Chapter 5: Property Transactions Flashcards
Realized gain or loss
Based on amount realized from sale or exchange vs adjusted basis of property sold or exchanged
Must be an identifiable event, not merely a change in value
Property transfers potentially resulting in rain or loss
Sale
Exchange
Condemnation
Casualty
Theft
Bond retirements
Corporate distribution
(NO gain or loss on gift or bequest)
Return of capital
Anything considered return of capital will reduce basis
Amount realized from disposition of propert
Sum of money received
FMV of all other property received
Any debt assumed by buyer
FMV per IRS
The price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to sell
Treatment of selling expenses
Generally reduce the amount realized
Adjusted basis
Initial basis
+ Capital additions
- capital recoveries (depreciation deduction etc .)
= Adjusted basis
Initial basis
Generally cost paid for purchase
If acquired from a decedent, basis = FMV at date of death (or six months from date of death: alternate valuation)
Capital additions
Aka capital expenditures
Expenditures that add to the value of the property, prolong the life of the property, or adapt the property to a new/different use
Increase basis
NOT ordinary or necessary business expenses (like basic repairs)
Capital recoveries
Reduce the basis
- deductions for casualty losses
- cost recovery
- depreciation/amortization/depletion
- return of basis
- compensation or awards for involuntary conversion
- insurance reimbursement
- cash rebates received by purchaser
Recovery of basis doctrine
Taxpayers are allowed to recover the basis of an asset without tax (such amount considered return of capital)
Recognized gain or loss
Amount of gain or loss recognized on the tax return
May be different from realized gain or loss depending on tax provisions
Losses that are generally deductable
- if incurred carrying out trade or business
- incurred in an activity engaged in for profit
- casualty
- theft
Realized losses on sale or exchange of property held for personal use
Not recognize (not deductible) for tax purposes
Cost of acquired property
Amount paid for property including:
- cash
- FMV of property given in exchange
- costs of acquiring the property and preparing it for use
- funds borrowed and used to pay for property
- obligations to the seller assumed by the buyer
Uniform capitalization rules
Dictate which costs taxpayers must capitalize for all property used in trade, business, and activity engaged in for profit
(Taxes are included in capitalized costs and reduce the amount reali,Ed on disposition)
Capitalization of interest
Interest on debt paid or incurred during the production period to finance the construction/installation/development/manufacture of real or tangible personal property must be capitalized if:
- property has a long useful life (20+ years)
- production period exceeding 2 years
Or
- estimated production period exceeding 1 year with cost exceeding $1M
To hold stock in “street name”
Brokerage firm holds title of stock certificates and does not make physical transfer of the actual securities
When investors want to sell they must give brokers specific instruction as to which blocks to sell. Otherwise defaults to FIFO
Identification of stock being sold
If want to sell specific blocks of stock just identify specifically. Otherwise FIFO will be used
Identification of shares of mutual funds being sold
Owners may choose specific identification, FIFO, or average cost
Average cost method is widely used
Basis of property received as a gift
generally the same as the donor’s basis
If FMV > = donor’s basis then donee’s basis = donor’s basis for all purposes
If FMV < donor’s basis then donee has dual basis in the property
Dual basis in gift property
Occurs when FMV at time of gift < donor’s basis
Basis for loss: donee’s basis is property’s FMV at time of gift
Basis for gain: donee’s basis is donor’s basis
If property is sold for more than FMV but less than donor’s basis no gain or loss is recognized
Effect of gift tax on basis
May increase donee’s basis if the FMV excess the donor’s basis on the date of the gift
Calculation of gift tax to increase donee’s basis
(for taxable gifts after 1976)
= Gift tax paid x ((FMV at time of gift - donor’s basis) / amount of the gift)
Amount of gift = FMV of property gifted less annual exclusion (15,000 in 2021)
Essentially pro rata portion of gift tax attributable to appreciation in property unrealized by doner
Gifts of property that has declined in value below original cost
Due to tax law loss will never be recognized (donee’s basis will be FMV)
Basis for property received from decedent
Either FMV at date of death or at an alternate valuation date (AVD)
Different rules for decedents who died in 2010!
Alternative valuation date option
For value of property from a decedent
AVD generally six months after date of death
Makes basis for all assets of that estate their FMV on the AVD unless property distributed to heirs/sold before AVD (in which case basis is the FMV on date of disposal)
Estate tax
2021: taxed if gross estate plus any previous taxable gifts exceeds 11.7 million
Requirements for electing AVD
For property received from a decedent
- AVD may ONLY be used if the value of the gross estate and the amount of estate tax after credits are REDUCED as a result (so only if value of assets decrease after death)
- AVD may not be used if no estate tax is required
Effect of AVF on property
AVD changes basis for purpose of estate taxes but also for purpose of income taxes for the heirs
Carryover basis rule for 2010
Estate tax eliminated for 2010 and not reinstated retroactively till Dec 2010. Estates of individuals who died in 2010 may elect to use provisions for 2010 when estate tax did not apply.
If estate elects not to have estate tax apply:
Taxpayer inheriting property will take the LESSER of the decedent’s basis or FMV at time of death
But basis may be increased if asset is appreciated
May not be increased over FMV. Total increase limited to 1.3Million + any unused built -in loss or NOL carryover
Surviving spouse may receive 3million adjustment
Basis for decedent’s community property
- half the jointly held property is included in the estate
- basis to surviving spouse is FMV
- surviving spouse’s basis ALSO adjusted to FMV
Basis for decedent’s jointly owned property in common law state
Decedent’s Half of jointly owned property is included in decedent’s estate and adjusted to FMV. Survivors share is not adjusted
Determining basis when property is converted from personal to business use
Basis is LOWER of adjusted basis or FMV
This is the basis to be used in depreciation - any subsequent loss on sale or exchange is calculated by this basis less depreciation AFTER transferred to business use
No loss recognized if business basis lower than personal basis
Gain on sale of property converted from personal to business use
Use adjusted basis less depreciation taken after transfer to business use to calculate gain
Allocation of basis in basket purchase
When multiple assets are acquired in a single transaction and later sold/disposed of separately the cost of the original transaction must be apportioned between the assets based on their relative FMV (no allocation needed if disposed of as a lot)
Allocation of common costs for basket purchases
Any common costs incurred to obtain or prepare an asset for use must be capitalized and allocated to the basis of the individual assets
Allocating basis of nontaxable stock dividends received
A portion of the basis of the stock on which the stock dividend is received must be allocated to the new shares and the cost basis of the previously acquired shares reduced
Stock dividend of the same type of stock: basis allocated equally to all shares
Stock dividend of a different type of stock: basis allocated basked on relative FMV
Stock rights
Rights to acquire shares of a specified corporation’s stock at a specific exercise price when specific conditions are met
Basis of nontaxable stock rights
If FMV of stock rights received < 15% DMV of the stock = basis is 0
Unless taxpayer elects to allocate the basis between the stock rights and the stock owned BEFORE distribution of the rights (in which case basis of original stock owned is allocate between stock and stock rights based on FMV)
If FMV > 15% of FMV of stock the basis of the stock previously owned MUST be allocated between stock and stock rights
Basis of stock purchases via exercises stock rights
Amount paid PLUS any basis allocated to the stock rights
Stock rights allows to expire
No loss recognized and full basis reverts to original shares
Property that is NOT a capital asset
Inventory/property to be sold to customers or property subject to depreciation or accounts /notes receivable or supplies used or acquired in ordinary course of business
Us government publications held by taxpayers who received it by means other than stated purchase price or received as a gift
Property held by taxpayer that was created by the taxpayer’s personal efforts
Letter, memo, or similar held by taxpayer for whom property was prepared or produced
Hedging transactions clearly identified as a hedge
Capital assets
Often determined by use
Investments in property, land, financial instruments held for personal use
Also patents, franchises, self-created musical works sold or exchanged
Sale of futures contracts related to purchase of raw materials
Results in ordinary (not capital) gains and losses
- transactions about an integral part of business not about investing
BUT limited to hedging transactions that are an integral part of a taxpayer’s system of acquiring inventory
Gain or loss on securities held by security dealer
Generally ordinary income
If property is clearly identified as held for investment by the close of the day the security is acquired loss or gain is capital loss or gain (cannot be held for sale to customers)
If removed from investment account and held as inventory gains are ordinary gains and losses are capital losses
