Property Transactions: Basis Determination

1
Chapter 14

• Property Transactions Basis Determination
  Recognition of Gain or Loss
• Read all relevant examples!

2
Introduction to Property Transactions

• Recovery of Cost Doctrine
• Realization Concept Realization requires
• An external transaction
• Plus a change in basic property right

• Realized Income may be
• Recognized immediately
• Recognized later (deferred)
• Never recognized as income

• EXCEPTIONS
• Gifts
• Death Transfers
• Loans

3
Introduction to Property Transactions

• General Rule
• Recognize income as soon as it is realized.

• EXCEPTIONS
• Tax exempt bond interest
• Installment sales
• Nontaxable exchanges
• Losses realized on personal use assets, except
  condemnations and casualties
• Certain other statutory provisions

4
DefinitionsAmount Realized Gain or Loss Realized

• Amount realized on sale or disposition of an
  asset Cash Received

• Less
• Selling expenses
• Cash paid to the buyer
• Liabilities assumed by the seller (ex., a note
  payable from the seller to the buyer, usually to
  equalize to FMVs of the transaction)
• Liabilities encumbering the property received
  that are assumed by the seller

• Plus
• FMV of other property received
• Liabilities assumed by the buyer (ex., notes
  receivable given to the seller)
• Liabilities or encumbrances on property
  transferred to the buyer (ex., mortgages
  transferred from seller to buyer)

• Equals Amount Realized Examples 1 through 7 25,
  26

5
DefinitionsAmount Realized Gain or Loss Realized

• Amount Realized
• Less Adjusted Basis
• Equals Gain or Loss Realized

6
Amount Realized Examples
John exchanges his tractor (FMV 3,000) for
Marcias auto (FMV 5,000). Because the tractor
is worth 2,000 less than the auto, John must pay
2,000 in boot.
His Amount Realized (FMV prop. recd) - (Cash
paid) 5,000 - 2,000 3,000
Her Amount Realized (Cash recd) (FMV prop.
recd) 2,000 3,000 5,000
Same example, except Marcias auto has a 1,000
mortgage which John assumes. John gets 4,000 of
value (5,000 - 1,000 mortgage assumption) and
gives up tractor worth 3,000. Thus, John must
pay 1,000 boot.
His Amount Realized (FMV prop. recd) - (Cash
paid) - (Liabilities assumed) 5,000 - 1,000 -
1,000 3,000
Her Amount Realized (Cash recd) (FMV prop.
recd (Liab. on property transferred) 1,000
3,000 1,000 5,000
7
General Basis of Property

• ADD
• Purchase Cost
• Cash paid
• FMV of property given up
• Unpaid mortgage of property received, if the
  purchaser assumes the mortgage
• Debt (notes payable) given to seller
• Other acquisition costs (legal, appraisals, etc.)
• Taxes relating to acquisition
• Interest and taxes on construction
• Most interest related to acquisition may be
  capitalized or deducted (TPs option)
• Capital additions (betterments improvements)

8
General Basis of Property

• LESS
• Depreciation allowed or taken
• Liquidating distributions by corporations
• Casualties and certain other losses
• Amortized bond premiums
• EQUALS Adjusted Basis
• Examples 8, 10, 11
• Other Determinants of Basis
• Adjustments to Basis in Nontaxable Exchanges -
  Chapter 15

9
Basis of Property Converted fromPersonal to
Business Use

• Property converted from personal use to business
  use
• Basis lower of adj. basis or FMV at date of
• conversion.
• But, for sale at gain, basis original basis -
  accum. depr.
• NOTE Sometimes this means no gain or loss on
  sale.
• Example House 40,000 AB, 30,000 FMV at
  conversion, 35,000 SP
• Example 23 ( similar to examples 14, 15, 16)

10
Basis of Inherited Property

• General Rule Basis
• FMV at date of death or
• Alternative valuation date FMV at date of
  death plus 6 mos. if estate tax is due and estate
  has declined in value
• Holding Period Deemed Long-term
• EXAMPLE
• P bought property at 100.
• FMV at death 250.
• W inherits property, sells at 310.
• Gain (l.t.) (310 - 250) 60
• Examples 19, 20

11
Basis of Inherited Property

• Exception 1 Income in Respect of a Decedent
• Or, IRD Items(Section 691)

EXAMPLE Decedent has earned income, but has not
received it by time of death. Either the estate
or the heirs include it in their income,
depending on who has it at tax time. The TP has
no basis in it until is is taxed.
12
Basis of Inherited Property

• Exception 2

EXAMPLE For decedents who acquired property w/in
one year of death and that property passes back
to donor, new basis donors old basis Example 21
13
Basis of Property Acquired by Gift

• General Rule
• Carryover of Basis, in general
• Adjust basis for gift tax paid on the
  appreciation of the property up to the date of
  the gift. The adjustment is called the gift tax
  add-on. Add the gift tax add-on to the
  carryover basis

Gift Tax (FMV date of gift) - donors basis x
(Gift tax paid) Add-on FMV date of
gift Examples 12, 13
14
Basis of Property Acquired by Gift

• FMV at date of gift lt donors basis an
  exception
• Basis for gain/loss depends on whether asset is
  later sold for more or less than donors basis

If sold at a gain, basis for gain is donors basis
if sold at a loss, basis for loss is FMV at date
of gift
Holding Periods Starts on donors date of
acquisition, generally Starts on date of gift for
situation if sold at a loss above Examples 14,
15, 16
15
Events Which Generally Trigger Recognition

• Unless there are statutory exceptions, the
  following types of events are taxable, i.e., they
  trigger G/L recognition
• Sale or disposition
• Exchanges - Example 27
• Transfers of property to satisfy debt (in lieu of
  cash) - Examples 28, 29
• Part sale - part gift (where SP lt FMV)
• Bargain sales to charities

16
Bargain Sales

• Where selling price lt FMV Treat as part sale,
  part gift
• Gains on sale subject to income tax
• Amount of gift subject to gift tax rules

• General Rules (Reg. Sections 1.1001-1(e)
  1.10115-4)
• Recognize gains but not losses
• Donees basis is greater of purchase price paid
  or regularly determined gift basis
• Amount of donors gift FMV of gift asset less
  amount realized
• Examples 34, 35

17
Bargain Sales Example 1

• F sells property FMV 90, basis 30, to S for 60

Fs Gain Ss Basis Amt. realiz. 60 60 -Adj.
Basis (30) Gain real./recog. 30 Amt. of Fs
gift FMV (90) - Amt. realiz. (60) 30
18
Bargain Sales Example 2

• F sells property FMV 90, basis 60, to S for 30

Fs G/L Amt. of Gift Amt. realiz.
30 FMV 90 -Adj. Basis 60 - Amt. realiz.
30 realiz. loss (30) gift 60 NOT RECOGNIZED Ss
Basis 60
19
Bargain Sale to Charity

• General Rule Bargain sales are part sale and
  part contribution, therefore allocate basis
  between sale part and contribution part so gain
  or loss can be calculated.

Gains on bargain sales subject to income tax
amount of gift is not subject to gift tax and a
charitable deduction is available for income tax
purposes.
20
Bargain Sale to Charity Example

• 1) Charitable Contribution
• FMV - amt realiz.
• 50,000 - 10,000 40,000 Rs charitable
  contribution
• 2) Basis Allocation
• 10,000 amt realiz. x 25,000 basis 5,000
  basis allocated to sale portion
• 50,000 FMV
• 3) Calculate Gain/Loss
• (10,000 amt realiz.) - (5,000 adj. basis)
  5,000 gain on sale for R
• Examples 38, 39

21
Charitable Contributions of Mortgaged Property

• General Rule Treat as a bargain sale of
  encumbered property, with a contribution element.

1) Charitable Contribution 50,000 FMV - 22,000
amt realiz. 28,000 charitable contribution for
D 2) Basis Allocation 22,000 amt realiz. x
20,000 basis 8,800 basis allocated to sale
portion 50,000 FMV 3) Calculate
Gain/Loss (22,000 amt realiz.) - (8,800 adj.
basis) 13,200 gain on sale for D
22
Disallowed Losses

• No loss deductions are allowed for the following
• Loss on sale or disposition of personal use
  assets
• Losses on property acquired by gift are limited
  to the loss subsequent to the gift
• Losses on property converted from personal use to
  business use are limited to the loss happening
  after conversion
• Losses on sales between related parties are
  disallowed, but if the asset is later sold to an
  outside party at a gain, the gain may be reduced
  by the previously disallowed loss
• Definition of related parties Section
  276 Brothers, sisters, spouses, lineal
  antecedents and descendants
• Corporation owned more than 50 (directly
  or indirectly) by TP
• Example 51

23
Disallowed Losses
Wash Sale Losses
DEFINITION Where TP sells stock or securities and
within 30 days before or after the sale acquires
substantially identical stock or securities

• Add unrecognized loss to the basis of the
  replacement stock/securities to enable later
  recovery of basis
• Holding period of old stock/securities carries
  over
• Examples 49, 50

24
Installment Sales
Individuals not on an accrual basis (limited
exceptions) gain realized on a transaction is
recognized on an installment basis if one or more
payments will be received in future years -
Examples 44, 45
Amount recognized each year
Gross Profit Percentage
Principal Payment Rec.
Gross Profit Recognized
X

Gross profit Gross profit Total
contract price
Gross profit Sales price - A/B - Selling exp.
Total contract price Total cash to be received
(not including interest)
25
Installment Sales Example

• A, a cash basis TP, sells land valued at 100,
  basis of 10 for 80 cash and a 20 note payable
  in 5 annual installments (plus interest) starting
  next year.

In the year of the sale, A recognizes 72 gain A
will recognize 90 of each installment received
as gain. The other 10 is a non-taxable return of
capital
As gain realized 80 cash 20 note 100 amount
realized (10) adjusted basis 90 gain
realized Gross profit 90 gain realized
90 100 total
contract price