M-1 - Basis and Holding Periods of Assets

Question 1

What is included in the cost of property?

Answer 1

Property includes all amounts to purchase the property, prepare the property for use, and place the property into service. Examples include: shipping costs, installation costs, sales tax, and testing costs.

Question 2

What is the difference between Real Property and Personal Property?

Answer 2

Real Property are things that are fixed to land and cannot be moved (ex: building). Personal property can be moved and is not real property, ex a car.

Question 3

What is basis called after depreciation expense is taken out of the basis?

Answer 3

Adjusted basis or Net Book Value

Question 4

When you receive property as a payment, what is the taxable income and basis recorded at?

Answer 4

When you receive payment in property and it is taxable, BOTH the basis and the taxable income, is recorded at Fair Market Value.

Question 5

What if you get property as a payment and it is not taxable? What is the properties taxable income and basis recorded at?

Answer 5

Property has no taxable income, and the properties basis is recorded at Net Book Value (NBV).

Question 6

What is an example of a non taxable property that was gotten as payment?

Answer 6

Like Kind Exchanges

Question 7

What are basis spreading adjustments?

Answer 7

This is when a shareholder gets paid out a nontaxable stock dividend or stock split and has to allocate the basis based on the new shares. For example, a shareholder has 200 shares at 10 per share. The shareholder got 10% nontaxable stock dividend, so now they own 220 shares. The basis was 200*10 = 2000 but they now have to allocate the 2000 among 220 shares. That means the new basis per share is 2000/220 = 9.09. That is how basis spreading works.

Question 8

What is the difference between the donee and the donor?

Answer 8

Donee gets the gift while the donor gives the gift.

Question 9

Does the donee have to pay tax on the gift?

Answer 9

No, never!

Question 10

Does the donor have to pay tax on the gift?

Answer 10

Possibly, depends how big the gift is

Question 11

What is the general rule (most of the time), on what the donee’s tax basis is on the gifted property?

Answer 11

The donee’s tax basis will be what the donor’s tax basis was on the property, and this basis is measured at Net Book Value (NBV). This is called the rollover rule, and we can figure if they had a gain or loss on sale.

Question 12

What is the exception to the general rule of deterring the tax basis on gifted property?

Answer 12

When the FMV at the date of the gift, is less than the donor’s NBV. Then the basis of the property depends on the donee’s future sales price of the asset. We do not know the basis of the asset until they sell it.

Question 13

When determining the basis of gifted property, was is the first scenario where the exception of the general rule may kick in?

Answer 13

When the FMV at the date of the gift is less than the donor’s NBV, the exception to the general rule kicks in. The firs scenario is when the sales price is greater than the NBV, we will still use the NBV as the basis. For example, if the FMV is 3,000, NBV is 5,000, and the sales price is 6,500, then the basis will be the NBV 6,500-5,000 = 1,500 gain.

Question 14

When determining the basis of gifted property, was is the second scenario where the exception of the general rule may kick in?

Answer 14

When the FMV at the date of the gift is less than the donor’s NBV, the exception to the general rule kicks in. The second scenario is when the sales price is less than the FMV, we will still use the FMV as the basis. For example, if the FMV is 3,000, NBV is 5,000, and the sales price is 1,000, then the basis will be the FMV 1,000-3,000 = 2,000 loss.

Question 15

When determining the basis of gifted property, was is the third scenario where the exception of the general rule may kick in?

Answer 15

When the FMV at the date of the gift is less than the donor’s NBV, the exception to the general rule kicks in. The third scenario is when the sales price is between the NBV and FMV, then the selling price is our basis and no gain is recognized. For example, if the FMV is 3,000, NBV is 5,000, and the sales price is 3,500, then the basis will be the selling price 3,500-3,500 = no gain/loss.

Question 16

What is the depreciation basis for gifted property?

Answer 16

If you have property gifted and you are going to depreciate it, you pick the lessor of the NBV or the FMV, to depreciate the gifted property.

Question 17

What is the general rule for the holding period of gifted property? (Holding period is used to determine if the property is short term or long term).

Answer 17

The general rule is, the recipient of the gift gets to absorb the donor’s holding period in the asset. Example, if the donor held it for 5 years and gifted it, the donee’s holding basis is five years.

Question 18

What is the exception to the general rule for holding period of a gifted property in scenario number 1?

Answer 18

When the donee sells the gifted property for more than the NBV, the donee will still use the donor’s holding period.

Question 19

What is the exception to the general rule for holding period of a gifted property in scenario number 2?

Answer 19

This is when the sales price is sold for less than the FMV. A loss will be recognized and the holding period begins at the date of the gift. Donee cannot use the donor’s holding period.

Question 20

What is the exception to the general rule for holding period of a gifted property in scenario number 3?

Answer 20

This is when the sales price is between the NBV and the FMV. The holding period is not relevant, no gain or loss is recognized.

Question 21

What is the general rule for a properties basis that was inherited?

Answer 21

The general rule is, when property is inherited, the basis will be the FMV at the date of the death. This is called a step up basis or step down basis.

Question 22

What is the Alternate Valuation Date (AVD)?

Answer 22

When you inherit property, usually the basis of the property is the FMV at date of death, unless you do the AVD method. The AVD method, the basis of the asset is the FMV at the earlier of 1.) distribution of the asset, 2.) six months after the date of death. This is a rule people sometimes use since the FMV increases and that would reduce your gain.

Question 23

What is the holding period of inherited property?

Answer 23

All inherited property is treated as long term, regardless of when the person who passed purchased it. This means the person who inherited it, can sell it whenever they want at capital gain rates.

Question 24

What is the general rule (with exceptions) to capitalizing property?

Answer 24

If it has a useful of more than one year, we normally capitalize it.

Question 25

Are improvements capitalized what about repairs and maintenance?

Answer 25

Improvements are capitalized, but repairs and maintenance are not, you can expense them.

Question 26

What is De Minimis Safe Harbor Rule?

Answer 26

This is a business policy that allows business to deduct purchases if they are under a certain amount. If they have audited financial statements, they can deduct up to $5,000 of the cost of an asset. If they do not have audited financial statements, they can deduct up to 2,500. If the amount is above this threshold, they have to capitalize the whole amount.

Question 27

What are the two types of basis for converting personal property to business use property?

Answer 27

Tax basis for deprecation and tax basis for calculating a gain or loss if the property is sold.

Question 28

How is tax basis for depreciation calculated when converting personal property to business use?

Answer 28

Tax basis for depreciation is calculated based on the lessor of the two values below:

1.) The original cost; adjusted for any improvements to the property; or
2.) The FMV at the date of conversion from personal to business use.

Question 29

How is the tax basis for the gain or loss calculated for converting personal property to business use?

Answer 29

To figure out what the tax basis of the property is depends on whether the property is sold at either a gain or a loss. The gain or loss is calculated by taking the adjusted basis (original cost basis - depreciation), minus the sale price.

1.) If it is a gain, the tax basis is the adjusted basis of the property at the date of the sale.

2.) If it is a loss, then you take the lesser of the two numbers at the time of conversion to business use:
*Adjust cost basis; or
* FMV of the property
* Then reduce the lesser amount by an depreciation deductions taken after the conversion to business use.

Question 30

What is generally the initial tax basis of intangible assets?

Answer 30

Normally the tax basis for intangibles is the cost or purchase price, and it is reduced by amortization (just like depreciation).

Question 31

What is Section 197 Intangibles?

Answer 31

This is when someone purchases intangible’s from someone else rather than developing the intangible on their own. Like buying a patent from another company. Includes: Goodwill, going-concern value, covenant not complete, and more.

Question 32

How does research and development work for patents?

Answer 32

When you have research and development costs for developing a patent, all those costs must be capitalized and amortized.

Question 33

How is the basis for patents and copyrights determined?

Answer 33

Two ways, one if it is purchased and one if it is developed:

1.) If it is purchased, then the purchase price is the basis of the patent.

2.) If it was built yourself, then the costs of development, legal costs, and government fees are all included in the basis.

If R&D costs are not immediately expensed, the costs can be used in the basis.

Question 34

Can loan costs be capitalized as an intangible?

Answer 34

Yes, they can be capitalized and amortized just like any other intangible.

Question 35

What are the rules for deducting organizational and business costs?

Answer 35

If you have organizational and business costs, you can deduct the first $5,000 of expenses for both business and organizational costs. Anything after those 5,000, must be capitalized and amortized over 15 years, or 180 months. There are some rules to this:

If your organizational or business costs exceed 50,000, the 5000 deduction gets phased out dollar for dollar, based on how much your costs exceed 50,000. So for example, if you have 52,000 in business costs, you can only deduct 3,000 in business costs, since it was phased out 5000-2000.

Question 36

What qualifies as organizational costs?

Answer 36

Legal fees, accounting fees, filing fees, and costs of organizational meetings. These normally are costs for forming an organization such as a partnership or corporation.

NOTE: Any cost associated with adding equity, costs to issuing or selling stock, transferring assets to the company, these are not organizational costs.

Question 37

What are some start up costs?

Answer 37

Investigation of protentional markets, marketing and advertising, costs to secure distributors, hiring workers and training, facility set up costs. All of these qualify.

Question 38

What are some examples of not equity securities?

Answer 38

Preferred stock redeemable at the option of the investor

Treasury stock

Convertible bonds

Question 39

What are equity securities normally valued at?

Answer 39

Normally at market to market fair value or better called trading securities like we have covered .

All realized, unrealized, dividends, all go on the income statement.

Question 40

What is the practicability exception?

Answer 40

This is where an entity is private so you cannot market to market value the security.

Instead it is valued at cost less impairment, plus/minus observable price changes.

Question 41

What is the journal entry for unrealized holding gains and losses for equity securities under the fair value through net income method?

Answer 41

DR: Unrealized loss on equity securities

CR: Valuation account (fair value adjustment)

All goes on the income statement

Question 42

Dividend income from an equity security is recognized in net income, except in which situations?

Answer 42

Liquidating dividend

Stock dividend

Common equity for using the equity method (investor has significant influence)

Question 43

What is the normal journal entry to record dividend income

Answer 43

DR cash

CR Dividend Income

Question 44

What is a liquidating dividend?

Answer 44

That is when a distribution exceeds investors share of the investees retained earnings.

This would not be income, instead reduces the basis in the investors investment.

DR Cash

CR Investment in investee

Question 45

For equity securities, when do we care about impairment?

Answer 45

We care about it for both when it is recorded at fair value, and when it is recorded at cost, but here how it is treated for both.

Fair value (public) - You record it market to market, so you record the impairment anyway. You record any losses at year end depending on what the fair value is at year end.

Cost Method (private) - When an impairment is noticed, you have to book the loss right away. This loss will reduce the carrying value of your security, so it reflects the actual value of the security.

Question 46

When you sell an asset at the fair value through the P&L, what is the formula and the journal entry?

Answer 46

Gain (loss) = Selling price - Carrying value

DR Cash

CR Equity Security