REG CPA Practice Questions Explained: Calculate Capital Gains from the Sale of Gifted Assets

In this video, we walk through 5 REG practice questions demonstrating how to calculate capital gains from the sale of gifted assets to be included in an individual’s gross income. These questions are from REG content area 4 on the AICPA CPA exam blueprints: Federal Taxation of Individuals.

The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.

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How to Calculate Capital Gains from the Sale of Gifted Assets

Here’s a detailed overview to guide you through the process, including how to determine if a capital gain is short-term or long-term, how to determine the gain or loss based on the adjusted basis and the Fair Market Value (FMV), the implications of the donee taking on the donor’s adjusted basis and holding period, and the $3,000 capital loss limit.

Determining Short-term vs. Long-term Capital Gains

• Short-term Capital Gains: If you sell a gifted asset that you cumulatively have held for one year or less (including the donor’s holding period and your holding period), any profit from the sale is considered a short-term capital gain, which is typically taxed at ordinary income tax rates.
• Long-term Capital Gains: If you sell a gifted asset that you cumulatively have held for more than one year (including the donor’s holding period and your holding period), any profit is considered a long-term capital gain. Long-term capital gains are usually taxed at lower rates than short-term gains, depending on your taxable income.

Determining Gain or Loss from Sale

• Adjusted Basis: For the purpose of calculating gain or loss, the donee (receiver of the gift) generally takes on the donor’s (giver of the gift) adjusted basis in the asset. The adjusted basis is essentially what the donor paid for the asset, plus any improvements, minus any depreciation.
• Fair Market Value (FMV): The FMV of the asset at the time of the gift is also important. If the sale price is more than the adjusted basis, you use the adjusted basis to determine your gain. However, if the asset has depreciated (the FMV is less than the donor’s adjusted basis at the time of the gift), and you then sell the asset for less than the FMV, you use the FMV as your basis for the loss calculation.

Gain or Loss Calculation

To calculate your gain or loss from the sale of the gifted asset:

1. Determine the selling price of the asset.
2. Subtract the adjusted basis (or FMV if applicable for loss) from the selling price.
   • If the selling price is greater than the adjusted basis, you have a capital gain.
   • If the selling price is less than the adjusted basis, but still greater than the FMV, there is no capital gain or loss.
   • If the selling price is less than the adjusted basis and the FMV, you have a capital loss.

Holding Period

• The donee’s holding period for the gifted asset includes the donor’s holding period. This is critical for determining whether the capital gain is short-term or long-term.

$3,000 Capital Loss Limit

• Capital Loss Deduction: If you incur a capital loss, you can use this loss to offset any capital gains you have for the year. If your total net capital loss is more than the limit you can deduct ($3,000 or $1,500 if married filing separately), you can carry over the unused part to the next year and treat it as if you incurred it in that next year.
• Application to Gifted Assets: This rule applies equally to capital losses incurred from the sale of gifted assets. If your losses exceed your gains, you can deduct the difference on your tax return, up to $3,000 per year, with any excess carried forward to future years.

Example:

Imagine you received a gift of stock from a family member on January 1, 20X3. They had only held the stock since the day previous, December 31, 20X2. At the time of the gift, the stock had a Fair Market Value (FMV) of $5,000. However, the donor’s adjusted basis in the stock (what they originally paid for it) was $4,000. You then sell the stock on December 15, 20X3, for $6,000.

Steps to Calculate the Gain:

1. Determine the Holding Period: Since you sold the stock less than a year after receiving it as a gift and the donor’s holding period only adds one day to your holding period, any gain is considered a short-term capital gain.
2. Calculate the Adjusted Basis: You inherit the donor’s adjusted basis of $4,000 for the purpose of calculating your gain.
3. Calculate the Gain: Subtract the adjusted basis from the sale price to determine your gain.
   • Sale Price: $6,000
   • Adjusted Basis: $4,000
   • Capital Gain: $6,000 – $4,000 = $2,000

Tax Implications:

• Since the gain is short-term, it will be taxed at your ordinary income tax rate.
• If, in the same tax year, you also sold other assets at a loss, you could offset this $2,000 gain with those losses. If your total net capital loss for the year is more than the gain, you could deduct up to $3,000 of this loss against other income (like wages) and carry over any remaining loss to future years.