Basis and Property Transactions Flashcards
Arthur is a proprietor of Arthur’s Pizza Emporium. He bought a commercial building several years ago. He made a down payment of $20,000 in cash and assumed a mortgage for $100,000. After he paid off the mortgage, Arthur later sold the building for $180,000. Straight-line depreciation taken up to the date of sale was $18,000. What is the total gain on the sale?
A. $160,000
B. $78,000
C. $60,000
D. $80,000
$78,000
The adjusted basis of property is typically the cost basis increased by certain items, such as boot given. The cost basis for the commercial building is the $20,000 down payment of cash by Arthur, increased by the assumption of the $100,000 mortgage. Therefore, Arthur’s basis in the commercial building is $120,000. However, this basis is reduced by the $18,000 of depreciation taken. When Arthur sells the commercial building for $180,000, he must recognize a gain on the difference between the amount realized of $180,000 and his adjusted basis of $102,000 ($120,000 basis – $18,000 depreciation) for a total of $78,000.
Alisa purchased a day care center on December 10 of the current year. The contract showed the following adjusted basis and fair market value for the assets: Building Adjusted Basis $150,000 FMV $300,000 Land Adjusted basis 40,000 FMV 50,000 Furniture and fixtures Adjusted Basis 60,000 FMV 50,000 The contract provided that the agreed sale price was a lump-sum amount of $360,000. What is Alisa’s basis in the building?
A. $250,000
B. $270,000
C. $300,000
D. $216,000
$270,000
Under Sec. 1060, both the buyer and seller involved in a transfer of assets that amount to a trade or business must allocate the purchase price among the assets using the “residual method.” The residual method requires the purchase price to first be allocated to tangible assets up to their fair market values. Then any residual purchase price is allocated to intangible assets such as goodwill and going concern value.
In this case, Alisa paid $360,000, which is less than the total FMV of the assets ($400,000). The basis of each noncash tangible and intangible asset is then determined by allocating the total cost allocable to the noncash assets based on their relative fair market values. Alisa’s basis in the building is its FMV ($300,000) divided by the FMV of all noncash assets ($400,000) times the total cost of the noncash assets. The total cost of the noncash assets is $360,000. The allocation to the real estate is
$300,000 / $400,000 × $360,000 =
$270,000
Section 1060 also provides that the transferor and transferee may agree in writing as to the allocation of consideration or as to the FMV of any assets. This agreement is binding on the transferor and transferee unless determined inappropriate by the IRS.
Setting Sun Partnership purchased a business, Family Dry Cleaners, for $750,000. The acquired Family Dry Cleaners assets consisted of the following:
*$50,000 in cash,
*Equipment with a fair market value of $200,000, and
*Land and building with a fair market value of $450,000.
For real estate tax purposes, the city assessed the value of the land at $100,000 and the building at $200,000. The buyer and seller did not enter into an allocation agreement for this transaction. What basis must Setting Sun Partnership use for the land, building, and intangible asset “goodwill”?
A. Land, $100,000; building, $200,000; and goodwill, $150,000.
B. Land, $100,000; building, $350,000; and goodwill, $50,000.
C. Land, $150,000; building, $300,000; and goodwill, $0.
D. Land, $150,000; building, $300,000; and goodwill, $50,000.
Land, $150,000; building, $300,000; and goodwill, $50,000.
When more than one asset is purchased for a lump sum, the basis of each is computed by apportioning the total cost based on the relative FMV of each asset. The residual method, particularly relevant to goodwill and going concern value when a transferor-transferee agreement is not applicable, allocates purchase price for both transferor and transferee to asset categories up to FMV in the following order:
1. Cash (face value)
2. Near-cash items, such as CDs, U.S. government securities, and other marketable items
3. Tangible and intangible assets, such as land, buildings, equipment, inventory, accounts receivable, and covenants not to compete
4. Intangible assets (up to any residual amount), such as goodwill and going concern value
Selling price of the company $750,000
Less:
Cash
$(50,000)
Equipment (at FMV)
$(200,000)
Land and building (at FMV)
$(450,000)
= $(700,000)
Value of goodwill
$50,000
Value of building and land is computed as follows:
Land:
($100,000 ÷ $300,000) × $450,000 = $150,000
Building:
($200,000 ÷ $300,000) × $450,000 = $300,000
Erwin purchased a beauty shop on October 1 of the current year. The contract showed the following fair market values for the assets: Cash $200,000 Building & land $300,000 Furniture & fixtures $100,000 Equipment $100,000 The contract also showed that the agreed sale price was a lump-sum amount of $600,000. What is Erwin’s basis in the building and land?
A. $257,160
B. $300,000
C. $350,000
D. $240,000
$240,000
Under Sec. 1060, both the buyer and seller involved in a transfer of assets that amount to a trade or business must allocate the purchase price among the assets using the residual method. The residual method requires the purchase price to first be allocated to tangible assets up to their FMV. Then any residual purchase price is allocated to intangible assets such as goodwill and going concern value.
In this case, Erwin paid $600,000, which is less than the total FMV of the assets ($700,000). First, $200,000 is allocated to cash. The basis of each noncash tangible and intangible asset is then determined by allocating the total cost allocable to the noncash assets based on their relative fair market values. Erwin’s basis in the building and land is the FMV ($300,000) divided by the FMV of all noncash assets ($500,000) times the total cost of the noncash assets. The total cost of the noncash assets is $400,000 ($600,000 total cost – $200,000 cash). The allocation to the real estate is
$300,000 / $500,000 x $400,000 = $240,000
Section 1060 also provides that the transferor and the transferee may agree in writing as to the allocation of consideration or as to the FMV of any assets. This agreement is binding on the transferor and the transferee unless it is determined inappropriate by the IRS.
Mike purchased a building lot in Year 1 for $25,000 and constructed his primary residence there for an additional $175,000. In Year 4, Mike moved to a different city but kept the house he constructed in Year 1 and converted it to a rental property. On the date Mike made this change, the fair market value of the converted property was $225,000. For depreciation purposes, what is Mike’s basis in this rental property?
A. $225,000
B. $175,000
C. $200,000
D. $150,000
$175,000
Property converted into business use uses a basis of depreciation of the lesser of the FMV of the property at the conversion date or the adjusted basis at conversion. Because Mike’s adjusted basis is less than the FMV at the date of conversion, the adjusted basis is used.
Robin purchased a beauty shop on October 1 of the current year. The contract showed the following adjusted basis and fair market value for the assets: Building Adjusted Basis $200,000 FMV $250,000 Land Adjusted Basis $100,000 FMV $100,000 Furniture and fixtures Adjusted Basis $100,000 FMV $50,000 The contract also reflected that the agreed sale price was a lump-sum amount of $300,000. What is Robin’s basis in the building?
A. $187,500
B. $250,000
C. $156,250
D. $112,500
$187,500
Under Sec. 1060, both the buyer and seller involved in a transfer of assets that amount to a trade or business must allocate the purchase price among the assets using the “residual method.” The residual method requires the purchase price to first be allocated to tangible assets up to their FMV. Then any residual purchase price is allocated to intangible assets such as goodwill and going concern value. In this case, Robin paid $300,000, which is less than the total FMV of the assets ($400,000). The basis of each noncash tangible and intangible asset is then determined by allocating the total cost allocable to the noncash assets based on their relative fair market values. Robin’s basis in the building is its FMV ($250,000) divided by the FMV of all noncash assets ($400,000) times the total cost of the noncash assets. The total cost of the noncash assets is $300,000. The allocation to the real estate is
$250,000 / $400,000 × $300,000 = $187,500
Section 1060 also provides that the transferor and transferee may agree in writing as to the allocation of consideration or as to the FMV of any assets. This agreement is binding on the transferor and transferee unless determined inappropriate by the IRS.
Ray purchased a manufacturing business on June 1 of the current year for a lump-sum price of $1.4 million. He will use the same business name. The values of the assets were as follows:
*Cash Book Value $200,000 FMV $200,000 *Land Book Value $150,000 FMV $150,000 *Building Book Value $300,000 FMV $350,000 *Equipment Book Value $250,000 FMV $300,000 *Jobs in process Book Value $100,000 FMV $100,000 *Covenant not to compete Book Value $0 FMV $100,000 Ray did not assume any loans. What is his basis for goodwill (or going concern) and equipment?
A. Goodwill $0 Equipment $350,000
B. Goodwill $200,000 Equipment $350,000
C. Goodwill $200,000 Equipment $300,000
D. Goodwill $0 Equipment $300,000
Goodwill $200,000. Equipment $300,000
Under Sec. 1060, both the buyer and the seller involved in a transfer of assets that amount to a trade or business must allocate the purchase price among the assets using the “residual method.” The residual method requires the purchase price to be allocated first to cash; then to near-cash items, such as CDs, government securities, and other marketable securities; then to other tangible and intangible assets, such as equipment, buildings, land, accounts receivable, and covenants not to compete. The allocation of the purchase price may not exceed the FMV for each of these categories. Then any residual purchase price is allocated to intangible assets, such as goodwill and going concern value.
In this case, Ray’s purchase price of $1.4 million is in excess of the FMV of all the assets listed ($1.2 million). Therefore, the purchase price is allocated to each asset listed based on its FMV, and the remaining $200,000 ($1,400,000 purchase price – $1,200,000 listed assets) is allocated to goodwill or going concern value. The equipment will have a basis equal to its FMV of $300,000. The purchased goodwill is amortizable under Sec. 197 over a 15-year period.
Section 1060 also provides that the transferor and the transferee may agree in writing as to the allocation of consideration or as to the FMV of any assets. This agreement is binding on the transferor and the transferee unless it is determined inappropriate by the IRS.
Amounts paid or incurred to demolish a structure are
A. Deductible as a casualty loss.
B. Capitalized and added to the basis of the land where the demolished structure was located.
C. Treated as a reduction of the basis of the structure.
D. Capitalized and amortized over a 180-month period.
Capitalized and added to the basis of the land where the demolished structure was located.
Initial basis is adjusted consistent with tax-relevant events. An adjustment is made for demolition of a structure. Costs and losses associated with demolishing a structure are allocated to the land. The costs include the adjusted basis (not FMV) of the structure and demolition costs.
Taxpayer J purchased a business building with a fair market value of $60,000 and a business auto with a fair market value of $10,000. Both were acquired in a bargain purchase for a total cost of $49,000. What is the basis of the auto?
A. $49,000
B. $7,000
C. $10,000
D. $5,000
$7,000
The basis of property is defined in Sec. 1012 as its cost. When several assets are purchased for a lump sum, the basis of each asset is determined by allocating the total cost based on the relative FMV of each asset. The basis of the auto is computed as the FMV of the individual asset over the FMV of all the assets times the total cost.
$10,000 / $70,000 × $49,000 = $7,000
Generally, you must capitalize rental expenses if any of the following apply EXCEPT
A. Produce real or tangible personal property for sale to customers if average annual gross receipts are greater than $26 million.
B. Acquire property for resale if the average annual gross receipts are greater than $26 million.
C. Produce real or tangible personal property for use in a trade or business or activity engaged in for profit if average annual gross receipts are greater than $26 million.
D. Rent increases during the lease.
Rent increases during the lease.
Publication 535 states that taxpayers must capitalize rental expenses under the uniform capitalization rules if they do any of the following: (1) produce real or tangible personal property for use in a trade or business or an activity engaged in for profit, (2) produce real or tangible personal property for sale to customers, or (3) acquire property for resale. However, these rules do not apply to personal property if the average annual gross receipts for the 3 previous tax years were not more than $26 million.
Under Sec. 467, cash basis lessors may be required to use the original issue discount rules to accrue rental income when there are increasing rents. The lessee on the accrual method of accounting would be allowed a deduction based on the accrued rent.
P&L Partnership purchased a building for commercial purposes on July 1 for $200,000. Carpeting was installed at a cost of $8,000 on August 30. Furniture was purchased at a cost of $10,000 on September 1. Legal fees of $700 and recording fees of $100 were incurred at the time the building was purchased. What is the cost basis of the building?
A. $218,800
B. $200,000
C. $218,000
D. $200,800
$200,800
Cost basis is the sum of capitalized acquisition costs. Capitalized acquisition costs include purchase price, closing costs, major improvements, and miscellaneous costs, e.g., freight. Examples of closing costs are legal fees and recording fees. The carpet and the furniture are newly acquired assets and must be capitalized separate from the building.
Mr. Black purchased his first house in March for $41,000. In addition, Mr. Black incurred the following expenses: $360 for 3 years of casualty insurance $820 for new driveway $250 interior painting $145 title insurance $400 exterior painting $405 new gutters What is Mr. Black’s basis in this house?
A. $42,730
B. $42,370
C. $43,020
D. $42,225
$42,370
Under Sec. 1012, the basis of property is the cost of the property. In addition, basis includes expenditures for major improvements and costs to acquire title. The costs that are not capitalized are the casualty insurance, the interior painting, and the exterior painting. Painting is usually considered ordinary maintenance. Furthermore, these costs are not deductible unless the house is rental property, i.e., unless the costs were incurred for the production of income. Basis is computed as follows: Purchase price $41,000 New driveway 820 Title insurance 145 New gutters 405 Basis in house $42,370
When a group of assets that is a trade or business is purchased for a lump sum, the price assigned to each asset may be determined by using any of the following rules EXCEPT
A. The seller and the buyer may make a specific allocation to each asset if it is based on the value of each asset and the seller and the buyer have adverse interests.
B. Make the allocation among the assets in proportion to (but not in excess of) their fair market value on the purchase date.
C. Make the allocation among the assets in the following order: (1) cash, demand deposits, etc.; (2) certificates of deposit, U.S. Government securities, readily marketable stock or securities, and foreign currency; (3) Section 197 intangibles (other than goodwill and going-concern value); and (4) any excess is allocated to tangible assets based on fair market value.
D. The seller and the buyer may make a written agreement to allocate the consideration or the fair market value of any asset. The agreement is binding on both parties unless the IRS determines that the amounts are not appropriate.
Make the allocation among the assets in the following order: (1) cash, demand deposits, etc.; (2) certificates of deposit, U.S. Government securities, readily marketable stock or securities, and foreign currency; (3) Section 197 intangibles (other than goodwill and going-concern value); and (4) any excess is allocated to tangible assets based on fair market value.
Under Sec. 1060, both the buyer and the seller involved in a transfer of assets that amount to a trade or business must allocate the purchase price among the assets using the “residual method.” The residual method requires the purchase price to be allocated first to cash; then to near-cash items, such as CDs, government securities, and other marketable securities; then to other tangible and intangible assets, such as equipment, buildings, land, accounts receivable, and covenants not to compete. The allocation of the purchase price may not exceed the FMV for each of these categories. Then any residual purchase price is allocated to intangible assets, such as goodwill and going concern value. Section 1060 also provides that the transferor and the transferee may agree in writing as to the allocation of consideration or as to the FMV of any assets. This agreement is binding on the transferor and the transferee unless it is determined inappropriate by the IRS.
Eli purchased a construction business on May 1 of the current year for a lump-sum price of $1.2 million. He will use the same business name. The values of the assets were as follows:
Cash Book Value $300,000 FMV $300,000 Bonds Book Value $100,000 FMV $100,000 Building & land Book Value $100,000 FMV $300,000 Equipment Book Value $100,000 FMV $200,000 Jobs in process Book Value $100,000 FMV $100,000 Covenant not to compete Book Value $0 FMV $100,000 Eli assumed no loans. What is his basis for goodwill or going concern?
A. $100,000
B. $200,000
C. $500,000
D. $0
$100,000
Under Sec. 1060, both the buyer and the seller involved in a transfer of assets that amount to a trade or business must allocate the purchase price among the assets using the “residual method.” The residual method requires the purchase price to be allocated first to cash; then to near-cash items, such as CDs, government securities, and other marketable securities; then to other tangible and intangible assets, such as equipment, buildings, land, accounts receivable, and covenants not to compete. The allocation of the purchase price may not exceed the FMV for each of these categories. Then any residual purchase price is allocated to intangible assets, such as goodwill and going concern value.
In this case, Eli’s purchase price of $1.2 million is in excess of the FMV of all the assets listed ($1.1 million). Therefore, the purchase price is allocated to each asset listed based on its FMV, and the remaining $100,000 ($1,200,000 purchase price – $1,100,000 listed assets) is allocated to goodwill or going concern value.
Section 1060 also provides that the transferor and the transferee may agree in writing as to the allocation of consideration or as to the FMV of any assets. This agreement is binding on the transferor and the transferee unless it is determined inappropriate by the IRS.
Matt and Jason, partners in the M&J Partnership, began business on June 15 of the current year. The business incurred the following expenses prior to June 15:
*Purchase of a commercial building for $200,000.
*New electrical wiring at a cost of $27,000.
*New plumbing at a cost of $75,000.
*Light fixtures (not part of the wiring) replaced at a cost of $6,500. These light fixtures were of the same quality as the previous ones.
What is the cost of improvements?
A. $275,000
B. $102,000
C. $108,500
D. $200,000
$108,500
Publication 535 states, “The costs of making improvements to a business asset are capital expenses if the improvements add to the value of the asset, appreciably lengthen the time you can use it, or adapt it to a different use. Improvements include new electric wiring, a new roof, a new floor, new plumbing, bricking up windows to strengthen a wall, and lighting improvements. You cannot deduct the cost of a replacement that stops deterioration and adds to the life of your property. Capitalize that cost and depreciate it.” The cost of improvements includes the $27,000 in wiring, $75,000 in new plumbing, and $6,500 in light fixtures.
Joe Crisco purchased the following assets for $100,000:
Certificate of Deposit $10,000 Equipment/Furniture $20,000 Franchise $90,000 Account Receivable $30,000 Total $150,000 What is the purchase price of the intangible asset?
A. $60,000
B. $49,091
C. $40,000
D. $90,000
$40,000
Under Sec. 1060, both the buyer and the seller involved in a transfer of assets that amount to a trade or business must allocate the purchase price among the assets using the “residual method.” The residual method requires the purchase price to be allocated first to cash; then to near-cash items, such as CDs, government securities, and other marketable securities; then to accounts receivable; and then to other tangible assets, such as equipment, buildings, and land. The allocation of the purchase price may not exceed the FMV for each of these categories. Finally, any residual purchase price is allocated to intangible assets, such as a franchise. In this case, the franchise is equal to $40,000 ($100,000 purchase price – $60,000 FMV of assets excluding the franchise).
Larry purchased an office building and land on February 1 of the current year for $1,000,000. No liabilities were assumed. The assessed value of the assets for real estate purposes at the time of the purchase were as follows:
Land $300,000 Building $500,000 What is the basis of the building?
A. $500,000
B. $600,000
C. $700,000
D. $625,000
$625,000
Answer (D) is correct.
When more than one asset is purchased for a lump sum, the basis of each is computed by apportioning the total cost based on the relative FMV of each asset. The allocable cost (basis) for each asset is calculated as follows:
FMV of asset / FMV of all assets purchased x Lump sum purchase price
Assuming the assessed value of the assets for real estate purposes reflects the FMV of the assets, the basis of the building is $625,000 [$1,000,000 × ($500,000 ÷ $800,000)] (Publication 551).
Bob purchased a building and land to use in his business for a price of $1,000,000. The land was valued at $300,000 (included in the price). He then incurred $90,000 to replace the roof of the building. The city replaced the sewage lines to his business and assessed Bob $20,000. Bob had been slow in getting insurance coverage on the real property and incurred a small fire loss of $10,000, which he plans to deduct on his business tax return. What is Bob’s basis for depreciation after deducting the loss?
A. $800,000
B. $720,000
C. $810,000
D. $1,100,000
$800,000
To determine the basis of the building for depreciation, the value of the land ($300,000) must be subtracted from the total purchase price of $1,000,000 to get $700,000. The $90,000 spent to replace the roof and the $20,000 spent to replace the sewage lines must be capitalized because they are capital expenditures, and they increase the value of the property. The $10,000 fire loss should reduce the basis because casualty losses reduce the basis by the amount of the loss. The total depreciation basis equals $800,000 ($700,000 + $90,000 + $20,000 – $10,000).
Under the updated capitalization and repair rules, amounts paid for which of the following activities generally are NOT required to be capitalized unless an election is made to treat them as capital expenditures?
A. Replacing a major component or substantial structural part of a unit of property.
B. Materially enlarging a unit of property.
C. Repair and maintenance that does not improve a unit of tangible property.
D. Adapting a unit of property to a new or different use.
Repair and maintenance that does not improve a unit of tangible property.
The costs of performing certain routine maintenance activities for property may result in an improvement to the unit of property, i.e., capitalized costs. However, a safe harbor allows routine repairs and maintenance to be expensed. This safe harbor applies to actions that maintain the asset and that are reasonably expected to be performed more than once for the asset’s class life under the alternative depreciation system.
Mr. A constructed a factory building costing $1,500,000 for use in his business. The construction started on January 2 of Year 1 and was completed and placed in service on July 1 of Year 2. During the construction period, Mr. A incurred and paid real property taxes of $10,000 attributable to the construction. Mr. A must
A. Capitalize the $10,000 as part of the land cost.
B. Amortize the $10,000 over a 10-year period starting in Year 2.
C. Capitalize the $10,000 as part of the building cost; recover the costs by claiming MACRS depreciation on the building.
D. Amortize the $10,000 over a 10-year period starting in Year 1.
Capitalize the $10,000 as part of the building cost; recover the costs by claiming MACRS depreciation on the building.
Section 263A requires production costs (direct and indirect) to be capitalized. Therefore, the construction-period taxes must be capitalized as part of the building cost.
Dianne’s Desserts, a sole proprietorship, bought a building for $350,000 cash in January. Settlement costs were $12,500. The business placed $15,000 in escrow for future payment on taxes and insurance and assumed an existing mortgage of $20,000 on the property. Legal fees of $7,500 were incurred for defending and perfecting title in a lawsuit that occurred during the same year. What is the adjusted basis of the building on December 31?
A. $405,000
B. $385,000
C. $390,000
D. $377,500
$390,000
The basis of the property purchased can include settlement fees and closing costs for purchasing the property. Some settlement fees and closing costs that are specifically included are abstract fees, legal fees, transfer taxes, and any amounts that the seller owes that you agree to pay. Settlement costs do not include amounts placed in escrow for the future payment of items, such as taxes and insurance (Publication 551, page 2). Thus, the adjusted basis of the building equals $390,000 ($350,000 cash paid + $12,500 in settlement costs + $7,500 in legal fees + $20,000 mortgage assumed).
Which of the following classes of property is (are) excepted from the uniform capitalization rules?
A. Qualified creative expenses incurred as a self-employed writer, photographer, or artist that are otherwise deductible.
B. All of the answers are correct.
C. Timber and certain ornamental trees raised, harvested, or grown, and the underlying land.
D. Intangible drilling and development costs of oil and gas or geothermal wells.
All of the answers are correct.
Uniform capitalization rules determine the costs and expenditures, including interest, that must be capitalized by a taxpayer. These uniform capitalization rules apply to all real and tangible personal property that is produced by a taxpayer and to all real or personal property that is acquired by a taxpayer for resale. The uniform capitalization rules do not apply to timber, to research and experimental costs, to intangible drilling costs, to mining exploration and development costs, to costs (other than circulation expenditures) subject to a 10-year amortization election made to minimize alternative minimum tax liability, or to the “qualified creative costs” of freelance artists, authors, and photographers.
On August 15 of the current year, Harold received 100 shares of stock as an inheritance from his mother, Mona, who died on January 20. Mona’s adjusted basis in the stock was $45,000. The stock had a fair market value of $50,000 on January 20. On July 20, its value was $65,000, and on the date Harold received it, its value was $48,000. The alternative valuation date was not selected. Harold’s basis in the inherited stock is
A. $48,000
B. $50,000
C. $45,000
D. $65,000
$50,000
The basis of property received from a decedent is generally the FMV of the property on the date of the decedent’s death [Sec. 1014(a)]. If the alternate valuation date for the estate tax return is elected by the executor, the basis of the assets is their FMV 6 months after death. Harold’s basis in the stock is the $50,000 FMV on January 20 (the date of Mona’s death).
On January 1 of the current year, Joe purchased new car wash equipment for use in his service station business. Joe’s costs in connection with the purchase were as follows: Cost of the equipment $43,000 Sales tax on the equipment $3,000 Delivery charges $800 Installation and testing charges $2,000 Current-year personal property taxes $1,100 What is the amount of Joe’s basis in the car wash equipment?
A. $48,800
B. $46,100
C. $45,800
D. $49,900
$48,800
Under Sec. 1012, the basis of property is the cost of the property. Sales tax paid in connection with the acquisition of property is treated as a cost of the property [Sec. 164(a)]. Delivery, installation, and testing charges are also included as part of the cost of the property. Basis is computed as follows: Purchase price $43,000 Sales tax $3,000 Delivery charges $800 Installation and testing charges $2,000 Basis in equipment $48,800
