Property Taxation

Question 1

For income tax purposes, how can property be categorized?

Answer 1

• How the property is held
  
  • Personal use, investment or production of income, or trade or business purposes

ALSO

• If it is a capital asset, an ordinary income asset, or a section 1231 asset

Question 2

Q1: What is a Capital Asset?

Q2: What is not a Capital Asset, as defined by Section 1221(a) of the IRC?

Answer 2

• A1: Most personal use and most investment assets
• A2:
  • Accounts and notes receivable
  • Copyrights and creative works (if held by the creator of such works)
  • Inventory
  • Depreciable property used in a trade or business

EXAM TIP: “All assets are capital assets except ACID

Question 3

Q1: What is an Ordinary Income Asset?

Q2: What are some specific assets included in this category?

Answer 3

• A1: Assets that, when sold, result in ordinary income to the owner of the asset
• Assets listed in Section 1221(a) that are not capital assets (ACID)
  • Inventory
  • Accounts receivable
  • creations in the hands of the creator
  • copyrights in the hands of the creator

Question 4

What are section 1231 assets?

Answer 4

1. assets used in a trade or business, AND
2. Either:
   
   1. Depreciable property, or
   2. Real property

Question 5

Which types of property are specifically included in section 1231?

Answer 5

• Timber
• Coal
• Iron Ore
• Certain Livestock, and
• Unharvested crops (under certain conditions)

Question 6

What assets are not included in section 1231?

Answer 6

• Inventory
• Property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or
• Copyrights or creative works

Question 7

• How can property be acquired?
• Does it matter?

Answer 7

• By purchase, gift, inheritance, or exchange
• The method of acquisition afects the adjusted taxable basis of the property

Question 8

What is included in cost basis?

Answer 8

• The amount of cash paid, debt obligations, other property or services, also includes:
  
  • Sales tax
  • Freight
  • Installation and testing
  • Excise taxes
  • Legal and accounting fees (when they must be capitalized)
  • Revenue stamps
  • Recording fees, and
  • Real estate taxes

Question 9

• What is the cost in a property acquired in a taxable exchange?
• What is the basis in a property acquired subject to a mortgage?
• What is the basis in a property acquired as a dividend in kind or as compensations for services?

Answer 9

• The Fair Market Value (FMV) of the property given in exchange
• The FMV of the property
• The FMV of the property at the time of acquisition

Question 10

What results in an increase to basis?

Answer 10

• Capital Improvements (home improvements)
• Assessments for local improvements (water connections, sidewalks, roads)
• The cost of restoring damaged property after a casualty loss
• Legal fees, including the cost of defending and perfecting a title to the property
• Zoning costs

Question 11

What results in an decrease to basis?

Answer 11

• Exclusions from income of subsidies for energy conservation measures
• Casualty or theft loss deductions and insurance reimbursements (business only)
• Deduction for clean-fuel vehicles and clean-fuel vehicle refueling property
• Section 179 deduction
• Credit for qualified electric vehicles
• Depreciation
• Nontaxable corporate distributions

Question 12

What is “boot”?

Answer 12

money or the fair market value of “other property” received by the taxpayer in an exchange.

Question 13

1. What is the adjusted taxable basis in the newly acquired property exchanged for equal value (no boot paid)?
2. Property exchanged for a more valuable asset (boot paid)?
3. Property exchanged for a less valuable asset (boot received)?

Answer 13

1. Newly acquired property will have a carryover basis
2. Newly acquired property will have a carryover basis PLUS any boot paid
3. Newly acquired property will have a carryover basis REDUCED any boot received that was greater than the gain

Question 14

What is the holding period for the basis on inherited property?

Answer 14

• The holding period for capital gains is always long-term for inherited property

Question 15

What is the general rule related to the basis in gifted property?

Answer 15

• General Rule: The donee’s basis in the gifted property is THE SAME as the donor’s basis in the gifted property.

Question 16

What is the first exception to the general rule on gifted property?

Answer 16

• Exception #1, when FMV of gifted asset is LESS than donor’s basis (loss property)Double Basis Rule applies:
  
  • For gains only, basis of donor is the adjusted basis of donee
  • For losses only, basis of donee is the FMV of the property on the date of the gift
  • If asset later sold by donee and amount realized is BETWEEN FMV at the time of the gift and the adjusted basis of the donor, no gain or loss is realized

Question 17

What is the second exception to the general rule on gifted property?

Answer 17

• Exception #2, when gift tax has been paid and the asset has appreciated in the hands of the donor, the portion of the tax which is associated with the appreciation is added to the donor’s basis to determine the donee’s basis
  
  • FORMULA: Donee’s Basis = Donor’s Basis + (Net Appreciation in Value of Gift / Value of Taxable Gift) X Gift tax paid
• Determining Loss on the Sale of Gifted Property
  
  • Basis of the property in the hands of the donee is the lower of:
    
    • Donor’s basis, or
    • FMV of property at the time of the gift
• Holding Period for Gifted Property
  
  • General Rule: includes the holding period of the donor, in the hands of donee
  • If double basis asset is sold for a loss, then the holding period for donee starts on the date of the gift

Question 18

Describe Basis of property transferred between spouse indident to divorce:

Answer 18

• Treated the same as gifts; carryover basis applies
  
  • no gain/loss recognized on transfer between spouses, or between former spouses incident to divorce
    
    • incident to divorce: within one year of the date on which the marriage legally ended and is related to the cessation of the marriage

Question 19

What is the Related Party Transactions (section 267) Rule?

Answer 19

• sale to a related party
  
  • only affects transactions where there is a loss
  • Transferor’s loss is forever lost, transferee takes asset with double basis rule
    
    • FMV for losses, transferor’s basis for gains
    • Holding period always begins at the date of the sale

Question 20

Describe Bargain Sales to Charity:

Answer 20

• If taxpayer sells property to a charity for less than FMV, the basis of the property must be allocated between the portion of the property sold and the portion given to charity
  
  • FORMULA: Basis for Sale Purposes = Amount Realized / FMV X Basis of Property

Question 21

Who does the 3.8% Medicare contribution tax apply to?

Answer 21

• Taxpayers with AGI over $200k (single) or $250k (MFJ) to the extent the AGI exceeds the threshold

Question 22

What are two exceptions to the capital gains tax rate?

Answer 22

1. Collectibles - taxed at 28%
2. Unrecaptured Section 1250 gain (equal to straight line deduction), taxed at 25%
3. Qualifying Small Business Stock (QSBS, Section 1202) - for which a percentage gain is taxed at 28% if the holding period is at least 5 years. Legislation has changed the percentage of the gain that you can exclude based on when you PURCHASED the stock, amount you can exclude:
   
   1. 50% if QSBS acquired before 2/18/2009
   2. 75% 2/17/2009 - 9/28/2010
   3. 100% after 9/27/2010 (made permanent by PATH 2015)

Question 23

How is holding period calculated for capital gains?

Answer 23

• the day of disposition is included in holding period, but the day of acquisition is not