Principles of Taxation

1
Principles of Taxation

• Chapter 8
• Nontaxable Exchanges

2
Objectives

• Explain how nontaxable exchanges create tax
  neutrality.
• Compute substituted basis of property received.
• Compute gain when boot is received.
• Identify qualifying like-kind property.
• Describe the effect of relief of debt.
• Compute recognized gain and basis in involuntary
  conversion.
• Explain nonrecognition treatment for corporation
  or partnership formation.
• Describe tax effects of a wash sale.

3
Tax Neutrality

• A nontaxable exchange removes the government as a
  party to the transaction the tax law is neutral.
• Example
• Sandra owns stock in ABC with a FMV of 1000 and
  a tax basis of 200.
• She wants to rebalance her portfolio and buy
  1000 of XYZ stock instead.
• Unfortunately, if she sells ABC and buys XYZ, she
  must pay tax on the 800 gain on ABC, and wont
  have 1000 to spend on XYZ.
• IF the exchange of ABC for XYZ were nontaxable,
  she could defer paying tax on 800, and could
  obtain a full 1000 value of XYZ stock.

4
Exchanges of Qualifying Property-Generic

• One qualifying property for another.
• Assume the FMVs are ________ or the parties
  wouldnt swap.
• Realized gain or loss may not be recognized.
• Example
• Sam has property with FMV 100, basis 60.
• Lisa has property with FMV 100, basis 110.
• Sam and Lisa swap Sam realizes, but does not
  recognize, the 40 gain.
• Lisa realizes, but does not recognize, the (10)
  loss.

5
Substituted Basis

• Nonrecognition of gain or loss is not permanent,
  but deferred.
• The mechanism for ensuring deferral is to imbed
  the deferred gain or loss in the new basis.
• Basis in property received
• 1) basis of property surrendered
• 2) FMV of property received - deferred ______
  deferred ______.
• What are Sams and Lisas new bases? Sam ___,
  Lisa ____.

6
The Effect of Boot

• Define boot
• Does boot include cash?
• Does book include relief of debt?
• Examples will first show CASH boot, then other
  types of boot.

7
Effect on Taxpayer Receiving Boot

• Any realized gain is recognized up to the ______
  of boot received.
• Boot cannot increase the amount of the ________
  gain.
• Receiving boot does not cause loss recognition.
• New basis in qualifying property received
• 1) basis of property surrendered ______
  recognized - _____ boot received
• or 2) FMV of qualifying property received -
  deferred ______ deferred ______.
• New basis in boot ______ of boot.

8
Example Receiving Cash Boot

• Luke has qualifying property with a FMV of 1000
  and a basis of 700.
• Robert has qualifying property with a FMV of 900
  and a basis of 300. He also has cash of 100.
• If they swap, Luke receives property worth 1000
  in total. His realized gain is _____. He must
  recognize _____ because he received boot. He
  defers ____ of gain.
• Luke has basis on qualifying property of ____
  1) 700 ____ - ____ 2) 900 - _____.

9
Taxpayer Giving boot

• Giving boot does not trigger gain recognition in
  qualifying property given.
• BUT all realized gains or losses ON the boot
  given up must be recognized.
• The FMV of the boot paid increases the basis of
  the qualifying property received
• 1) basis of qualifying property surrendered FMV
  of boot paid
• 2) FMV of qualifying property received - deferred
  gain deferred loss.

10
Example Giving Cash Boot

• Continue prior
• Roberts realized gain of 600 on the qualifying
  property he gives up is NOT recognized. It is
  deferred. Giving boot does not change this
  result.
• Roberts basis in the qualifying property he
  receives is ____
• 1) 300 original basis ____ boot paid
• 2) 1000 FMV - ____ deferred gain.

11
Example Relief of Debt Cash Boot

• Ginger owns qualifying property with a FMV 200
  (basis 120), subject to a mortgage of 50.
• Susan owns qualifying property with a FMV 150
  (basis 110).
• When they swap properties, Susan assumes the
  mortgage on Gingers property. This is treated as
  ___ boot that Susan pays Ginger.
• Ginger has a realized gain of 80. She
  recognizes __ and defers ___. Her new basis is
  ___.
• Susan has a realized gain of ___ which is
  completely deferred. Her new basis is ____.

12
Example Non-Cash Boot

• Dylan owns qualifying property with a FMV 120
  ( basis 70).
• Luke owns qualifying property with a FMV 100 (
  basis 90). Luke also owns stock (boot) with a
  FMV 20 (basis 5).
• Dylan recognizes 20 of his ____ realized gain
  and defers ___. His basis in the qualifying
  property received is ____. His basis in the
  stock is 20.
• Luke recognizes none of the ___ realized gain
  and defers ___. His basis in the qualifying
  property received is ____.

13
Like-Kind Exchanges

• Personalty within class Car for car, computer
  for computer, furniture for furniture. See
  regulations for details.
• Realty ANY business or investment realty is
  like-kind with other business realty land for
  warehouse, factory for office.
• Inventory, stocks, bonds, partnership interests
  are NOT like-kind.
• Under like-kind rules, NO Gain OR Loss is
  recognized except due to boot. This is mandatory,
  not elective. For this reason, usually loss
  properties should be sold rather than swapped.

14
Involuntary Conversions

• Involuntary conversion include
• Theft
• Government claim of property or condemnation
• Natural disasters fire, hurricane, tornado,
  earthquake
• Taxpayer may ELECT to defer gains.
• What happens to losses?

15
Involuntary Conversion

• Requirements to defer gain
• 1) Reinvest proceeds in property which is similar
  or related in service or use. (These rules are
  stricter than like-kind for realty.)
• 2) Replacement property must be purchased within
  ______ taxable years following the year in which
  the conversion took place.
• IF taxpayer does not reinvest full proceeds, gain
  is recognized UP TO the difference between the
  amount __________ and the amount__________.

16
Involuntary Conversion Example

• Amys factory has an adjusted basis of 500,000.
  The factory is destroyed by a tornado and she
  receives 650,000 from the insurance company.
• A) If Amy reinvests 700,000 in a new factory,
  she may defer all the gain. Her new basis will
  be ___,000 700,000 - ____,000 deferred gain.
• B) If Amy reinvests 600,000 in a new factory,
  she must recognize __,000 of gain, but can defer
  ___,000. Her new basis is 500,000.
• C) If Amy reinvests 400,000 in a new factory,
  she must recognize ALL 150,000 of gain. Her new
  basis is ___,000.

17
Corporate Formations

• No gain or loss is recognized when property is
  transferred to a corporation solely in exchange
  for that corporations stock IF the transferors
  of property are in control (gt____) of the
  corporation after the exchange.
• The shareholders basis in the stock
  substituted basis of property contributed.
• The corporations basis in the property
  carryover basis of property from shareholder.

18
Corporate Formation Example

• Phil and Lil form a corporation. Phil
  contributes 10,000 cash. Lil contributes a
  building with a FMV of 10,000 and an adjusted
  basis of 6,000. Phil and Lil each receive stock
  with a FMV of 10,000. After forming the
  corporation, Phil and Lil own 100 of the stock
  in aggregate.
• Phil has no gain or loss. His basis in the stock
  is _______.
• Lil defers her gain of ________. Her basis in
  the stock is _______. The corporations basis
  in the building is 6,000.

19
Partnership Formation

• Similar to corporation rule but with no (80)
  control requirement.
• No gain or loss recognized.
• Partner and partnership keep old basis in
  property contributed.

20
Wash Sales

• Special rule requires LOSS DEFERRAL.
• If taxpayer sells a security at a loss but
  repurchases substantially same securities within
  ____ days after OR____ days prior to the sale.
• New basis new purchase price deferred loss.

21
Wash Sale Example

• Dorothy owns Nike stock she bought 3 years ago
  for 50 per share.
• She sells it on September 6 for 40.
• She repurchases more Nike stock on September 23
  for 38.
• She cannot recognize the loss of ____ per share
  on the September 6 sale.
• Her new basis in the stock bought September 23
  will be ____.

22
Concept Review

• Tax deferral produces carryover or substituted
  basis.
• Taxable income recognition produces
  step-up/step-down to new fair market value basis.