Question

Sarah purchased a diamond bracelet for $3,000 while vacationing in Hong Kong during 2008. Sarah gives the bracelet to her daughter Amy when she graduates from college in 2015. The bracelet is appraised at $8,000 on that date. In October 2015, Amy sells the bracelet for $9,000. What is the amount of gain Amy should recognize on the sale?

	a.	No gain or (loss) is recognized
	b.	$1,000
	c.	$4,000
	d.	$5,000
	e.	$6,000

According to the test bank 2016, the answer is (e) $6,000. Please explain how to calculate this number.

Answer 1

Gifted property basis for Gain/Loss Purpose

General Rule : Donor's Rollover Cost Basis

Property acquired as a gift generally retains the cost basis it had in the hands of donor at the time of the gift. Basis is increased by any gift tax paid that is attributable to value of gift.

When taxpayer subsequently sell the property, the gains or losses are calculated using this rollover cost basis

Hence gain on sales of property is calculated as, Amount realized from sales of property less adjusted basis of assets sold (i.e. Donor's rollover cost basis in this example), (Gain 6,000 = 9,000 - 3,000)

Exception

If the fair market value (FMV), at the date of gift is lower the rollover cost basis from the donor, the basis for the donee depends on the donee future selling price of the property

1. When a taxpayer sells the gift for greater than the rollover basis, the gain shall be the difference between the sale price and that rollover basis

2. When a taxpayer sells the gift for less than the FMV at the date of the gift, the basis of the gift for purpose of determining the loss is the FMV of the gift at the date of gift received

3. When a taxpayer sells a gift for a price less than the Donor's rollover cost basis, but more than the FMV at the date of gift, neither gain nor loss is recognized. The basis to the donee is equal to his selling price.

Same can be summarized as per below example. hope this will help to explain concept

Sarah (Donor) purchased a diamond bracelet for $3,000, Sarah gives the bracelet to her daughter Amy in 2015, FMV on that date was $ 8,000 (Case 1 - General rule), Amy sells the bracelet in 2016, for $9,000 (Case 1 - General rule)

Sarah gives the bracelet to her daughter Amy in 2015, FMV on that date was $ 2,000 (Exception Case 2, 3, 4), Amy sells the bracelet in 2016, for $1,000 (Case 2) , For $ 2,500 (Case 3), For $ 5,000 (Case 4)

Below will be Gain/ (Loss) in each case

	General Rule	Exception
	FMV > Donor Basis	FMV < Donor Basis
	at the date of gift	at the date of gift
Description	Case 1	Case 2	Case 3	Case 4
Sarah (Donor) basis	$                        3,000	$                       3,000	$           3,000	$           3,000
FMV on date of gift	$                        8,000	$                       2,000	$           2,000	$           2,000
Amy (Donee) selling price (A)	$                        9,000	$                       1,000	$           2,500	$           5,000
Amy (Donee) Basis will be (B)	$                        3,000	$                       2,000	$           2,500	$           3,000
Gain / (loss) (A - B)	$                        6,000	$                     (1,000)	$                  -	$           2,000