Basis Basics

Question 1

What is the fundamental rule of basis

Answer 1

Basis After Transaction = Basis Before Transaction +/- Recognized gain/loss

Question 2

What is the caveat to the fundamental rule of basis

Answer 2

It gives you the total basis but it does not tell you how that basis is allocated (that is a legislative decision)

Question 3

What is the difference in realization and recognition?

Answer 3

Realization occurs after a disposition that qualifies as a realization event
Recognition occurs when the gain/loss affects taxable income

Question 4

Where is the realization doctrine codified?

Answer 4

It’s not. It’s assumed in the 1001(a) definition of gain or loss

Question 5

What is a mark-to-market system

Answer 5

It kills there realization doctrine and forces taxpayers to realize gain/loss at regular intervals

Question 6

Does the receipt of a dividend affect the basis in the stock? What about total basis?

Answer 6

It does not affect the basis in the stock because basis = cost + recognized gain/loss. It does affect total basis because you now have a basis equal to the value of the cash (or property) received in the dividend. TOTAL BASIS INCREASES IF YOU RECOGNIZE INCOME (see fundamental rule of basis

Question 7

What is the consequence of a stock dividend?

Answer 7

Not considered a realization event, so no tax and no change in basis

Question 8

What is the computation for gain?

Answer 8

Amount realized - Adjusted Basis

Question 9

What is amount realized?

Answer 9

Money received + FMV of property received (form disregarded)

Question 10

What is the theoretical description of FMV for amount realized?

Answer 10

The price property would trade at between a willing buyer and seller when netter is under a compulsion and reasonably informed

Question 11

What is the practical way to find FMV of property for amount realized?

Answer 11

If parties bargain at arms length, you can assume that traded values are equal (US v Davis)

Question 12

How do you determine FMV if the parties did not bargain at arms length?

Answer 12

FMV is a question of fact, so you hire experts and make a case

Question 13

A sells B a car for $35K plus $2K sales tax. What is the FMV of the car?

Answer 13

$37K FMV because you can think of the sales tax as a commission expense paid by the seller. Amount realized is $35K because you can take out the selling expenses.

Question 14

How is FMV determined if two pieces of property are received in a disposition?

Answer 14

If the parties are at arms length, can trust them for an aggregate value but cannot trust them for allocating that value

Question 15

What are common ways to find basis?

Answer 15

Cost (1012) Gift (1015) Inheritance (1014)

Question 16

What are common adjustments to basis

Answer 16

Capitalized improvements to property Increase basis

Depreciation decreases basis

Question 17

Can you always deduct losses?

Answer 17

No - only if you can find a code provision that allows you to

Question 18

what is a non-recognition provision?

Answer 18

It allows taxpayer to realize gains but not recognize them. Failure to recognize means there is to change to basis, but that’s a good trade for deferral

(e.g. like kind exchange)

Question 19

What are the 3 steps to a non-recognition problem?

Answer 19

1) Gain/loss realized
2) Gain/loss recognized
3) Basis in new property

Question 20

What is an easy way to check your answer on a non-recognition problem?

Answer 20

The gain/loss deferred should equal the built in gain/loss on the property.
Gain realized - Gain recognized = Gain Deferred

Question 21

What are the 4 requirements for like kind exchange under 1031? How are they applied

Answer 21

1) Exchange of real estate for real estate
2) Taxpayer trades real estate for investment or for use in trade or business
3) Properties are of “like kind” (all us real estate is like kind)
4) Property traded by the tax payer cannot be held primarily for sale
(These are applied for each person so one half of the transaction can see the test while the other may not)

Question 22

Why does the 1031 like kind exchange rule exists?

Answer 22

It could be a pain to value the real estate in a trade so we can just wait and tax it later

Question 23

What are the terms for the property traded in a like kind exchange

Answer 23

Relinquished property = Property traded away

Replacement property = Property rec’d

Question 24

What is “boot” in a like kind exchange?

Answer 24

Any property that does not qualify under 1031(a)

Question 25

What is the effect of boot on a like-kind exchange

Answer 25

The gain recognized is capped at the value of the boot

Loss is not recognized if there is boot

Question 26

What is the effect on loss if there is boot in a like kind exchange?

Answer 26

The loss is not recognized

Question 27

What is the basis in the replacement property in a 1031 like kind exchange?

Answer 27

Where no boot is received, the basis in the replacement property is the same as the basis in the relinquished property

Where boot is received, the basis in replacement property = Basis in relinquished property - cash received + Gain Recognized - Loss recognized
Of course this only gives you the total basis for non-cash property received you will still need to allocate basis between property and non-cash boot

Question 28

How much value should be allocated to non-cash boot received in a 1031 like kind exchange?

Answer 28

1031(d) give the non-cash boot its FMV at the time of the exchange and then give the property what’s left over

Question 29

I just paid boot in a like kind exchange. How does that impact my gain?

Answer 29

You will reconceptualize into two transactions. One where you buy part of the property with the boot and the other with a pulse 1031(a) like kind exchange. If the boot is non-cash you may have a gain on the boot

Question 30

I just received boot in a like-kind exchange. How does that impact my gain?

Answer 30

Your gain recognized is capped at the value of the boot you received.

Question 31

What is the basis in replacement property in a like-kind exchange where there is no boot? if there is boot received?

Answer 31

If no boot, then basis in replacement property = basis in relinquished property

If boot, then TOTAL basis = basis in relinquished property - Value of cash boot + Gain recognized - Loss Recognized
If you received non-can boot then you will need to allocate this total basis. The non-cash boot gets the FMV at time of trade and the replacement property gets the remainder

Question 32

What is a deferred 3 party exchange? What are the steps?

Answer 32

When a buyer wants to buy land but the seller (taxpayer) doesn’t want to recognize a taxable gain (and is looking to buy different land in the future)
Step 1: Taxpayer deeds property to buyer. Buyer pays cash to qualified intermediary
Step 2: Seller deeds property to taxpayer and QI pays cash to seller

Question 33

What are the timing rules for deferred 3 party exchanged?

Answer 33

Replacement property must be identified within 45 days of the transfer of the relinquished property
Replacement property must be received but eh taxpayer by the earlier of (180 days post transfer of relinquished property and due date of transferor’s tax return that covers the transfer of the relinquished property)

Question 34

What is an involuntary conversion?

Answer 34

If real or personal property is involuntarily taken/lost/destroyed/condemned and taxpayer accepts some kind of compensation for the loss, then the taxpayer does not recognize any gain when they use the proceeds to buy replacement property

Question 35

What is the holding of cottage savings?

Answer 35

1001a implicitly establishes the realization doctrine when its says there is a gain on “sale or other disposition of property”

Commissioner interpreted 1001a as requiring the disposition to be for property that is ‘materially different’

Cottage savings read “materially different” as having distinct sets of legal entitlements (even if the obligations are economically identical)

Question 36

What are the implications of cottage savings for modifying debt instruments?

Answer 36

1001-3 If debt is significantly modified, there is an exchange and a realization event
If debt is not significantly modified there is no exchange and so realization event
What is a significant modification?
More than a deminimis change in interest rate or identify of party (from parent to sub)
More than a modification that occurs pursuant to the terms of the debt itself

Question 37

What was a better argument that SCOTUS could have used in arguing that an exchange of economically similar mortgages was a realization?

Answer 37

Since Congress chose not to include economically similar mortgages in 1031 like kind exchange, we should assume its taxable. If congress had wanted to make it not taxable, they would have included it in 1031