and the handling of gifts. The basis rules influence decisions on gifting property, as they affect the potential tax consequences for the recipient.

The tax basis is a fundamental concept in taxation that affects the calculation of gain or loss, tax liability, and eligibility for various tax benefits. Mastery of this concept is crucial for CPA candidates, as it underpins many areas of tax law and practice. Understanding the intricacies of how the basis is determined, especially for gifted and inherited property, is essential for success in the REG CPA exam and in professional tax advisory roles.

Tax Basis of Property Received as a Gift

General Rule for Determining the Tax Basis of Gifted Property

The tax basis of property received as a gift is generally determined by the donor’s adjusted basis in the property. This means that the recipient (donee) typically takes on the same basis that the donor had in the property at the time of the gift. This rule helps to ensure continuity in the calculation of gain or loss when the property is eventually sold by the recipient.

For example, if a donor purchased a piece of property for $30,000 and gave it as a gift when its fair market value (FMV) was $50,000, the recipient’s basis in the property would generally be $30,000 (the donor’s adjusted basis).

Adjustments to the Basis for the Donor’s Basis, Gift Tax Paid, and Other Considerations

Several adjustments may affect the basis of gifted property. These adjustments can increase or decrease the donee’s basis in the property:

Donor’s Adjusted Basis: The primary starting point for the donee’s basis is the donor’s adjusted basis at the time of the gift.
Gift Tax Paid: If the donor pays gift tax on the transfer, the basis of the gifted property may be increased by the amount of gift tax paid attributable to the net appreciation in value of the gift. The increase in basis is calculated as follows:
$\text{Increase in Basis} = \text{Gift Tax Paid} \times \left( \frac{\text{Net Appreciation}}{\text{FMV} – \text{Donor’s Adjusted Basis}} \right) $
- Net Appreciation: The difference between the FMV of the property at the time of the gift and the donor’s adjusted basis.
Improvements and Depreciation: Any capital improvements made by the donor before the gift are included in the donor’s adjusted basis. Depreciation claimed by the donor before the gift reduces the donor’s adjusted basis.

Special Situations (e.g., When the Fair Market Value (FMV) is Less Than the Donor’s Basis)

There are special rules that apply when the FMV of the property at the time of the gift is less than the donor’s adjusted basis. In these cases, the donee’s basis for determining gain or loss is as follows:

Determining Gain: If the donee sells the property for more than the donor’s adjusted basis, the basis for calculating gain is the donor’s adjusted basis.
Determining Loss: If the donee sells the property for less than the FMV at the time of the gift, the basis for calculating loss is the FMV at the time of the gift.
No Gain or Loss: If the donee sells the property for an amount between the donor’s adjusted basis and the FMV at the time of the gift, no gain or loss is recognized.

Example

Consider a property with a donor’s adjusted basis of $50,000 and a FMV of $40,000 at the time of the gift:

Gain Calculation: If the recipient sells the property for $60,000, the basis for gain is $50,000 (the donor’s adjusted basis). The gain would be $10,000 ($60,000 – $50,000).
Loss Calculation: If the recipient sells the property for $30,000, the basis for loss is $40,000 (the FMV at the time of the gift). The loss would be $10,000 ($30,000 – $40,000).
No Gain or Loss: If the recipient sells the property for $45,000, no gain or loss is recognized because the sale price is between the donor’s adjusted basis and the FMV at the time of the gift.

Understanding these rules is essential for accurately determining the basis of gifted property and ensuring compliance with tax regulations. This knowledge is also crucial for REG CPA exam candidates, as it forms the foundation for various tax-related calculations and scenarios.

Examples of Calculating Basis for Gifted Property

Step-by-Step Example with Hypothetical Numbers

To illustrate how to calculate the basis for gifted property, let’s consider a detailed example with hypothetical numbers.

Scenario:

Donor’s Adjusted Basis: $30,000
Fair Market Value (FMV) at the Time of Gift: $50,000
Gift Tax Paid by Donor: $5,000

Step-by-Step Calculation:

Determine the Initial Basis:
The initial basis for the recipient is the donor’s adjusted basis.
Initial Basis = Donor’s Adjusted Basis = $30,000
Calculate the Increase in Basis Due to Gift Tax Paid:
First, calculate the net appreciation:
Net Appreciation = FMV – Donor’s Adjusted Basis = $50,000 – $30,000 = $20,000
Next, calculate the increase in basis:
$\text{Increase in Basis} = \text{Gift Tax Paid} \times \left( \frac{\text{Net Appreciation}}{\text{FMV}} \right) $
$\text{Increase in Basis} = \$5,000 \times \left( \frac{\$20,000}{\$50,000} \right) = \$5,000 \times 0.4 = \$2,000 $
Determine the Total Adjusted Basis:
Add the initial basis and the increase in basis due to gift tax:
Total Adjusted Basis = Initial Basis + Increase in Basis = $30,000 + $2,000 = $32,000

Result:

The donee’s basis in the gifted property is $32,000.

Considerations for Calculating Gain or Loss Upon Disposition

When the recipient of the gift eventually sells the property, the basis calculated above will be used to determine the gain or loss. Here are some considerations for calculating gain or loss upon disposition:

Gain Calculation:

Sale Price: The amount for which the property is sold.
Gain: If the sale price exceeds the total adjusted basis, the difference is recognized as a gain. [
Gain = Sale Price – Total Adjusted Basis
Example: If the recipient sells the property for $60,000:
Gain = $60,000 – $32,000 = $28,000
The recipient recognizes a gain of $28,000.

Loss Calculation:

Loss: If the sale price is less than the total adjusted basis, the difference is recognized as a loss. [
Loss = Total Adjusted Basis – Sale Price
Example: If the recipient sells the property for $25,000:
Loss = $32,000 – $25,000 = $7,000
The recipient recognizes a loss of $7,000.

No Gain or Loss:

In some cases, particularly when the FMV at the time of the gift is less than the donor’s adjusted basis, special rules apply to determine whether a gain or loss is recognized. This was discussed in the special situations section earlier.
Example: If the FMV at the time of the gift was $20,000 (less than the donor’s adjusted basis of $30,000), and the recipient sells the property for $25,000, no gain or loss is recognized since the sale price is between the donor’s adjusted basis and the FMV at the time of the gift.

These examples highlight the importance of understanding the rules for calculating the basis of gifted property and the subsequent gain or loss upon its sale. For CPA candidates, mastering these calculations is crucial for accurately addressing tax-related scenarios on the REG CPA exam.

Tax Basis of Property Inherited from a Decedent

General Rule for Determining the Tax Basis of Inherited Property

The general rule for determining the tax basis of property inherited from a decedent is that the basis is the fair market value (FMV) of the property at the date of the decedent’s death. This rule applies to most types of property, including real estate, stocks, bonds, and personal property. The FMV at the date of death becomes the new basis for the heir, which is used to calculate gain or loss when the property is eventually sold.

Explanation of the “Step-Up” (or “Step-Down”) in Basis to FMV at the Date of Death

The “step-up” (or “step-down”) in basis refers to the adjustment of the basis of inherited property to its FMV at the date of the decedent’s death. This adjustment can significantly affect the amount of taxable gain or loss recognized when the property is sold by the heir.

Step-Up in Basis: If the FMV at the date of death is higher than the decedent’s basis, the basis is “stepped up” to the FMV. This means that any appreciation in the value of the property during the decedent’s lifetime is not subject to capital gains tax.
Example: If the decedent’s basis in a property was $50,000 and its FMV at the date of death is $100,000, the basis for the heir is stepped up to $100,000.
Step-Down in Basis: If the FMV at the date of death is lower than the decedent’s basis, the basis is “stepped down” to the FMV. This means that any depreciation in the value of the property during the decedent’s lifetime is not deductible as a loss by the heir.
Example: If the decedent’s basis in a property was $100,000 and its FMV at the date of death is $80,000, the basis for the heir is stepped down to $80,000.

Special Rules for Community Property States

In community property states, special rules apply to the basis of property inherited from a decedent. Community property is generally owned equally by both spouses. When one spouse dies, the basis of both the decedent’s half and the surviving spouse’s half of the community property is adjusted to the FMV at the date of death.

Full Step-Up in Basis: Both the decedent’s and the surviving spouse’s shares of community property receive a step-up (or step-down) in basis to the FMV at the date of death. This rule applies even though the surviving spouse’s share was not inherited but was already owned by them.
Example: If a couple owned a house as community property with a basis of $200,000, and its FMV at the date of one spouse’s death is $400,000, the basis of the entire house is stepped up to $400,000.

Alternate Valuation Date and Its Impact on Basis

The executor of the estate may elect to use an alternate valuation date to determine the basis of inherited property. This date is six months after the decedent’s death and can be chosen if it results in a lower overall estate tax liability. The election must be made for all property included in the estate.

Impact on Basis: If the alternate valuation date is elected, the basis of the property is the FMV on that date rather than the date of death. This can affect the amount of gain or loss when the property is sold by the heir.
Example: If the FMV of a property is $300,000 at the date of death but decreases to $250,000 six months later, and the alternate valuation date is elected, the basis for the heir will be $250,000.

The tax basis of inherited property is generally the FMV at the date of the decedent’s death, with potential adjustments in community property states and an option to use an alternate valuation date. Understanding these rules is critical for determining the correct basis and calculating the taxable gain or loss when the property is sold. This knowledge is essential for CPA candidates preparing for the REG CPA exam, as it forms the foundation for many estate and tax planning scenarios.

Examples of Calculating Basis for Inherited Property

Step-by-Step Example with Hypothetical Numbers

Scenario:

Date of Death: January 1, 2023
Fair Market Value (FMV) at Date of Death: $150,000
Decedent’s Adjusted Basis: $100,000
Executor Elects to Use Alternate Valuation Date
FMV Six Months After Death: $140,000

Step-by-Step Calculation:

Determine the Initial Basis Using Date of Death:
By default, the basis is the FMV at the date of death.
Initial Basis = FMV at Date of Death = $150,000
Determine the Basis Using Alternate Valuation Date:
Since the executor elects to use the alternate valuation date, the basis is the FMV six months after the date of death.
Adjusted Basis (Alternate Date) = FMV Six Months After Death = $140,000

Result:

The heir’s basis in the inherited property is $140,000 using the alternate valuation date.

Considerations for Calculating Gain or Loss Upon Disposition

When the heir eventually sells the inherited property, the adjusted basis calculated above will be used to determine the gain or loss. Here are some considerations for calculating gain or loss upon disposition:

Gain Calculation:
- Sale Price: The amount for which the property is sold.
- Gain: If the sale price exceeds the adjusted basis, the difference is recognized as a gain.
  Gain = Sale Price – Adjusted Basis
  Example: If the heir sells the property for $160,000:
  Gain = $160,000 – $140,000 = $20,000
  The heir recognizes a gain of $20,000.
Loss Calculation:
- Loss: If the sale price is less than the adjusted basis, the difference is recognized as a loss.
  Loss = Adjusted Basis – Sale Price
  Example: If the heir sells the property for $130,000:
  Loss = $140,000 – $130,000 = $10,000
  The heir recognizes a loss of $10,000.
No Gain or Loss:
- In some cases, particularly when the FMV at the time of the alternate valuation date or the date of death is used, the sale price may result in no significant gain or loss.
  Example: If the property is sold for $140,000, the sale price equals the adjusted basis:
  Gain/Loss = $140,000 – $140,000 = $0
  The heir recognizes neither a gain nor a loss.

These examples illustrate how to determine the basis of inherited property using both the date of death and the alternate valuation date and how this basis impacts the calculation of gain or loss upon disposition. Understanding these rules is essential for accurate tax reporting and compliance, as well as for preparing for the REG CPA exam. Mastery of these concepts ensures that candidates can navigate complex tax scenarios effectively and provide valuable tax planning advice in their professional careers.

Differences Between Basis for Gifted and Inherited Property

Key Differences and Implications for Tax Calculations

Understanding the differences between the basis for gifted and inherited property is crucial for accurate tax calculations. Here are the key differences and their implications:

Determination of Basis:
- Gifted Property: The basis of gifted property is generally the donor’s adjusted basis at the time of the gift. If the FMV at the time of the gift is less than the donor’s basis, special rules apply for calculating gain or loss.
- Inherited Property: The basis of inherited property is typically the FMV at the date of the decedent’s death. This is known as the “step-up” or “step-down” in basis.
Impact on Gain or Loss:
- Gifted Property: The recipient of a gift may have a different basis for calculating gain and loss, depending on whether the FMV is less than the donor’s basis. This can lead to more complex tax calculations and potential variations in tax liability.
- Inherited Property: The step-up or step-down in basis to the FMV at the date of death simplifies the calculation of gain or loss. This often results in a lower taxable gain when the property is sold, as the appreciation during the decedent’s lifetime is not subject to capital gains tax.
Adjustments and Special Situations:
- Gifted Property: Adjustments may be made to the basis for gift tax paid and improvements made by the donor. Special rules apply if the FMV is less than the donor’s basis.
- Inherited Property: The basis adjustment to the FMV at the date of death applies universally, with special rules for community property states and the option to use an alternate valuation date.
Tax Planning Implications:
- Gifted Property: Gifting property with a low basis can result in higher taxable gains for the recipient upon sale. Donors should consider the recipient’s potential tax liability when making gifts.
- Inherited Property: The step-up in basis can significantly reduce the taxable gain for heirs, making it a favorable option for transferring appreciated property.

Importance of Proper Record-Keeping

Accurate record-keeping is essential for determining the correct basis of both gifted and inherited property. Here’s why it matters:

Verification of Basis:
- Gifted Property: Recipients need to know the donor’s adjusted basis and any adjustments for gift tax paid or improvements. Proper documentation ensures that the correct basis is used for tax calculations.
- Inherited Property: Heirs must have documentation of the FMV at the date of death or the alternate valuation date, as well as any relevant estate tax returns.
IRS Compliance:
- Gifted Property: The IRS requires documentation to verify the basis of gifted property. This includes gift tax returns (Form 709) and records of the donor’s original purchase price and improvements.
- Inherited Property: Executors must file estate tax returns (Form 706) and provide heirs with documentation of the FMV at the date of death. This is crucial for substantiating the step-up or step-down in basis.
Accurate Tax Reporting:
- Gifted Property: Proper record-keeping ensures that recipients accurately report the basis and calculate gain or loss upon disposition. This prevents errors that could lead to penalties or audits.
- Inherited Property: Accurate records allow heirs to correctly determine the basis and report gain or loss when the property is sold. This is especially important for compliance with IRS rules and avoiding disputes over the reported basis.
Estate Planning:
- Gifted Property: Donors should maintain detailed records of their basis and any adjustments to ensure that recipients have the necessary information for tax reporting.
- Inherited Property: Executors and heirs should work together to document the FMV at the date of death and any elections made for the alternate valuation date. This helps in accurate tax planning and compliance.

Understanding the key differences between the basis for gifted and inherited property and maintaining proper records are essential for accurate tax calculations and compliance. These practices are crucial for CPA candidates preparing for the REG CPA exam and for professionals providing tax planning and advisory services.

Reporting and Compliance

IRS Requirements for Reporting Basis of Gifted and Inherited Property

The IRS has specific requirements for reporting the basis of both gifted and inherited property to ensure accurate tax calculations and compliance. Understanding these requirements is crucial for avoiding penalties and ensuring that tax returns are properly filed.

Gifted Property

Gift Tax Returns (Form 709):
- When a gift is made, the donor may be required to file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. This form reports the details of the gift, including the donor’s basis in the property and any gift tax paid.
- The recipient (donee) should retain a copy of Form 709, as it contains important information needed to determine the basis of the gifted property. The donor’s adjusted basis and any adjustments for gift tax paid are crucial for the donee’s tax reporting when the property is sold.
Documentation of Donor’s Basis:
- The donee must maintain records of the donor’s adjusted basis, including the original purchase price, improvements, and any depreciation taken. These records are necessary to establish the donee’s basis and to calculate gain or loss upon the sale of the property.

Inherited Property

Estate Tax Returns (Form 706):
- The executor of the estate is required to file Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, if the estate exceeds the federal estate tax exemption threshold. This form reports the FMV of the estate’s assets at the date of the decedent’s death or the alternate valuation date.
- Heirs should retain a copy of Form 706, as it provides the FMV of the inherited property, which is used to determine the basis. The step-up or step-down in basis to the FMV at the date of death simplifies the calculation of gain or loss when the property is sold.
Documentation of FMV:
- The executor must provide heirs with documentation of the FMV at the date of death or the alternate valuation date. This includes appraisals, valuations, and any relevant estate tax returns. Proper documentation ensures that heirs can accurately determine the basis and comply with IRS requirements.

Relevant Forms and Documentation

Form 709 – United States Gift (and Generation-Skipping Transfer) Tax Return:
- Filed by the donor to report gifts that exceed the annual exclusion amount. It includes details about the donor’s basis in the gifted property and any gift tax paid.
- Relevant for the donee to establish the basis of the gifted property.
Form 706 – United States Estate (and Generation-Skipping Transfer) Tax Return:
- Filed by the executor of the estate to report the FMV of the estate’s assets. It includes information about the decedent’s assets, their values at the date of death, and any alternate valuation date used.
- Relevant for heirs to determine the basis of inherited property.
Form 8971 – Information Regarding Beneficiaries Acquiring Property from a Decedent:
- Filed by the executor to provide the IRS and beneficiaries with information about the property received from the decedent and its basis. This form helps ensure that beneficiaries report the correct basis when they eventually sell the property.
- Includes a Schedule A, which lists the assets distributed to each beneficiary and their respective values.
Documentation Requirements:
- For Gifted Property: Donors and donees should maintain detailed records of the donor’s adjusted basis, any gift tax paid, and relevant improvements or depreciation. This documentation is necessary to establish the donee’s basis and ensure accurate tax reporting.
- For Inherited Property: Executors and heirs should keep records of the FMV at the date of death, any alternate valuation date, appraisals, and estate tax returns. These documents are crucial for determining the basis and complying with IRS requirements.

In conclusion, proper reporting and compliance with IRS requirements for the basis of gifted and inherited property are essential for accurate tax calculations and avoiding penalties. Maintaining detailed records and filing the relevant forms ensures that taxpayers can substantiate their basis and comply with tax laws. This knowledge is critical for CPA candidates preparing for the REG CPA exam and for professionals providing tax advisory services.

Practice Questions and Scenarios

Sample Questions to Test Understanding

Question: A donor gives property with an adjusted basis of $30,000 and a fair market value (FMV) of $25,000. The recipient sells the property for $35,000. What is the gain or loss?
- Answer: Gain of $5,000. Since the FMV at the time of the gift is less than the donor’s adjusted basis, the basis for calculating gain is the donor’s adjusted basis of $30,000. The gain is $35,000 – $30,000 = $5,000.
Question: An heir inherits property valued at $200,000 on the date of the decedent’s death. Six months later, the property’s FMV is $180,000. The executor elects the alternate valuation date. If the heir sells the property for $190,000, what is the gain or loss?
- Answer: Gain of $10,000. The basis of the property is the FMV at the alternate valuation date, which is $180,000. The gain is $190,000 – $180,000 = $10,000.
Question: A donor transfers property with a basis of $50,000 to a donee. The FMV of the property at the time of the gift is $70,000. The donor pays $5,000 in gift tax. What is the donee’s basis in the property?
- Answer: $51,429. The donee’s initial basis is the donor’s adjusted basis of $50,000. The increase in basis due to the gift tax is calculated as follows:
  $\text{Increase in Basis} = \$5,000 \times \left( \frac{\$20,000}{\$70,000} \right) = \$1,429 $
  The donee’s total basis is $50,000 + $1,429 = $51,429.
Question: An heir inherits a property with a FMV of $300,000 at the date of death. The decedent’s adjusted basis in the property was $150,000. The heir sells the property for $320,000. What is the gain or loss?
- Answer: Gain of $20,000. The heir’s basis is the FMV at the date of death, which is $300,000. The gain is $320,000 – $300,000 = $20,000.

Real-World Scenarios to Apply the Concepts Learned

Scenario: A donor gives a piece of land with an adjusted basis of $40,000 and a FMV of $60,000 to their child. No gift tax is paid. The child decides to build a house on the land, spending $100,000 on construction. A few years later, the child sells the property (land and house) for $250,000. What is the gain or loss on the sale?
- Analysis:
  - The initial basis for the land is the donor’s adjusted basis of $40,000.
  - The construction cost adds to the basis: $40,000 (land) + $100,000 (construction) = $140,000.
  - The gain on sale: $250,000 (sale price) – $140,000 (basis) = $110,000.
  - The child recognizes a gain of $110,000.
Scenario: An individual inherits a stock portfolio with a FMV of $500,000 at the date of the decedent’s death. The original purchase price of the stocks was $300,000. Six months after the date of death, the FMV of the portfolio is $480,000. The executor does not elect the alternate valuation date. The heir sells the entire portfolio for $520,000. What is the gain or loss?
- Analysis:
  - The basis of the inherited stocks is the FMV at the date of death: $500,000.
  - The gain on sale: $520,000 (sale price) – $500,000 (basis) = $20,000.
  - The heir recognizes a gain of $20,000.
Scenario: A donor gives a piece of artwork with a basis of $100,000 and a FMV of $150,000. The donor pays $10,000 in gift tax. The recipient later sells the artwork for $160,000. What is the gain or loss for the recipient?
- Analysis:
  - The recipient’s basis is the donor’s adjusted basis of $100,000, plus the portion of the gift tax attributable to the net appreciation:
    $\text{Increase in Basis} = \$10,000 \times \left( \frac{\$50,000}{\$150,000} \right) = \$3,333 $
  - The total basis: $100,000 + $3,333 = $103,333.
  - The gain on sale: $160,000 – $103,333 = $56,667.
  - The recipient recognizes a gain of $56,667.
Scenario: An heir inherits a rental property with a FMV of $400,000 at the date of the decedent’s death. The decedent had an adjusted basis of $250,000. The heir decides to continue renting the property and claims $50,000 in depreciation over several years. The heir then sells the property for $450,000. What is the gain or loss, and how does depreciation affect the calculation?
- Analysis:
  - The basis of the inherited property is the FMV at the date of death: $400,000.
  - Depreciation claimed: $50,000.
  - Adjusted basis after depreciation: $400,000 – $50,000 = $350,000.
  - The gain on sale: $450,000 (sale price) – $350,000 (adjusted basis) = $100,000.
  - The heir recognizes a gain of $100,000.

These practice questions and real-world scenarios help reinforce the understanding of calculating the basis for gifted and inherited property. They provide practical applications of the concepts, ensuring that CPA candidates are well-prepared for the REG CPA exam and real-life tax situations.

Conclusion

Recap of Key Points

Understanding the tax basis of property received as a gift or inheritance is fundamental for accurate tax reporting and compliance. Here are the key points covered in this article:

Definition of Tax Basis: The tax basis is the starting point for determining gain or loss upon the sale of property. It includes the original cost, adjustments for improvements, depreciation, and specific rules for gifts and inherited property.
Basis of Gifted Property: The basis of gifted property is generally the donor’s adjusted basis, with adjustments for gift tax paid and improvements. Special rules apply when the FMV at the time of the gift is less than the donor’s basis.
Basis of Inherited Property: The basis of inherited property is typically the FMV at the date of the decedent’s death, with an option to use an alternate valuation date. Special rules exist for community property states.
Reporting and Compliance: Proper documentation and IRS forms (e.g., Form 709 for gifts, Form 706 for estates) are essential for accurate reporting of the basis. Maintaining detailed records ensures compliance and supports the correct calculation of gain or loss.
Practice Questions and Scenarios: Real-world examples and practice questions help solidify the understanding of how to determine and apply the tax basis for gifted and inherited property.

Final Thoughts on the Importance of Understanding the Tax Basis for REG CPA Exam Success

Mastering the concepts related to the tax basis of gifted and inherited property is crucial for success on the REG CPA exam. Here’s why:

Core Tax Knowledge: The tax basis is a foundational concept in federal taxation. A strong grasp of how to determine and adjust the basis ensures that CPA candidates can handle a wide range of tax scenarios accurately.
Application to Exam Questions: The REG CPA exam includes numerous questions that require understanding the tax basis to calculate gain or loss. Proficiency in these calculations is essential for answering these questions correctly and achieving a high score.
Practical Relevance: Beyond the exam, understanding the tax basis is vital for professional practice. Tax professionals frequently encounter situations involving gifted and inherited property. Being able to apply these principles accurately helps in providing valuable advice to clients and ensuring compliance with tax laws.
Effective Tax Planning: Knowledge of the tax basis rules enables better tax planning and decision-making. Understanding the implications of gifting property or bequeathing assets can lead to more strategic and tax-efficient outcomes.

In conclusion, a thorough understanding of the tax basis for gifted and inherited property is not only essential for excelling in the REG CPA exam but also for effective tax practice. By mastering these concepts, CPA candidates can confidently navigate complex tax scenarios and provide expert guidance in their professional careers.