Ppt ch 14

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Individual Income Taxes

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Chapter 14

Property Transactions:Determination of Gain or Lossand Basis Considerations

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The Big Picture (slide 1 of 3)

• Alice owns a house that she received from her mother 7 months ago. – Her mother’s cost for the house was

$275,000.

• Alice is considering selling the house to her favorite nephew, Dan, for $275,000. – Alice anticipates she will have no gain or

loss on the transaction.

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• She comes to you for advice. As Alice’s tax adviser, you need answers to the following questions: – You are aware that Alice’s mother died around the time Alice indicates

she received the house from her mother. • Did Alice receive the house by gift prior to her mother’s death?

– If so, what was the mother’s adjusted basis?• Did Alice instead inherit the house from her mother?

– If so, what was the fair market value of the house on the date of her mother’s death?

– Has the house been Alice’s principal residence during the period she has owned it?

– Was it her principal residence before she received it from her mother?– How long did Alice’s mother own the house? – What is the fair market value of the house?– Does Alice intend for the transaction with Dan to be a sale or part sale

and part gift?– What does Alice intend to do with the sale proceeds?

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• Alice would also like to know the tax consequences of selling her car– She paid $22,000 for the car 4 months ago and has used it exclusively

for personal use. – Based on the ‘‘Blue Book’’ value, she anticipates that she can sell it for

$20,000 to $23,000.

• In addition, earlier this year Alice sold some stock at a realized loss and subsequently repurchased some shares of the same stock.

• She has also asked you about the tax consequences of these transactions.

• Once you have more information, you can advise Alice on the tax consequences of these various transactions. – Read the chapter and formulate your response.

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Determination of Gain or Loss (slide 1 of 7)

• Realized gain or loss– Difference between amount realized from sale or

other disposition of the asset and its adjusted basis– Sale or other disposition

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

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Determination of Gain or Loss(slide 2 of 7)

• Amount realized from disposition– Total consideration received, including cash, FMV

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

– Reduced by any selling expenses

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• Adjusted basis– Original cost (or other adjusted basis) plus capital

additions less capital recoveries

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• Capital additions– Cost of improvements and betterments to the

property that are capital in nature and not currently deductible

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• Capital recoveries– Amount of basis recovered through:

• Depreciation or cost recovery allowances

• Casualty and theft losses (and insurance proceeds)

• Certain corporate distributions

• Amortizable bond premium

• Easements

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• Recognized gain or loss– Amount of realized gain (loss) that is included in

(deducted from) gross income

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• 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) are 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

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The Big Picture - Example 8

Gain On Sale of Personal Use Assets• Return to the facts of The Big Picture on p. 14-1.

• Assume Alice sells the car, which she has held exclusively for personal use, for $23,000.– Recall that her adjusted basis of the car is $22,000.

• Alice has a realized and recognized gain of $1,000.

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Loss On Sale of Personal Use Assets• Return to the facts of The Big Picture on p. 14-1.

• Assume Alice sells the car in Example 8 for $20,000. – She has a realized loss of $2,000, but the loss is

not recognized.

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Capital Recovery Doctrine

• Taxpayer is entitled to recover cost or other original basis of property acquired and is not taxed on that amount

• To extent receive only investment back upon disposition of an asset, taxpayer has no gain

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Basis Considerations(slide 1 of 6)

• Original basis of an asset is generally its cost

• Bargain purchase assets have a basis equal to their FMV– Bargain amount may be income to purchaser (e.g.,

employee = compensation; shareholder = dividend)

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Basis Considerations (slide 2 of 6)

• Identification problems– Security sales where specific identification not

possible, use FIFO to compute basis

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• Allocation problems: lump-sum purchase– Must allocate basis to each asset obtained– Allocation usually based on relative FMV of assets

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• Allocation problems: Going concern purchase– Assign purchase price to assets (excluding goodwill)

to extent of their total FMV

– Then allocate among assets based on FMV

– Residual amount is goodwill• Goodwill is an amortizable § 197 asset

– Allocation applies to both purchaser and seller

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• Allocation problems: Nontaxable stock dividends– Basis of original shares is allocated over the

original and new shares• Based on number of shares (common on common), or

• Based on relative FMV (preferred on common)

– Holding period includes the holding period of the original shares

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• Allocation problems: Nontaxable stock rights– Basis in rights is zero unless taxpayer is required

or elects to allocate basis from stock• Required to allocate if FMV of rights is at least 15% of

the FMV of the stock• Allocation is based on relative FMV of rights and stock

– Holding period includes holding period of the stock on which the rights were distributed

• However, if the rights are exercised, holding period of newly acquired stock begins with date the rights are exercised

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Gift Basis(slide 1 of 10)

• 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

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• Gift basis for cost recovery– The donee's basis for cost recovery is the donor’s

basis (donee's gain basis)

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• Gift basis for subsequent gain– When a gifted asset is disposed of by the donee,

the basis for calculating any gain is the donor’s adjusted basis (carryover basis)

– This basis is called the “gain basis”• Gain basis may be increased if donor incurred gift tax

on gift

– Holding period for donee includes that of donor

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• Gift basis for subsequent loss– When a gifted asset is disposed of by a donee, the

basis for calculating any loss is the lesser of FMV at the date of gift or the donor’s adjusted basis

– This basis is called the “loss basis”

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• 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

– If dual basis and sold for loss, holding period for donee starts on date of gift

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• Gift basis when no gain or loss– If a dual basis exists and the amount realized from

the disposition of a gifted asset falls between the gain basis and the loss basis

• No gain or loss is realized

– Holding period for donee is not needed since there is no gain or loss

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• Example of gift basis determination– Alex received a gift from Beth on June 15 this year– FMV of asset on June 15 was $8,000– Beth bought the asset on May 5, 1985 for $10,000

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• Example of gift basis determination (cont’d)– If Alex sells the asset for $11,000, there is a $1,000

gain ($11,000 – $10,000)– If Alex sells the asset for $7,000, there is a $1,000

loss ($7,000 – $8,000)– If Alex sells the asset for $9,000, there is no gain

or loss ($9,000 – $9,000)

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• Adjustment for gift taxes– 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]

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• Example of gift tax:– Cathy received a gift from Darren on June 15 of

this year– FMV on June 15 was $33,000– Darren had a basis in the asset of $28,000– Darren paid gift tax of $800– Cathy’s basis in the gifted property is $28,200

[$28,000 + ($5,000/($33,000 – $13,000) × $800)]

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Property Acquiredfrom a Decedent (slide 1 of 7)

• Generally, beneficiary’s basis in inherited assets will be the FMV of the asset at decedent’s date of death– Exception: If the executor/administrator of estate

elects alternate valuation date, basis is FMV on such date

• Inherited property is always treated as long-term property

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• Inherited property valuation date– Date assets valued for estate tax is either:

• 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

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• Inherited property valuation date– When PVD is used, beneficiary’s basis will be the

FMV at date of decedent’s death– When AVD is used, beneficiary’s basis will be the

FMV at the earliest of:• Date asset is distributed from estate, or

• 6 months after date of decedent’s death

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• Example of inherited property valuation:– At Rex’s date of death, April 30 of this year, his

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

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• Example of inherited property valuation (cont’d)– October 30 this year (six months after date of

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

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• Deathbed gifts– Property inherited by taxpayer (or spouse) which

was both appreciated and gifted by same taxpayer to decedent within 1 year of decedent's death

– Beneficiary’s basis in property is carryover of decedent’s basis (not date of death FMV)

– Generally the same basis taxpayer had on date of gift

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• Survivor’s share of community property– Both decedent’s share and surviving spouse’s share of

community property receives basis of FMV on date of death

• Surviving spouse’s share deemed to be acquired from decedent

• Survivor’s share in common law state– Only 1/2 of jointly held property of spouses is included in

the estate• In such a case, no adjustment of the basis is permitted for the

excluded property interest (the surviving spouse’s share)

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Property Acquired From A Decedent• Return to the facts of The Big Picture on p. 14-1.

• In 2012, Alice inherited her mother’s house. – At the date of death, the mother’s adjusted basis

for the house was $275,000. – The house’s fair market value at the date of death

was $475,000. – The alternate valuation date was not elected. – Alice’s basis for income tax purposes is $475,000.

• This is commonly referred to as a stepped-up basis.

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Property Acquired From A Decedent• Return to the facts of The Big Picture on p. 14-1.

• Assume the same facts as in Example 25, except the house’s fair market value at the date of the mother’s death was $260,000.

• Alice’s basis for income tax purposes is $260,000. – This is commonly referred to as a stepped-down

basis.

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Disallowed Losses(slide 1 of 5)

• Related parties (§ 267)– Losses on sale of assets between related parties are

disallowed– For income-producing or business property, any

loss disallowed can be used to reduce gain recognition on subsequent disposition of asset to unrelated party

• Only available to original transferee

• Not available for sales of personal use assets

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• Related parties include:– Family members,– Corporation and a shareholder who owns greater

than 50% (directly or indirectly) of the corporation, and

– Partnership and a partner who owns greater than 50% (directly or indirectly) of the partnership

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• Wash sales– Losses from wash sales are disallowed– Wash sale occurs when taxpayer disposes of stock

or securities at loss and acquires substantially identical stock or securities within 30 days before or after the date of the loss sale

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• Wash sales– Disallowed loss is added to the basis of the

substantially identical stock or securities that caused the disallowance

– Does not apply to gains realized on disposition of securities

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• Personal use assets– Loss on the disposition of personal use assets is

disallowed– Personal use asset loss cannot be converted into a

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

• Cost recovery basis similarly limited

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Wash Sale• Return to the facts of The Big Picture on p. 14-1. • Alice owned 100 shares of Green Corporation stock (adjusted

basis of $20,000). – She sold 50 shares for $8,000. – Ten days later, she purchased 50 shares of the same stock for $7,000.

• Alice’s realized loss of $2,000 ($8,000 amount realized -$10,000 adjusted basis) is not recognized because it resulted from a wash sale.

• Alice’s basis in the newly acquired stock is $9,000 ($7,000 purchase price + $2,000 unrecognized loss from the wash sale).

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Refocus On The Big Picture (slide 1 of 4)

• Alice inherited the house from her mother. – The fair market value of the house at the date of her

mother’s death was $475,000. – An appraisal indicates that the house currently is worth

$485,000.

• Alice’s mother lived in the house for 38 years. – Her adjusted basis for the house was $275,000. – As a child, Alice lived in the house for 10 years, but she

has not lived there in 25 years.– The house has been vacant during the 7 months Alice has

owned it.

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• Alice has been trying to decide whether she should sell the house for its fair market value or sell it to her nephew for $275,000. – Alice has suggested a $275,000 price for the sale

to Dan • She believes she will have no gain or loss at this price.

• You advise Alice that her adjusted basis for the house is the $475,000 fair market value on the date of her mother’s death.

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• If Alice sells the house for $485,000, she would have a recognized gain of $10,000

Amount realized $485,000

Adjusted basis 475,000

Recognized Gain $10,000

• The gain would be long-term capital gain.

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• If, instead, Alice sells the house to her nephew for $275,000, she will have a part sale and part gift. The realized gain on the sale of $5,670 is recognized as long-term capital gain.

Amount realized $ 275,000Less: Adjusted basis * (269,330)Realized gain $ 5,670

Recognized gain $ 5,670

*[($275,000/$485,000) X $475,000] = $269,330

• Alice is then deemed to have made a gift to Dan of $210,000 ($485,000 - $275,000).

• With this information, Alice can make an informed selection between the two options.

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 50

If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact:

Dr. Donald R. Trippeer, CPA [email protected]

SUNY Oneonta

Ppt ch 14

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