Essentials of taxation 2016 cengage chapter 07

Determination of Gain or Loss slide 1 of 7 • Realized gain or loss other disposition of the asset and its adjusted basis • Includes trade-ins, casualties, condemnations, thefts, bond re

Essentials of Taxation

Chapter 7

Property Transactions: Basis,

Gain and Loss, and

Nontaxable Exchanges

The Big Picture (slide 1 of 5)

years ago as a gift

$2,000 and was worth $10,000 at the time of the gift

– Alice’s father did not owe gift taxes upon making the

transfer

The Big Picture (slide 2 of 5)

• Alice also owns 500 shares of AppleCo stock.

her grandfather died in 1996

• Alice’s grandfather paid $12,000 for the shares, and

• The shares were worth $30,000 at the time of his death.

by Alice two months ago for $28,000

• The stock is currently worth $120 per share,

and Alice is considering selling the shares.

The Big Picture (slide 3 of 5)

• Alice owns a house that she inherited from her

grandmother 2 years ago

• A developer has recently offered Alice

$600,000 for the property.

her grandmother’s death was $475,000

$275,000

The Big Picture (slide 4 of 5)

• The building Alice used in her business,

adjusted basis of $50,000, was destroyed by a

fire on October 5, 2015.

reimbursement of $100,000 for the loss

proceeds in a new building and use the other

$20,000 to pay off credit card debt

The Big Picture (slide 5 of 5)

• Alice has come to you for tax advice with

respect to the property she owns.

– What is the recognized gain or loss for the land, stock, and

house if they are sold?

– Can Alice avoid paying taxes on any of the sales?

• Alice’s objectives are to minimize the

recognition of any realized gain and to

maximize the recognition of any realized loss.

Determination of Gain or Loss

(slide 1 of 7)

• Realized gain or loss

other disposition of the asset and its adjusted basis

• Includes trade-ins, casualties, condemnations, thefts,

bond retirements

Determination of Gain or Loss

(slide 2 of 7)

• Amount realized from disposition

of property received, mortgages/loans transferred

to buyer

• Fair market value (FMV): Value of asset determined by

arms-length transaction, i.e., amount set by transaction between willing buyer and seller with neither obligated

to enter into transaction

Determination of Gain or Loss

(slide 3 of 7)

• Adjusted basis

additions less capital recoveries

Determination of Gain or Loss

(slide 4 of 7)

• Capital additions

property that are capital in nature and not currently

deductible

Determination of Gain or Loss

(slide 5 of 7)

• Capital recoveries

• Depreciation or cost recovery allowances

• Casualty and theft losses (and insurance proceeds)

• Certain corporate distributions

• Amortizable bond premium

• Easements

Determination of Gain or Loss

(slide 6 of 7)

• Recognized gain or loss

(deducted from) gross income

Determination of Gain or Loss

(slide 7 of 7)

• Realized gains and losses are not always recognized

– Realized gains may be deferred or excluded

– Realized losses may be deferred or disallowed

• Realized losses from the sale, exchange, or

condemnation of personal use assets (e.g., a personal

residence) is not recognized for tax purposes

– Exception - casualty or theft losses from personal use assets

• In contrast, any gain realized from the sale or other

disposition of personal use assets is, generally, fully

taxable

Determination of Gain or Loss

(slide 7 of 7)

• Realized gains and losses are not always recognized

– Realized gains may be deferred or excluded

– Realized losses may be deferred or disallowed

• Realized losses from the sale, exchange, or

condemnation of personal use assets (e.g., a personal

residence) is not recognized for tax purposes

– Exception - casualty or theft losses from personal use assets

• In contrast, any gain realized from the sale or other

disposition of personal use assets is, generally, fully

Basis Considerations

(slide 1 of 5)

• Original basis of an asset is generally its cost

• Bargain purchase assets have a basis equal to

their FMV

employee = compensation; shareholder =

dividend)

Basis Considerations

(slide 2 of 5)

• Identification problems

possible, use FIFO to compute basis

Basis Considerations

(slide 3 of 5)

• Allocation problems: lump-sum purchase

Basis Considerations

(slide 4 of 5)

• Allocation problems: Going concern purchase

goodwill) to extent of their total FMV

• Goodwill is an amortizable § 197 asset

Basis Considerations

(slide 5 of 5)

• Allocation problems: Nontaxable stock

dividends

original and new shares

• Based on number of shares (common on common), or

• Based on relative FMV (preferred on common)

original shares

Gift Basis

(slide 1 of 6)

• Gift property may have a dual basis, i.e., basis

for gain and loss may differ

• Basis is dependent on relationship between

FMV at date of gift and donor’s adjusted basis

Gift Basis

(slide 2 of 6)

• Gift basis for cost recovery

basis (donee's gain basis)

Gift Basis

(slide 3 of 6)

• Gift basis for subsequent gain

the basis for calculating any gain is the donor’s

adjusted basis (carryover basis)

• Gain basis may be increased if donor incurred gift tax

on gift

The Big Picture - Example 15

Gift – Carryover Basis

market value was $10,000

– No gift tax was paid on the transfer

currently worth $50,000

– If she sells the property for $50,000, Alice will have a

realized gain of $48,000 ($50,000 amount realized - $2,000 basis in the land).

Gift Basis

(slide 4 of 6)

• Gift basis for subsequent loss

basis for calculating any loss is the lesser of FMV

at the date of gift or the donor’s adjusted basis

Gift Basis

(slide 5 of 6)

• Gift basis for subsequent loss

– If FMV < donor’s basis on the date of the gift, a

dual basis will exist for the asset

• Gain basis = donor’s basis

• Loss basis = FMV on date of gift

donee starts on date of gift

The Big Picture - Example 16

Gift – Loss Basis

• Return to the facts of The Big Picture on p 7-1

• Instead, assume Alice’s father had purchased the land

in 1992 for $12,000

– He gave the land to Alice 10 years ago, when the fair

market value was $10,000 and paid no gift tax on the

transfer

• If Alice sells the property for $50,000, she has a

realized gain of $38,000

– $50,000 amount realized - $12,000 basis in the land

• However, if the property has declined in value and

Gift Basis

(slide 6 of 6)

• Gift basis when no gain or loss

the disposition of a gifted asset falls between the

gain basis and the loss basis

• No gain or loss is realized

is no gain or loss

The Big Picture - Example 17

Gift – No Gain Or Loss

• Return to the facts of The Big Picture on p 7-1

• Assume Alice’s father had purchased the land for $12,000.

– He gave the land to Alice 10 years ago when it was worth $10,000

– No gift tax was paid on the transfer

• Now, Alice plans to sell the property for $11,000

• To calculate gain, she would use a basis of $12,000, her

Gift Basis- Adjustment For Gift Taxes

(slide 1 of 2)

• The proportion of gift tax paid (on gifts after

1976) by the donor on appreciation of asset

can be added to basis of donee

• The donee's basis is equal to: Donor’s basis +

[(unrealized appreciation/taxable gift) × gift

tax]

Gift Basis- Adjustment For Gift Taxes

(slide 2 of 2)

• Example of gift tax:

this year

Property Acquired from a Decedent (slide 1 of 6)

• Generally, beneficiary’s basis in inherited

assets will be the FMV of the asset at

decedent’s date of death

elects alternate valuation date, basis is FMV on

such date

• Inherited property is always treated as

long-term property

The Big Picture - Example 20

Property Acquired From A Decedent

• Return to the facts of The Big Picture on p 7-1

which were inherited from her grandfather

– Her grandfather’s cost basis in the stock was $12,000

– The shares were worth $30,000 at the time of his death

– The 300 shares received as an inheritance take a stepped up

Property Acquired from a Decedent (slide 2 of 6)

• Inherited property valuation date

• Date of decedent’s death, which is called the primary

valuation date (PVD), or

• 6 months after date of decedent’s death, which is called

the alternate valuation date (AVD)

– Can only be elected if both the value of gross estate and the

estate tax liability are lower than if PVD was used

Property Acquired from a Decedent (slide 3 of 6)

• Inherited property valuation date

FMV at date of decedent’s death

FMV at the earliest of:

• Date asset is distributed from estate, or

• 6 months after date of decedent’s death

Property Acquired from a Decedent (slide 4 of 6)

• Example of inherited property valuation:

assets had an adjusted basis of $200,000, and a

FMV of $700,000

• PVD selected and assets distributed June 30;

beneficiary’s basis is $700,000

Property Acquired from a Decedent (slide 5 of 6)

• Example of inherited property valuation

(cont’d)

Rex’s death), the assets had a FMV of $650,000

• AVD selected and assets distributed November 10;

beneficiary’s basis is $650,000

• AVD selected and assets distributed June 30 when FMV

of assets is $670,000; beneficiary’s basis is $670,000

Property Acquired from a Decedent (slide 6 of 6)

• Deathbed gifts

was both appreciated and gifted by same taxpayer

to decedent within 1 year of decedent's death

decedent’s basis (not date of death FMV)

– Generally the same basis taxpayer had on date of gift

loss disallowed can be used to reduce gain

recognition on subsequent disposition of asset to

unrelated party

• Only available to original transferee

Disallowed Losses

(slide 2 of 5)

• Related parties include:

than 50% (directly or indirectly) of the

corporation, and

50% (directly or indirectly) of the partnership

Disallowed Losses

(slide 3 of 5)

• Wash sales

or securities at loss and acquires substantially

identical stock or securities within 30 days before

or after the date of the loss sale

Disallowed Losses

(slide 4 of 5)

• Wash sales

substantially identical stock or securities that

caused the disallowance

securities

Disallowed Losses

(slide 5 of 5)

• Personal use assets

disallowed

business (or production of income) use deductible

loss

• Original loss basis for an asset converted is the lower of

personal use basis or FMV at date of conversion

Nontaxable Transactions

(slide 1 of 4)

• In a nontaxable transaction, realized gain or

loss is not currently recognized

carryover basis) rather than eliminated

Nontaxable Transactions

(slide 2 of 4)

• In a tax-free transaction, nonrecognition of

realized gain is permanent

Nontaxable Transactions

(slide 3 of 4)

• Holding period for new asset

nontaxable transaction carries over to the new asset acquired

Nontaxable Transactions

(slide 4 of 4)

• Depreciation recapture

carries over to the new asset acquired in the

transaction

Like-Kind Exchanges

(slide 1 of 11)

• §1031 requires nontaxable treatment for gains

and losses when:

held for production of income

• However, inventory, securities, and partnership

interests do not qualify

character as replacement property

Like-Kind Exchanges

(slide 2 of 11)

• Like-kind property defined

• Real estate for real estate

– Improved for unimproved realty qualifies– U.S realty for foreign realty does not qualify

• Tangible personalty for tangible personalty

– Must be within the same general business asset or product

class

– Personalty used mainly in the U.S for personalty used mainly

Like-Kind Exchanges

(slide 3 of 11)

• When taxpayers involved in an exchange are

related parties

related parties must not dispose of property

exchanged within the 2 year period following

exchange

recognized as of date of early disposition

• Dispositions due to death, involuntary conversions, and

certain non-tax avoidance transactions are not treated as

Like-Kind Exchanges

(slide 4 of 11)

• Exchange requirement

property to qualify as a like-kind exchange

exchange, there are time limits on its completion

• The new property must be identified within 45 days of

date old property was transferred

• The new property must be received by the earlier of the

following:

Like-Kind Exchanges

(slide 4 of 11)

• Exchange requirement

property to qualify as a like-kind exchange

exchange, there are time limits on its completion

• The new property must be identified within 45 days of

date old property was transferred

• The new property must be received by the earlier of the

following:

– Within 180 days of date old property was transferred– The due date (including extensions) for tax return covering

Like-Kind Exchanges

(slide 5 of 11)

• Boot

like-kind property is “boot”

to the lesser of boot received (FMV) or gain

realized

• No loss is recognized even when boot is received

Like-Kind Exchanges

(slide 6 of 11)

• Boot

or loss on that property

• Gain or loss is recognized to the extent of the difference

between the adjusted basis and the fair market value of the boot

Like-Kind Exchanges

(slide 7 of 11)

• Basis in like-kind asset received:

FMV of new asset – Gain not recognized + Loss not recognized

= Basis in new asset

• Basis in boot received is FMV of property

= Basis in new asset

Like-Kind Exchanges

(slide 9 of 11)

• Example of an exchange with boot:

business asset class

FMV = $10,000

Like-Kind Exchanges

(slide 10 of 11)

Example (Cont’d)

Zak Vira FMV Property Rec’d$30,000 $40,000

Like-Kind Exchanges

(slide 11 of 11)

Example (Cont’d)

Zak Vira FMV Property Rec’d $30,000 $40,000

Postponed Gain -5,000 -10,000

Basis Property Rec’d $25,000 $30,000

Involuntary Conversions

(slide 1 of 8)

• §1033 permits (i.e., not mandatory) nontaxable

treatment of gains if the amount reinvested in

replacement property ≥ the amount realized

• If the amount reinvested in replacement

property is < amount realized, realized gain is

recognized to the extent of the deficiency

Involuntary Conversions

(slide 2 of 8)

• Involuntary conversion

requisition, condemnation, or sale or exchange

under threat of condemnation of property

• A voluntary act by taxpayer is not an involuntary

conversion

Involuntary Conversions

(slide 3 of 8)

• §1033 requirements

service or use as involuntarily converted property

specified time period

Involuntary Conversions

(slide 4 of 8)

• Replacement property defined

converted property

• Definition is interpreted very narrowly and differently

for owner-investor than for owner-user

condemned, replacement property has same

meaning as for like-kind exchanges

Involuntary Conversions

(slide 5 of 8)

• Taxpayer use test (owner-investor)

similar endeavors

• Example: Rental apartment building can be replaced

with a rental office building because both have same use to owner (the production of rental income)

Involuntary Conversions

(slide 6 of 8)

• Functional use test (owner-user)

as the converted property

• Example: A manufacturing plant is not replacement

property for a wholesale grocery warehouse because each has a different function to the owner-user

Involuntary Conversions

(slide 7 of 8)

• Time period for replacement

conversion or threat of condemnation occurs

condemnation of realty) after the close of the

taxable year in which gain is realized

Involuntary Conversions

(slide 8 of 8)

• Example of time period for replacement

November 4, 2011

10, 2012

The Big Picture - Example 37

Involuntary Conversion (slide 1 of 3)

destroyed by fire on October 5, 2015

– Alice is a calendar year taxpayer

reimbursement of $100,000 for the loss

– Alice invests $80,000 in a new building

– Alice uses the other $20,000 of insurance proceeds to pay

off credit card debt.