Your client sold a duplex she rented for eight years, exercised an incentive stock option (ISO), harvested a brokerage loss, and traded some Bitcoin. Every disposition has a basis, a holding period, a character, and a netting bucket. This lesson maps the property workflow from acquisition through reporting.
Basis is the dollar yardstick used to measure gain or loss on disposition. Three acquisition modes drive three rules.
Purchased property. Basis equals cost plus capitalized acquisition expenses (commissions, transfer taxes, title insurance, legal fees, sales tax on equipment). For real estate, add closing costs the buyer paid that were not deductible as current expenses. Reduce basis by any seller-paid items the buyer received credit for, by depreciation allowed or allowable, by §179 expensing, by casualty deductions, and by any nontaxable corporate distributions received as a shareholder.
Gifted property. General rule: carryover basis from the donor, plus any gift tax paid attributable to the appreciation in the gift. Holding period also carries over (tacked).
Common mistakes
- Using donor's basis for inherited property. Inheritance gets a stepped-up FMV at date of death. Carryover basis applies to gifts, not inheritances.
- Excluding depreciation recapture under §121. Post-May-6-1997 depreciation on a home office or rental conversion is always recaptured at up to 25%, even when §121 covers the rest.
- Treating crypto-to-crypto swaps as nontaxable. Every disposition is taxable; only real property qualifies for §1031, and only since 2018.
Bottom line
- Basis: cost for purchases; carryover basis for gifts (dual basis if FMV < donor basis at gift); stepped-up FMV at death for inherited property, automatically long-term
- Holding period: more than one year is long-term (0/15/20%); one year or less is short-term (ordinary rates); net short against short, long against long, then cross-net
- Capital netting: any excess net loss deducts up to $3,000 against ordinary income, with an indefinite carryforward that retains its short or long character
- Section 121: exclude up to $250,000 single / $500,000 MFJ of gain on a principal residence if owned and used 2 of last 5 years, once every 2 years; post-1997 depreciation is still recaptured at max 25%
Exam shortcut
"Inherited" trigger words → stepped-up FMV, automatically long-term. Ignore decedent's original cost no matter how prominently it's stated. §121 + rental conversion → carve out post-1997 depreciation first at max 25%; apply nonqualified-use fraction to gain; then exclusion against what's left. Installment sale of depreciable property → recognize all §1245 recapture in year one; apply gross profit ratio only to the non-recapture slice.
The full lesson (about 3,417 words, 23 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
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