Chapter 10
Property: Basis and Nontaxable Exchanges
Realized Gain or Loss
Realized gain (loss) = Amount realized - Adjusted basis
" Realized gain is not always recognized gain
" Amount Realized
o Sales price less selling expense
o Sales price is
" Cash received and/or
" FMV of property received and/or
" FMV of services received and/or
" Reduction of debt
Adjusted Basis
Initial basis in property
+ Capital additions
- Capital recoveries
= Adjusted basis
Initial Basis
" Property acquired by purchase
" Property received from a spouse - spouse's basis
" Inherited property - FMV
" Gifted property - See slide
" Property converted to business or rental use - See slide
" Special rules for stock ownership - See slide
" Return-of-capital - SUBTRACTED - Utility companies
Donee's Initial Basis in Gifted Property
When FMV donor's basis and the donee disposes of the property for
" a gain, donee's basis = donor's basis
" a loss, donee's basis = FMV at time of gift
" no gain or loss, donee's basis = amount realized
When FMV donor's basis,
" Donee's basis = Donor's basis + Percentage of the gift tax
" Percentage for pre-1977 gifts: 100%
" Percentage for post-1977 gifts: FMV - Donor's basis / FMV
Property Converted to Business/Rental Use
" When at conversion FMV > Adjusted Basis
o Adjusted basis = initial basis + Capital additions - capital recoveries
o Depreciable basis = Adjusted basis
" When at conversion FMV < Adjusted Basis
o Sell at a gain - basis is initial basis + capital additions - capital recoveries
o Sell at a loss - basis is FMV at conversion + postconversion capital additions - postconversion capital recoveries
o Depreciable basis = FMV at conversion
Capital Additions
Some examples of improvements include:
" Installing a new furnace
" Putting up a fence
" Paving a driveway
" Rebuilding an engine in a car
" Landscaping
" Building a recreation room in an unfinished basement
" Paying special assessments for sidewalks, roads, etc.
" Adding a room onto a house
Capital Recoveries
" Return of the taxpayer's investment in property.
" Examples
o Insurance proceeds
o Easement
Special Rules for Stocks
" Purchase price + commission or gift or inheritance
" Several different purchases of the same stock
o Specific Identification
o First-in, First-out (FIFO)
" Mutual Funds
o Can use average price per share in addition to Specific ID and FIFO
" Stock Splits - increase # of shares; decrease cost per share; no income recognized
" Stock Dividends - increase # of shares; decrease cost per share; may or may not recognize income
Basket Purchases
Single purchase price for several assets.
FMV of the property
Initial basis = Purchase price X
FMV of all properties
Recognized Gains and Losses
In general, taxpayers recognize all realized gains but recognize losses only from the disposal of business or investment property. Some exceptions to this rule include the following:
" Casualty or theft losses on personal-use property - Schedule A
" Losses involving wash sales
" Losses from sales between related parties
" Gains from qualified small business stock
" Gains and losses from like-kind exchanges
" Certain gains from the sale of a principal residence
" Certain gains from involuntary conversions
Wash Sales
Because securities are an investment, the taxpayer usually recognizes the loss realized on the sale of securities.
" However, no loss is allowed when the taxpayer repurchases "substantially identical" securities within 30 days before or after the sale.
" The basis in the shares involved in the wash sale is increased by the amount of the disallowed loss.
Sales Between Related Parties
Taxpayers cannot recognize losses when they sell business or investment property to a related party. For tax purposes, individuals and their family members are related parties.
" Family members include parents, siblings, descendents, and ancestors.
" The related party purchaser can use the disallowed loss to offset any subsequent realized gain.
Section 1202 Qualified Small Business Stock
" Individuals can exclude 50% of the gain realized
" Stock must be held for more than five years
" the Section 1202 stock must have been part of the corporation's original issuance of stock and have been purchased after August 10, 1993.
" Only certain corporations qualify - less than $50,000,000 in gross assets and a qualified trade.
Like-Kind Exchanges - Overview
" Property exchange with potential tax savings - Form 8824
" Requirements of nontaxable exchanges
o There must be an exchange
o Real property must be exchanged for other real property. Personal property must be exchanged for personal property of like class.
o The property exchanged cannot be inventory, foreign real property, securities, or partnership interests
" Receipt of boot often triggers recognition of gain
o Boot property
" In exchanges of property rarely are the FMV of both properties equal boot is given to make exchange values equitable
o Boot is property given or received in a like-kind exchange that is not like-kind property (such as an asset exchanged for another asset plus cash)
o General rule regarding the receipt of boot - when boot is received, the recognized gain is the lesser of
" The FMV of the boot received or
" The realized gain on the exchange
" Time period for finding exchange property
o Taxpayer has 45 days after relinquishing property to identify replacement property
o Taxpayer must receive the replacement property within the earlier of 180 days after property was given up, or the due date for filing a return (including extensions) for the year of the transfer
" Exchange between Related Parties
o Not like-kind exchange if either party disposes of property within two years of the exchange
" Most common arrangement is to have title to property to be exchanged to be placed in escrow with a custodian (CPA or an attorney)
o Custodian sells the property and places cash in an escrow account
o Taxpayer has 45 days to identify like-kind property
o Once identified, custodian purchases new property and distributes title to the taxpayer
o The main restriction is that taxpayer cannot have access to proceeds
" California has conformed
FMV of the new property
+ Postponed losses
- Postponed gains
= Basis of the new property
Sale of a Personal Residence
" Taxpayer Relief Act of 1997 changed sales of personal residences in favor of taxpayers
" A taxpayer may exclude up to $500,000 ($250,000 if single) of gain
" To qualify for exclusion, the following tests must be met:
o Ownership tests - owned home for = 2 years
o The use test - lived in the home as your main home = 2 years
o Tests do not have to be continuous
" Exclusion applies to only one sale every 2 years
" May be able to exclude gain of second home sale within 2 year period if sale is due to employment, health reasons, or disability
o Portion of gain can be excluded by taking a ratio of the number of days used divided by 730 days
" Special problems with married individuals
o If only one spouse is eligible for exclusion, only $250,000 of exclusion is available
o If any special situation occurs, look it up
" California has conformed
" Tax Tip
o Convert a residential rental property to person
Involuntary Conversions
Involuntary Conversions result from condemnations, casualties, and thefts.
" A gain results when the proceeds received from the conversion exceed the adjusted basis in the converted property.
" A loss from an involuntary conversion results when the amount of the loss exceeds the proceeds received from the conversion.
" Gains can be postponed to the extent that the proceeds are reinvested in qualified replacement property in a timely manner.
End of Chapter 10
