Rule: Property acquired as a gift generally retains the rollover cost basis as it had in the hands of the donor at the time of the gift. Basis is increased by any gift tax paid attributable to the appreciation in the value of the gift (but the facts in this case indicate to ignore gift tax consequences). There is an exception to the general rule: if the fair market value at the date of gift is lower than the roll-over cost basis from the donor, the basis for the donee depends upon the donee's future selling price of the asset.

The asset may sell for (1) greater than the donor's basis, (2) between the donor's basis and the lower FMV at the date of gift, or (3) less than the FMV at the date of gift.

Choice "d" is correct. The first step is to determine the donor's basis in the asset at the gift date. In this case, the basis is $31,000 ($35,000 + $1,000 - $5,000). The fair market value of the asset is $32,000 at the date of gift, which is greater than the donor's basis, so the general rule applies. Property acquired as a gift generally retains the rollover cost basis as it had in the hands of the donor at the time of the gift. Thus, Russett's basis in the equipment is $31,000.

Choice "c" is incorrect. The first step is to determine the donor's basis in the asset at the gift date. In this case, the basis is $31,000 ($35,000 + $1,000 - $5,000). The fair market value of the asset is $32,000 at the date of gift, which is greater than the donor's basis, so the general rule applies. Property acquired as a gift generally retains the rollover cost basis as it had in the hands of the donor at the time of the gift. Thus, Russett's basis in the equipment is $31,000 (the cost basis of the donor), not the $32,000 fair market value at the date of gift.

Choice "a" is incorrect. This answer option incorrectly assumes the basis is only the $35,000 purchase price of the asset and ignores the $1,000 in improvements and the basis reduction for the $5,000 in accumulated depreciation.

Choice "b" is incorrect. This answer option incorrectly assumes the basis is only the $35,000 purchase price of the asset plus the $1,000 in improvements and ignores the basis reduction for the $5,000 in accumulated depreciation.