Taxable Gain

A client inherits stock that the deceased originally bought for 20,000 dollars but was worth 90,000 dollars on the date of death. What is the heir's cost basis for tax purposes?

1. A.0 dollarsInherited property has a basis equal to its date-of-death fair market value.
2. B.20,000 dollars (the decedent's original cost)Step-up resets the basis; the original cost does not carry over.
3. C.90,000 dollars (the date-of-death value)Correct — inherited property gets a stepped-up basis to fair market value at death.
4. D.70,000 dollars (the built-in gain)The gain is not the basis; the stepped-up basis equals date-of-death value.

Why: Inherited property generally receives a stepped-up basis equal to its fair market value on the date of death — here, 90,000 dollars. If the heir sells at that price, there is no taxable gain.

A father gives his daughter stock he bought for $20,000 when it is worth $50,000. She later sells it for $65,000. Her taxable gain is:

1. A.$65,000, because gifted stock has zero basisWrong. Carryover, not zero, basis applies.
2. B.$15,000, using the $50,000 date-of-gift valueWrong-but-tempting. FMV-at-gift basis applies only to loss computations on depreciated gifts.
3. C.$0, because gifts are never taxableWrong. The GIFT may be tax-free to her; the later SALE gain is fully taxable.
4. D.$45,000, using her father's $20,000 carryover basisCorrect. Donor basis and holding period follow the gift.

Why: Gifted appreciated property takes carryover basis: $65,000 - $20,000 = $45,000 gain (holding period also carries over). The fair-market-value basis applies only for computing LOSSES on property gifted after it declined. Citation: IRC Sec. 1015. Takeaway: gifts = carryover basis for gains; step-up belongs to INHERITANCES.

When rebalancing a taxable account back to target weights, all of the following help minimize the tax impact EXCEPT:

1. A.Directing new contributions to underweight asset classesIncorrect - using new cash rebalances without realizing gains.
2. B.Harvesting losses to offset realized gainsIncorrect - loss harvesting reduces the taxable impact.
3. C.Selling the largest long-term winners first to reach the target quicklyCorrect - this realizes large taxable gains, so it is the exception.
4. D.Rebalancing within tax-advantaged accounts where possibleIncorrect - rebalancing inside tax-advantaged accounts avoids current tax.

Why: Selling large long-term winners realizes taxable gains, the opposite of tax minimization. Directing new cash, harvesting losses, and rebalancing inside tax-advantaged accounts all reduce the tax cost.

An investor buys an ORIGINAL ISSUE DISCOUNT municipal zero-coupon bond at issue and holds it to maturity. The accreted discount is:

1. A.Tax-exempt interest that increases her basis to par by maturityCorrect. OID accretion on municipals keeps its tax-exempt character.
2. B.Taxable ordinary income each yearWrong-but-tempting. Annual ordinary taxation describes CORPORATE zeros (and muni MARKET discount), not muni OID.
3. C.A capital gain recognized at maturityWrong. Basis reaches par by maturity, so no gain arises.
4. D.Deferrable until she sells the bondWrong. Accretion happens annually - it is simply tax-exempt.

Why: Original issue discount on a tax-exempt bond is treated as tax-exempt interest that accretes annually and increases basis, so redemption at par produces no taxable gain. Citation: IRC Sec. 1288 (OID on tax-exempts); contrast Sec. 1276 (market discount). Takeaway: muni OID = tax-free accretion; muni market discount = taxable.