PROPERTY TRANSACTIONS: Determination of Gain or Loss

1
PROPERTY TRANSACTIONSDetermination of Gain or
Loss

• Amount Realized
• - Adjusted Basis
• ________________
• Gain or Loss

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Determination of Gain or Loss

• Adjusted basis
• Original cost (or other adjusted basis) plus
  capital additions less capital recoveries

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Example of Basis

• Jake acquires property by paying 20,000 in cash
  and taking out an 80,000 mortgage from the bank.
• What is his basis?
• What if he pays 20,000 in cash and assumes the
  Sellers 80,000 mortgage?
• What is his basis?

4
Determination of Gain or Loss

• Capital additions
• Cost of improvements and betterments to the
  property that are capital in nature and not
  currently deductible

5
Determination of Gain or Loss

• 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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Example

• Paul, a calendar year taxpayer, purchased real
  property to be used as a factory for 80,000. He
  paid commissions of 2,000 and title search
  legal fees of 600.
• His cost basis is 82,600. This must be
  allocated
• Land 10,325
• Building 72,275

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Example (contd)

• He immediately spent 20,000 in capital
  improvements to the building.
• He took a total of 9600 in depreciation over 5
  years.

8
Example (contd)Adjusted basis after 5 years
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Determination of Gain or Loss

• Amount realized from disposition
• Total consideration received, including cash, FMV
  of property received, mortgages/loans assumed by
  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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Problem

• Alice buys a building by paying 20,000 in cash
  and taking out a 25,000 mortgage.
• 3 years later she sells it for 60,000 in cash,
  and the buyer assumes her mortgage which now has
  a balance of 20,000.

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Problem (contd)In that 3 years

• Painted rooms 750
• Cleaned carpets 300
• Installed air
  
• conditioning 6,000
• Repaired fence 500
• Rewired building 15,000
• Partitioned rooms 5,000
• Depreciation 9,000
• What is her gain or loss?

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Gift Basis donor vs donee

• Donees basis in the gift property is the same as
  donors basis on the date of the gift
  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

• UNLESS on the date of the gift, FMV lt AB
• Use FMV basis if property is sold for a loss
  (This basis is called the loss basis) The
  holding period for donee starts on date of gift
• Use c/o AB if property is sold for a gain
• If subsequently sold for an amount in between, no
  gain or loss

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Gift Basis

• 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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Gift Basis

• Example of gift basis determination (contd)
• 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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Gift Basis

• 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 donees basis is equal to Donors basis
  (unrealized appreciation/taxable gift) gift
  tax

17
Gift Basis

• Example of gift tax
• Cathy received a gift from Darren on June 15 of
  this year
• FMV on June 15 was 31,000
• Darren had a basis in the asset of 26,000
• Darren paid gift tax of 800
• Cathys basis in the gifted property is 26,200
  26,000 (5,000/(31,000 11,000) 800)
  

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Property Acquiredfrom a Decedent

• Generally, beneficiarys basis in inherited
  assets will be the FMV of the asset at decedents
  date of death STEPPED UP (or DOWN) BASIS
• Inherited property is always treated as long-term
  property

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Property Acquiredfrom a Decedent

• Inherited property valuation date
• Date assets valued for estate tax is either
• Date of decedents death, which is called the
  primary valuation date (PVD), or
• 6 months after date of decedents death, which is
  called the alternate valuation date (AVD)
• Can only be elected if value of gross estate and
  estate tax liability are lower than if PVD was
  used

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Property Acquiredfrom a Decedent

• Example of inherited property valuation
• At Rexs 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
  beneficiarys basis is 700,000

21
Property Acquiredfrom a Decedent

• Example of inherited property valuation (contd)
• October 30 this year (six months after date of
  Rexs death), the assets had a FMV of 650,000
• AVD selected and assets distributed November 10
  beneficiarys basis is 650,000
• AVD selected and assets distributed June 30 when
  FMV of assets is 670,000 beneficiarys basis is
  670,000

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Disallowed Losses

• 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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Disallowed Losses

• 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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Disallowed Losses

• 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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Disallowed Losses

• John purchased a residence on 1/1 of YR1 for
  50,000. He added improvements at a cost of
  20,000.
• On 6/1 of YR3 John moved to a new residence
  converted the old to rental property. FMV of the
  old was 65,000.
• What is the basis for gain? What is the basis
  for loss? What if he subsequently sells the old
  residence for 68,000?