Tax Basis

Lesson

Tax basis refers to the original value of an asset for tax purposes, which is used to determine the taxable gain or loss when the asset is sold.

Practice Question #1

What is the tax basis of an asset?

A) The original value of an asset for tax purposes

B) The amount of tax owed on the sale of an asset

C) The amount of tax saved through deductions and credits

D) The amount of tax deferred on an investment

Select an option above to see an explanation here.

A) The tax basis is the original value of an asset for tax purposes, used to determine the taxable gain or loss when the asset is sold. B) The amount of tax owed on the sale of an asset is determined by the taxable gain or loss, not the tax basis. C) Tax deductions and credits reduce the amount of tax owed, but they are not the tax basis of an asset. D) Tax-deferred investments postpone taxes on earnings, but this is not the tax basis of an asset.

Terms

Tax Basis:: The original value of an asset for tax purposes, used to determine the taxable gain or loss when the asset is sold.
Cost Basis:: The original cost of an asset, including any additional costs incurred to acquire the asset, such as commissions and fees.

Practice Question #2

Which of the following is an example of a tax-exempt investment?

A) A rental property

B) A corporate bond

C) A municipal bond

D) A stock

Select an option above to see an explanation here.

A) A rental property is subject to taxes on rental income and capital gains. B) A corporate bond is subject to taxes on interest income. C) A municipal bond is an example of a tax-exempt investment, as the interest income is not subject to federal income tax. D) A stock is subject to taxes on dividends and capital gains.

Real-World Example

An investor purchases a rental property for $200,000 and spends $20,000 on improvements. The investor's cost basis in the property is $220,000. After several years, the investor sells the property for $300,000. The investor's taxable gain on the sale is $80,000 ($300,000 - $220,000).

Practice Question #3

What is the difference between a short-term capital gain and a long-term capital gain?

A) The amount of tax owed

B) The type of asset sold

C) The holding period of the asset

D) The tax basis of the asset

Select an option above to see an explanation here.

A) The amount of tax owed on a capital gain depends on the holding period, not the difference between short-term and long-term capital gains. B) The type of asset sold does not determine whether a capital gain is short-term or long-term. C) The difference between a short-term capital gain and a long-term capital gain is the asset's holding period. Short-term capital gains are realized on assets held for one year or less, while long-term capital gains are realized on assets held for more than one year. D) The asset's tax basis does not determine whether a capital gain is short-term or long-term.

Formulas to Remember

Tax Liability = (Selling Price - Tax Basis) * Capital Gains Tax Rate - Selling Price: The price at which the appreciated investment is sold. - Tax Basis: The original cost of the investment, including any commissions or fees. - Capital Gains Tax Rate: The tax rate applied to the profit made from the sale of the investment.

Practice Question #4

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Example Series 65 Example Practice Question

Formula Examples

1. Determine the Selling Price: $15,000 2. Determine the Tax Basis: $10,000 (original cost of the investment) 3. Determine the Capital Gains Tax Rate: 15% 4. Calculate the Tax Liability: ($15,000 - $10,000) * 15% = $5,000 * 15% = $750

Practice Question #5

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Example Series 65 Example Practice Question

Pitfalls to Remember

- *Long-term vs. short-term capital gains*:: If the investment is held for less than one year, it may be subject to short-term capital gains tax rates, which are generally higher.