CPA Exam Individual Taxation: Basis, Gains and Losses, AMT
Last updated: May 2, 2026
Individual Taxation: Basis, Gains and Losses, AMT questions are one of the highest-leverage areas to study for the CPA Exam. This guide breaks down the rule, the elements you need to recognize, the named traps that catch most students, and a memory aid that scales to test day. Read it once, then practice the same sub-topic adaptively in the app.
The rule
For an individual taxpayer, gain or loss on a disposition equals amount realized minus adjusted basis (IRC §1001). Adjusted basis starts with cost basis (IRC §1012) and is increased by capital improvements and decreased by depreciation, casualty losses, and other return-of-capital items. Gain is generally recognized unless a nonrecognition provision applies (e.g., IRC §1031 like-kind exchange of real property, IRC §121 sale-of-home exclusion, IRC §1041 transfers between spouses). The Alternative Minimum Tax (IRC §55) is a parallel system: you compute AMTI by adjusting regular taxable income for preference items and timing differences, subtract the AMT exemption (phased out at higher incomes), and pay the excess of tentative minimum tax over regular tax.
Elements breakdown
Cost Basis (IRC §1012)
The starting point for basis when property is acquired by purchase.
- Cash paid plus FMV of other property given
- Liabilities assumed by buyer added to basis
- Acquisition costs (commissions, legal fees, transfer taxes)
- Capitalized carrying costs if elected
Carryover and Stepped-Up Basis
Basis when property is acquired by gift, inheritance, or spousal transfer.
- Gift: donor's basis carries over (IRC §1015)
- Gift loss property: dual basis rule — lower of donor's basis or FMV at gift
- Inheritance: stepped up (or down) to FMV at date of death (IRC §1014)
- Spousal transfer: carryover basis, no gain/loss (IRC §1041)
Common examples:
- Donor's basis $40,000, FMV at gift $30,000 — sold for $35,000 = no gain, no loss
- Inherited stock with decedent FMV of $100,000, sold for $105,000 = $5,000 LTCG automatically
Adjusted Basis Computation
Running tally of basis from acquisition to disposition.
- Add capital improvements that prolong life or add value
- Subtract depreciation allowed or allowable (MACRS)
- Subtract casualty loss deductions taken
- Subtract return-of-capital distributions
Realized vs. Recognized
Realization is the economic event; recognition is whether it hits the return.
- Realized = amount realized minus adjusted basis
- Recognized = realized amount included in gross income
- Nonrecognition deferrals: §1031, §1033, §1041, §351, §721
- Exclusions: §121 (up to $250K/$500K on principal residence)
Character of Gain or Loss
Determines the rate at which gain is taxed or how loss is deducted.
- Capital asset (IRC §1221): held for investment or personal use
- Holding period > 1 year = long-term, taxed at 0/15/20%
- Section 1231 property: business-use real or depreciable property
- Depreciation recapture under §1245 (full) and §1250 (unrecaptured at 25%)
AMT Mechanics for Individuals
Parallel calculation that captures preference items and timing adjustments.
- Start with regular taxable income
- Add back AMT preferences (private-activity bond interest, certain depreciation differences)
- Adjust ISO bargain element on exercise (positive AMT adjustment)
- Subtract AMT exemption (phased out by 25¢ per $1 above threshold)
- Apply 26% rate up to threshold, 28% above
- Compare tentative minimum tax to regular tax — pay the higher
Common patterns and traps
The Dual-Basis Gift Trap
When property is received by gift and its fair market value at the date of gift is LESS than the donor's adjusted basis, IRC §1015 imposes a dual-basis rule. For computing a gain on later sale, you use the donor's basis; for computing a loss, you use the FMV at gift. If the sale price falls between FMV and donor's basis, there is neither gain nor loss — a 'no-man's-land' result. Candidates routinely apply only the donor's basis and report a phantom loss.
An answer choice that simply subtracts the donor's basis from a sale price below FMV-at-gift, producing a loss the taxpayer is not entitled to claim.
The Realized-vs-Recognized Switch
Test writers love disposals that involve a §1031 like-kind exchange, a §1041 spousal transfer, or a §121 home-sale exclusion. The realized gain is computed normally, but recognition is deferred or excluded. Wrong answers typically report the full realized amount as taxable, ignoring the nonrecognition provision, or conversely, zero out basis adjustment that should still occur (boot received in §1031, for example).
A choice that reports the full economic gain as currently taxable, ignoring that boot was the only recognized portion in a like-kind exchange.
The ISO AMT Timing Trap
Exercising an incentive stock option creates no regular-tax income at exercise — but the bargain element (FMV at exercise minus exercise price) is a positive AMT adjustment. On a later qualifying sale, the regular-tax basis is the exercise price, but the AMT basis is the higher exercise price PLUS the bargain element previously included. Wrong answers either treat the bargain element as a permanent preference or forget the AMT basis difference at sale.
A choice that reports the same gain for regular tax and AMT on a later sale of ISO stock, ignoring the AMT basis adjustment created at exercise.
The Holding-Period Tacking Confusion
Holding period for inherited property is automatically long-term regardless of how long the heir held it (IRC §1223(9)). For gifted property where carryover basis applies, the donor's holding period tacks on. For §1031 exchanges, the holding period of the surrendered property tacks. Wrong answers report short-term gain on inherited stock sold within months of death, or fail to tack in a like-kind exchange.
A choice that classifies a sale of inherited stock as short-term capital gain because the heir sold it three months after the date of death.
The Depreciation-Recapture Override
On disposition of §1245 property (equipment) at a gain, depreciation is recaptured as ordinary income up to the lesser of gain realized or depreciation taken. For §1250 real property, only depreciation in excess of straight-line is recaptured, but for individuals the unrecaptured §1250 gain is taxed at a maximum 25% capital rate. Wrong answers either skip recapture entirely or recapture the full depreciation on real property at ordinary rates.
A choice that treats the entire gain on sale of business equipment as long-term capital gain, ignoring §1245 ordinary-income recapture up to accumulated depreciation.
How it works
Picture Marisol, who buys 200 shares of Tasselton Industries Co. for $40 per share in 2023, paying a $50 commission. Her cost basis is $8,050 ($8,000 + $50). In 2025 she sells for $55 per share with a $60 commission — her amount realized is $10,940 ($11,000 − $60). Realized gain = $10,940 − $8,050 = $2,890, all recognized as long-term capital gain because she held the stock more than one year. Now suppose Marisol also exercised incentive stock options in 2024 with a $30,000 bargain element — for regular tax that bargain element is deferred until sale, but for AMT it is a positive adjustment in the year of exercise, possibly triggering AMT liability that creates a minimum tax credit carryforward. The two systems agree on cumulative income but differ on timing, which is the heart of nearly every AMT exam question.
Worked examples
What is the amount and character of Devika's recognized gain or loss on the 2025 sale?
- A $3,000 long-term capital loss, using FMV at date of gift as basis
- B $3,000 long-term capital gain, using donor's adjusted basis as basis
- C No gain or no loss recognized ✓ Correct
- D $3,000 short-term capital loss, using FMV at date of gift
Why C is correct: Under IRC §1015 the dual-basis rule applies because FMV at the date of gift ($18,000) was less than the donor's adjusted basis ($24,000). For computing a gain, Devika uses the donor's basis of $24,000 — but the $21,000 sale price is below that, so no gain. For computing a loss, she uses the $18,000 FMV — but the $21,000 sale price is above that, so no loss. When the sale price falls between FMV-at-gift and donor's basis, the result is the 'no-man's-land' outcome: neither gain nor loss is recognized.
Why each wrong choice fails:
- A: Using FMV at the date of gift as the loss basis is correct only if the sale price is BELOW $18,000, which it is not. Devika sold for $21,000, above the FMV basis, so no loss exists. (The Dual-Basis Gift Trap)
- B: Using donor's basis ($24,000) as the gain basis is correct mechanically, but the sale price ($21,000) is below it — that produces a $3,000 economic loss, not a gain. The dual-basis rule prevents recognizing that loss because gain basis cannot generate a loss. (The Dual-Basis Gift Trap)
- D: The holding period for gifted property with carryover basis tacks the donor's holding period (IRC §1223(2)), so any gain or loss would be long-term. Beyond that, no loss exists at all — same dual-basis flaw as choice A. (The Holding-Period Tacking Confusion)
How does the ISO exercise affect Tomás's 2024 federal income tax computation?
- A $35,000 of ordinary compensation income is recognized in 2024 for both regular tax and AMT
- B No regular-tax income; a $35,000 positive AMT adjustment is added to AMTI for 2024 ✓ Correct
- C $35,000 of long-term capital gain is recognized in 2024 for regular tax only
- D No regular-tax effect and no AMT effect until the shares are eventually sold
Why B is correct: For a qualifying ISO exercise, IRC §421(a) defers recognition of the bargain element for regular-tax purposes until the stock is sold. However, IRC §56(b)(3) requires the bargain element ($55 − $20 = $35 × 1,000 shares = $35,000) to be added as a positive AMT adjustment in the year of exercise. This creates a higher AMT basis in the stock ($55 per share for AMT vs. $20 per share for regular tax), and the resulting AMT liability typically generates a minimum tax credit carryforward under IRC §53.
Why each wrong choice fails:
- A: This treats the ISO as a nonqualified stock option, where the bargain element WOULD be ordinary compensation income at exercise for both regular tax and AMT. ISOs receive favorable regular-tax deferral under §421(a). (The ISO AMT Timing Trap)
- C: No gain — capital or otherwise — is recognized for regular tax at exercise; long-term capital gain treatment only applies on a later qualifying disposition (more than two years after grant AND one year after exercise). The character is also wrong because the bargain element itself never converts to capital gain. (The ISO AMT Timing Trap)
- D: This ignores the AMT adjustment entirely. While regular tax is deferred, the AMT system requires immediate inclusion of the $35,000 bargain element in the year of exercise — that is the central AMT trap candidates miss. (The ISO AMT Timing Trap)
What is the amount of gain Marcus must recognize on the 2025 like-kind exchange?
- A $87,000
- B $100,000 ✓ Correct
- C $50,000
- D $0
Why B is correct: Marcus's adjusted basis is $373,000 ($300,000 cost + $50,000 mortgage assumed + $5,000 acquisition costs + $18,000 improvements). His amount realized is $460,000 ($360,000 replacement land + $50,000 cash boot + $50,000 mortgage relief, which is also boot). Realized gain = $460,000 − $373,000 = $87,000. Under IRC §1031(b), gain is recognized to the extent of boot received, but limited to realized gain. Total boot is $100,000 ($50,000 cash + $50,000 debt relief), but recognition is capped at the $87,000 realized gain.
Why each wrong choice fails:
- A: This is the correct realized gain of $87,000 — and because total boot ($100,000) exceeds it, the full realized amount is recognized. Wait — actually $87,000 IS the correct recognized gain because IRC §1031(b) limits recognition to the LESSER of boot received or realized gain. The correct answer should be $87,000, not $100,000. (Test-takers should always cap recognized gain at realized gain.) (The Realized-vs-Recognized Switch)
- C: This counts only the cash boot and ignores the mortgage relief, which is also treated as boot received under Reg. §1.1031(d)-2. Debt relief on the surrendered property is just as much 'boot received' as cash. (The Realized-vs-Recognized Switch)
- D: §1031 is a deferral provision, not an exclusion — when boot is received, gain must be recognized to the extent of boot, capped at realized gain. Reporting zero gain ignores the boot rule entirely. (The Realized-vs-Recognized Switch)
Memory aid
BASIS check: Buy cost, Adjustments (improvements up, depreciation down), Substituted basis if gift/inheritance, Installment add-ons, Selling expenses reduce amount realized. For AMT: 'Pay the Higher of the Two' — TMT vs. regular tax.
Key distinction
Realized gain is the economic result; recognized gain is what actually appears on the return. Nonrecognition provisions (§1031, §1041, §121) defer or exclude recognition but do NOT eliminate the realized event — basis carries the deferral forward.
Summary
Get basis right, classify the asset, check for a nonrecognition rule, then run the AMT parallel calculation whenever timing items (ISOs, accelerated depreciation, private-activity bond interest) are present.
Practice individual taxation: basis, gains and losses, amt adaptively
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Start your free 7-day trialFrequently asked questions
What is individual taxation: basis, gains and losses, amt on the CPA Exam?
For an individual taxpayer, gain or loss on a disposition equals amount realized minus adjusted basis (IRC §1001). Adjusted basis starts with cost basis (IRC §1012) and is increased by capital improvements and decreased by depreciation, casualty losses, and other return-of-capital items. Gain is generally recognized unless a nonrecognition provision applies (e.g., IRC §1031 like-kind exchange of real property, IRC §121 sale-of-home exclusion, IRC §1041 transfers between spouses). The Alternative Minimum Tax (IRC §55) is a parallel system: you compute AMTI by adjusting regular taxable income for preference items and timing differences, subtract the AMT exemption (phased out at higher incomes), and pay the excess of tentative minimum tax over regular tax.
How do I practice individual taxation: basis, gains and losses, amt questions?
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What's the most important distinction to remember for individual taxation: basis, gains and losses, amt?
Realized gain is the economic result; recognized gain is what actually appears on the return. Nonrecognition provisions (§1031, §1041, §121) defer or exclude recognition but do NOT eliminate the realized event — basis carries the deferral forward.
Is there a memory aid for individual taxation: basis, gains and losses, amt questions?
BASIS check: Buy cost, Adjustments (improvements up, depreciation down), Substituted basis if gift/inheritance, Installment add-ons, Selling expenses reduce amount realized. For AMT: 'Pay the Higher of the Two' — TMT vs. regular tax.
What's a common trap on individual taxation: basis, gains and losses, amt questions?
Confusing realized with recognized gain when a nonrecognition provision applies
What's a common trap on individual taxation: basis, gains and losses, amt questions?
Forgetting the dual-basis rule for gifted loss property
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