Senior Tax Specialist Practice Test

When property is gifted, the tax basis for the recipient (the donee) is typically the donor's adjusted basis. However, in the case where the fair market value (FMV) of the gifted property is less than the donor's adjusted basis, special rules apply for calculating loss on the potential sale of that property.

The recipient's basis for loss calculation is determined to be the lower of the FMV at the time of the gift or the donor's adjusted basis. This means that if the recipient later sells the property for less than this basis, they can recognize a loss for tax purposes.

For example, if the donor’s adjusted basis in the property is $10,000 but the FMV when received by the donee is only $7,000, the basis for calculating loss on any subsequent sale would be $7,000. This prevents the donee from claiming an artificial loss based on a basis higher than what the market would support.

Thus, the correct choice reflects the proper treatment of the basis when the FMV is lower than the donor's adjusted basis, helping ensure that tax calculations are fair and reflect actual economic conditions.