Final answer:
In a nontaxable exchange, the correct statement is C) the replacement property is assigned a carryover basis. This means the cost basis from the old property is carried over to the new one, deferring the capital gains until the later sale of the new property.
Step-by-step explanation:
When considering a nontaxable exchange, the correct statement regarding the basis of replacement property is that C) In a nontaxable exchange, the replacement property is assigned a carryover basis. This means that the cost basis from the old property is transferred to the new property without the recognition of gains or losses at the time of the exchange. These types of exchanges happen under specific circumstances delineated in the Internal Revenue Code (IRC), most notably in Section 1031.
In other words, when you exchange one property for another in a qualifying exchange, such as a like-kind exchange commonly used in real estate, the IRS doesn't require you to pay taxes on the gain at that point in time. Instead, the original basis of the property you gave up (adjusted for any improvements or depreciation taken) is 'carried over' to the new property. This can defer recognition of capital gains until the new property is sold in a future taxable transaction.
By contrast, a 'stepped-up basis' (statement B) refers to readjusting the basis of an inherited property to its fair market value as of the date of the decedent's death. And assigning a fair market value basis (statement D) doesn't apply to nontaxable exchanges but to situations where property is obtained in a manner that requires immediate recognition of gain or loss, like a sale.