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Determine Initial Basis Of Property - CPA Reg

  1. A taxpayer purchases a used machine for $60,000 and immediately spends $15,000 to recondition it before placing it in service. What is the taxpayer's depreciable basis in the machine?
    Answer: $75,000, because the purchase price plus reconditioning costs must be capitalized as the cost of the asset. Under Section 263, capital expenditures (including costs to bring an asset to a condition ready for use) must be capitalized and added to the basis of the asset. The $15,000 reconditioning cost incurred before placing the machine in service is a capital cost that must be included in the machine's depreciable basis. Total depreciable basis = $60,000 + $15,000 = $75,000. Answer A is incorrect because reconditioning costs incurred prior to placing an asset in service must be capitalized, not expensed. Answer C incorrectly separates the reconditioning cost as a separate asset. Answer D has no basis in Section 263 capitalization rules.
  2. Under Section 1014(b)(6), property that passes to the surviving spouse in a community property state receives what basis treatment?
    Answer: Both halves of the community property receive a step-up to FMV - the decedent's half and the surviving spouse's half - as long as at least half of the community property was includible in the decedent's gross estate. Under Section 1014(b)(6), in community property states, if the decedent's interest in community property is includible in the gross estate (and at least half of the community property was so included), both halves of the community property receive a step-up in basis to FMV at death. This is a significant advantage over separate property states, where only the decedent's interest receives the step-up. The surviving spouse benefits from the step-up on their own half as well. Answer A describes the rule for separate property states. Answer B is incorrect because community property does receive a step-up. Answer C has the wrong half receiving the step-up.
  3. A taxpayer purchases land for $200,000 and immediately pays $30,000 to clear the land for construction. The taxpayer then begins construction of a building at a cost of $500,000. What is the basis of the land and the basis of the building separately?
    Answer: Land: $230,000; Building: $500,000. The cost of clearing the land is a capital cost that must be allocated to the land (not the building) because it improves the land itself and is a prerequisite to using the land, not part of the construction costs of the building. Land basis = $200,000 + $30,000 = $230,000. Building basis = $500,000. Answer C is correct. Answer A incorrectly allocates the $30,000 clearing cost to the building instead of the land. Answer B incorrectly capitalizes the $30,000 clearing cost into both the land and the building, double-counting it. Answer D ignores the clearing cost entirely, understating the land basis.
  4. Which of the following correctly describes the basis of property acquired in a tax-free reorganization under Section 354?
    Answer: The shareholders' basis in the new stock received equals the basis of the old stock surrendered, adjusted for any boot received or gain recognized. In a tax-free reorganization under Section 368 and Section 354, a shareholder who exchanges stock in the target corporation for stock in the acquiring corporation receives a substituted basis: the basis of the new stock equals the basis of the old stock surrendered, decreased by any money received and any loss recognized, and increased by any gain recognized. This preserves the deferred gain (or loss) in the new shares. Answer A (FMV basis) would apply only if gain were fully recognized. Answer B (zero basis) is incorrect. Answer D has no basis in the reorganization provisions.
  5. A partner contributes cash of $40,000 and property with an adjusted basis of $25,000 to a partnership. Under Section 722, what is the partner's initial outside basis in the partnership interest?
    Answer: $65,000, the sum of the cash contributed and the adjusted basis of the property contributed. Under Section 722, a partner's initial outside basis in the partnership interest equals the sum of money contributed plus the adjusted basis (not FMV) of any property contributed. Outside basis = $40,000 (cash) + $25,000 (property adjusted basis) = $65,000. Answer B ($40,000) counts only the cash. Answer C incorrectly adds both the property's adjusted basis and its FMV. Answer D (FMV of partnership interest) would be the outside basis only if gain were recognized on the contribution, which does not occur in a typical Section 721 nonrecognition transaction.
  6. A taxpayer acquires real property through a like-kind exchange, giving up property with an adjusted basis of $80,000 and receiving replacement property worth $120,000 plus $10,000 cash. What is the taxpayer's basis in the replacement property?
    Answer: $80,000 (adjusted basis of relinquished property, minus $10,000 cash received, plus $10,000 gain recognized = $80,000). Realized gain = $120,000 + $10,000 - $80,000 = $50,000. Recognized gain = lesser of realized gain ($50,000) or boot received ($10,000) = $10,000. Under Section 1031(d), replacement property basis = adjusted basis of relinquished property - boot received + gain recognized = $80,000 - $10,000 + $10,000 = $80,000. The deferred gain is $40,000 ($50,000 - $10,000), preserved in the $80,000 basis (since FMV is $120,000 and basis is $80,000, the $40,000 difference is the deferred gain). Answer B (FMV) would apply only if all gain were recognized. Answer C ($90,000) incorrectly adds cash received. Answer D ($70,000) subtracts cash without adding back recognized gain.
  7. A taxpayer purchases a building for $800,000. In connection with the purchase, the taxpayer pays $15,000 in legal fees, $5,000 in title insurance, and $2,000 in recording fees. What is the taxpayer's initial basis in the building?
    Answer: $822,000 Under Section 1012, the cost of property includes the purchase price plus all costs incurred to acquire the property. The taxpayer's basis = $800,000 + $15,000 (legal fees) + $5,000 (title insurance) + $2,000 (recording fees) = $822,000. All of these costs are necessary to acquire and establish clear title to the property and are therefore capitalized into the basis. Answer A ignores all acquisition costs beyond the purchase price. Answer B adds only legal fees. Answer D adds only recording fees.
  8. Under Section 1031, a taxpayer exchanges like-kind business property (adjusted basis $60,000, FMV $100,000) for other like-kind property with a FMV of $100,000. No boot is received. What is the taxpayer's basis in the replacement property?
    Answer: $60,000, the adjusted basis of the relinquished property. Under Section 1031(d), the basis of property received in a like-kind exchange equals the adjusted basis of the property given up, decreased by any money received and any loss recognized, and increased by any gain recognized and any additional consideration paid. Since no boot was received and no gain was recognized, the basis of the replacement property = the adjusted basis of the relinquished property = $60,000. The $40,000 deferred gain is preserved in the replacement property's basis. Answer A (FMV) would apply if gain were fully recognized. Answer B (zero) is incorrect. Answer C ($40,000) is the deferred gain, not the replacement basis.
  9. A shareholder transfers property to a corporation in a qualifying Section 351 exchange and receives stock in return. Under Section 358, what is the shareholder's initial basis in the stock received?
    Answer: The adjusted basis of the property transferred, decreased by any money received and any loss recognized, and increased by any gain recognized and any other property included in income. Under Section 358(a), a shareholder's basis in stock received in a Section 351 exchange equals the adjusted basis of the property transferred to the corporation, decreased by money received and any loss recognized, and increased by any gain recognized and any amount included in income (such as boot characterized as ordinary income). If no boot is received and no gain is recognized, the stock basis equals the adjusted basis of the transferred property. Answer A (FMV of stock) would be the basis only if gain were fully recognized. Answer C (FMV of transferred property) is incorrect; transferred property basis, not FMV, is the starting point. Answer D (zero) is incorrect.
  10. Under Section 1033, a taxpayer's property is involuntarily converted and the taxpayer receives insurance proceeds. The taxpayer elects nonrecognition and reinvests in replacement property. Under Section 1033(b), what is the basis of the replacement property?
    Answer: The cost of the replacement property reduced by any gain not recognized (deferred gain). Under Section 1033(b), the basis of replacement property is the cost of the replacement property reduced by the gain not recognized (deferred gain). This preserves the deferred gain inside the replacement property until it is ultimately recognized on a later taxable sale. Formula: replacement basis = cost - deferred gain. Answer A (FMV of replacement) would be the basis only if all gain were recognized. Answer C (adjusted basis of converted property) may equal the replacement basis coincidentally when all proceeds are reinvested, but the statutory formula is cost minus deferred gain. Answer D (insurance proceeds) is not the formula for replacement property basis.
  11. Marlena receives stock as a gift from her uncle. The uncle's adjusted basis in the stock was $20,000, and the fair market value on the date of the gift was $35,000. No gift tax was paid. What is Marlena's basis in the gifted stock for purposes of determining gain?
    Answer: $20,000, the donor's adjusted basis (carryover basis for gain purposes). Under Section 1015, the basis of property received as a gift is generally the donor's adjusted basis (carryover basis), for purposes of determining gain. Since the FMV ($35,000) exceeds the donor's basis ($20,000), there is no 'loss basis' issue, and Marlena's basis for gain purposes is the donor's basis of $20,000. If Marlena later sells the stock for more than $20,000, the gain is measured from $20,000. Answer A (FMV) would be the basis under Section 1014 for inherited property, not gifted property. Answer C is an average, which has no basis in Section 1015. Answer D is incorrect because the donee receives a carryover basis, not zero.
  12. A corporation receives property in a Section 351 exchange. Under Section 362, what is the corporation's initial basis in the received property?
    Answer: The transferor's adjusted basis in the property, increased by any gain recognized by the transferor on the exchange. Under Section 362(a), when property is received by a corporation in a Section 351 exchange, the corporation's basis in the property equals the transferor's adjusted basis in the property, increased by any gain recognized by the transferor. If no boot was paid and no gain was recognized, the corporation takes a carryover basis equal to the transferor's basis. This preserves the built-in gain inside the corporation. Answer B (FMV) would apply only if gain were fully recognized. Answer C (zero basis) is incorrect because the corporation takes a carryover basis from the transferor. Answer D (lower of basis or FMV) is not the Section 362 rule.
  13. Under Section 1015(d), when a donor pays gift tax on a gift of appreciated property, how does the gift tax affect the donee's basis?
    Answer: The donee's basis is increased by the portion of the gift tax attributable to the net appreciation in the gifted property (appreciation-to-FMV ratio times gift tax paid). Under Section 1015(d)(6), for gifts made after 1976, when gift tax is paid, the donee's basis is increased by the portion of the gift tax that is attributable to the net appreciation in the property. The formula is: basis increase = gift tax paid x (net appreciation / FMV of gift). Net appreciation = FMV - donor's basis. This partial step-up prevents double taxation of the same appreciation at the gift tax level and the income tax level. Answer A is incorrect because gift tax does increase basis. Answer B is incorrect because only the portion attributable to appreciation, not the full gift tax, is added. Answer D incorrectly caps the addition at FMV without the correct formula.
  14. A taxpayer converts personal-use property (a boat) to business use. The adjusted basis was $40,000 and the FMV at the date of conversion was $28,000. What is the taxpayer's basis for purposes of depreciation and for purposes of determining loss on a subsequent sale?
    Answer: Depreciation basis: $28,000; Loss basis: $28,000. When personal-use property is converted to business use and the FMV at the date of conversion is less than the adjusted basis, the taxpayer uses the lower of cost or FMV as the basis for both depreciation and for determining loss. This rule prevents taxpayers from generating artificial tax losses by converting property that has already declined in personal use. Both the depreciation basis and the loss basis equal $28,000 (the FMV at conversion). Answer A ($40,000 for both) ignores the conversion basis rule. Answer B (depreciation $28,000, loss $40,000) incorrectly uses the higher basis for loss. Answer D (depreciation $40,000, loss $28,000) incorrectly uses the higher basis for depreciation.
  15. A taxpayer acquires property by winning it as a prize in a contest. The property has a fair market value of $15,000 on the date it is received. What is the taxpayer's initial basis in the prize?
    Answer: $15,000, because the prize is included in gross income at FMV, and the basis equals the amount included in income. When a taxpayer receives property as a prize, the FMV must be included in gross income under Section 74. When property is included in income at its FMV, the taxpayer takes a cost basis equal to the FMV included in income. The basis is $15,000 because that is the amount on which the taxpayer is taxed, ensuring the same gain is not taxed twice when the property is later sold. Answer A ($0) would be correct only if no amount were included in income, which is not the case for prizes. Answer B is a fabricated formula. Answer C incorrectly makes the $15,000 basis conditional on reporting; reporting is required, not optional.
  16. Under Section 1014, what is the basis of property acquired from a decedent by bequest or inheritance?
    Answer: The fair market value of the property on the date of the decedent's death (or the alternate valuation date if elected by the estate). Under Section 1014, property acquired from a decedent receives a stepped-up (or stepped-down) basis equal to the fair market value of the property on the date of the decedent's death. If the estate elects the alternate valuation date under Section 2032, the basis is the FMV on that date (6 months after death). This step-up effectively eliminates the income tax on appreciation accrued during the decedent's lifetime. Answer B (decedent's adjusted basis) describes a carryover basis, which is the old rule repealed in 1976 and then reinstated; Section 1014 provides FMV basis. Answer C (lower of cost or FMV) is an accounting concept. Answer D is incorrect because the heir does receive basis equal to FMV.
  17. Under Section 1014, which of the following types of property does NOT receive a stepped-up basis at death?
    Answer: Property held in a traditional IRA or 401(k) retirement account. Section 1014 applies to property includible in the decedent's gross estate for federal estate tax purposes. Retirement account assets (traditional IRAs, 401(k)s) receive income in respect of a decedent (IRD) treatment under Section 691 - the beneficiary receives the same income tax character as if the decedent had received the income, and no step-up in basis applies to IRD assets. When distributions are made from retirement accounts, they are taxable as ordinary income to the beneficiary. Answer A (appreciated stock in taxable accounts) is includible in the estate and receives a step-up. Answer C (real estate) similarly receives a step-up. Answer D (U.S. savings bonds) may be IRD, but the question targets retirement accounts as the clearest non-step-up category.
  18. A taxpayer receives a nontaxable stock right to purchase one share of stock for every 10 shares owned. The FMV of the stock right is $8 and the FMV of the underlying stock is $80. The taxpayer elects to allocate basis between the stock and the stock rights. What percentage of the original stock basis is allocated to the stock rights?
    Answer: 9.09% (FMV of rights / (FMV of stock + FMV of rights) = $8 / ($80 + $8) = $8 / $88 = 9.09%). When nontaxable stock rights are received, the taxpayer may elect to allocate a portion of the original stock's basis to the rights. The allocation is based on the relative FMVs: percentage to rights = FMV of rights / (FMV of stock + FMV of rights) = $8 / ($80 + $8) = $8 / $88 = approximately 9.09%. This allocated basis is assigned to each right. Answer B (10%) incorrectly divides rights FMV by stock FMV only, not the combined FMV. Answer C (50%) has no basis in the allocation formula. Answer D is incorrect because stock rights can have allocated basis when the taxpayer makes the election.
  19. A corporation issues stock to an investor in exchange for services rendered worth $50,000. The stock has a FMV of $50,000. What is the investor's initial basis in the stock?
    Answer: $50,000, because the FMV included in income as compensation becomes the cost basis. When a taxpayer receives stock in exchange for services, the FMV of the stock is included in ordinary income as compensation. The taxpayer's basis in the stock equals the amount included in income ($50,000 FMV), which serves as the 'cost' for basis purposes under Section 1012. This prevents the appreciation already taxed as compensation from being taxed again when the stock is sold. Answer A ($0) would result in double taxation since the full $50,000 was already included in income. Answer C (50%) has no basis in the Code. Answer D incorrectly conditions the basis on the holding period.
  20. A taxpayer buys land and a building together for a lump sum of $500,000. An independent appraisal values the land at $150,000 and the building at $350,000. What are the individual bases for the land and the building?
    Answer: Land: $150,000; Building: $350,000, allocated based on relative FMVs - land = $500,000 x ($150,000/$500,000); building = $500,000 x ($350,000/$500,000). When multiple assets are acquired for a lump sum, the total cost must be allocated among the individual assets based on their relative fair market values. Total FMV = $150,000 + $350,000 = $500,000. Land basis = $500,000 x ($150,000 / $500,000) = $150,000. Building basis = $500,000 x ($350,000 / $500,000) = $350,000. In this case the total cost equals total FMV, so the allocation equals the appraisal values. Answer A (equal split) ignores relative FMVs. Answer B states the same dollar amounts as D but without the allocation methodology explanation. Answer C incorrectly assigns all basis to land.

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