301503 Deferred Gain (Loss) 2D

Question 1

On December 31 of the current year a building owned by Carr, Inc., was destroyed by fire. Carr paid $12,000 for removal and clean-up costs. The building had a book value of $250,000 and a fair value of $280,000 on December 31. What amount should Carr use to determine the gain or loss on this involun­tary conversion?

$292,000

$250,000

$262,000

$280,000

Answer 1

$262,000

When an asset is destroyed by an involuntary conversion, gain or loss is generally recognized, based on insurance or other proceeds less the carrying value of the asset. The carrying value of the building was $250,000, and the $12,000 clean-up costs can be added to the overall loss computations, for a cost of $262,000.

Question 2

Deferred Gain (Loss)

Answer 2

A deferred gain or loss is a gain or loss realized on the sale, like-kind exchange, certain capital contributions to corporations or flow-through entities, or involuntary conversion where a gain is realized on an asset but is not recognized in the period of the transaction for tax purposes. A deferred gain or loss is one that will be recognized in the future on the occurrence of a specific event. The mechanism to defer the timing of the gain (or loss) recognition is through adjusting the basis of the replacement asset. Some examples include the following:

• The sale of an asset on the installment basis: Gain or loss will be deferred and a percentage recognized when each payment is received.
• The loss on a sale of an asset to a related party: The loss will be deferred until such time that the related party sells the asset for a gain outside of the related-party environment.
• In an involuntary conversion, if a gain results, all or part of the gain may be deferred if qualifying like-kind property is purchased within the specified time period (normally two years after the end of the tax year in which the realized gain occurs). The deferred gain (realized gain less recognized gain) reduces the basis of the new property.
• Tax-deferred exchanges such as those under IRC Section 1031 may result in a deferred gain or loss. The mechanism to defer the gain or loss is adjusting the basis of the acquired asset.

Example: Raston Corporation’s office building was destroyed in a fire during 20X1. At the date of the fire, the adjusted basis was $300,000. They received $500,000 from the insurance company based on the fair value at that date. Six months later, Raston purchased a new building costing $600,000. The realized gain is $200,000 ($500,000 - $300,000). Since they reinvested more than $500,000 in a new building, the realized gain is not recognized and is deferred. The new building will have a basis of $400,000 ($600,000 cost less the $200,000 deferred gain). If Raston had reinvested only $450,000, a total of $50,000 of the gain would be recognized ($500,000 realized less $450,000 reinvested) and only $150,000 would be deferred. The basis of the new building would be $300,000 ($450,000 cost less the $150,000 deferred gain).

A deferred gain or loss should be contrasted to a nontaxable gain or loss that will never be recognized in the future. Deferred gains and losses are temporary. The timing of the recognition is different from the timing of the transaction.

Question 3

2244.03

Answer 3

Property, plant, and equipment may be totally or partially destroyed by storm, fire, flood, or other similar causes. Damaged assets should be written down to their remaining value in use, if any, and a loss recognized in the current period.

Question 4

2244.04

Answer 4

Casualty losses: Property, plant, and equipment items are usually insured against casualty losses. A gain or loss should be recognized depending on whether the amount due from the insurer exceeds the carrying amount of the loss.

Question 5

2244.05

Answer 5

Recognition of gain or loss: A gain or loss on the involuntary conversion (e.g., due to casualty, condemnation, theft) of a nonmonetary asset should be recognized even if the proceeds received as a result of the involuntary conversion (e.g., insurance settlement, condemnation award) are reinvested in a replacement nonmonetary asset. Removal and clean-up costs are used to determine the gain or loss recognized on the involuntary conversion. Incidental costs incurred in the acquisition of replacement property are capitalized as costs of acquiring the replacement property (i.e., they do not affect the gain or loss recognized on involuntary conversion).