(Test 2) Chapter 7: Property transactions: basis, Gain and loss, and nontaxable exchanges.

Question 1

realized gain or loss

Answer 1

Gain or loss is the difference between the amount realized from the sale or other disposition of property and the property’s adjusted basis on the date of disposition.

Question 2

Realized gain

Answer 2

there is a realized gain if the amount realized exceeds the property’s adjusted basis.

Question 3

Realized loss

Answer 3

there is a realized loss if the amount realized does not exceed the property’s adjusted basis.

Question 4

Define sale or other disposition

Answer 4

defined broadly to include virtually any disposition of property (trade-ins, casualties, condemnations, thefts, bond retirements)

The key factor in determining whether a disposition has taken place is whether an identifiable event has occurred as opposed to a mere fluctuation in the value of a property..

Question 5

Amount realized

Answer 5

amount realized from the sale or other disposition of property is the sum of any money received plus the fair market value of other property received. (also, any real property taxes treated as imposed on the seller that are actually paid by the buyer.

includes any liabilities on the property disposed of. (even if the debt is non recourse and even if the amount of the debt is greater than the fair market value

Amount realized is net amount the tax payer received, directly or indirectly, in the form of cash or anything else of future value, from the disposition of property.

Question 6

Fair market value

Answer 6

FMV of property received in a sale or other disposition has been defined by the courts as the price at which the property will change hands between a willing seller and a willing buyer when neither is compelled to sell or buy. FMV is determined by considering the relevant factors in each case.

When the fair market value cannot be determined the call of the property received cannot be determined, the value of the property given up by the taxpayer may be used.

Selling expenses relating to the disposition are deducted.

Question 7

Adjusted basis

Answer 7

Adjusted basis of property disposed of is the property’s original basis adjusted to the sale or disposition.

Cost (or other adjusted basis) on the date of acquisition
+ capital additions
- capital recoveries
= adjusted basis on date if disposition

Question 8

Original basis

Answer 8

the cost or other basis of the property on the date the property is acquired by the taxpayer

Question 9

Capital additions

Answer 9

These increase the original basis of a property!

Include the cost of capital improvements and betterments made to the property by the taxpayer

Question 10

Recoveries of Capital

Answer 10

These decrease the original basis so that on the date of disposition, the adjusted basis reflects the unrecovered cost or other basis of the property.

Question 11

depreciation and cost recovery allowances (capital recovery)

Answer 11

The original basis of depreciable property is reduced by the annual depreciation charges (or cost recovery allowances) while the property is held by the taxpayer. the amount of depreciation that is subtracted from the original basis is the greater of the allowed or allowable depreciation calculated on an annual basis.

Question 12

Casualties and theft (capital recovery)

Answer 12

This may result in the reduction of the adjusted basis of property. The A.B is reduced by the amount of insurance proceeds received, however, the receipt of insurance proceeds may result in a recognized gain rather than a deductible loss. The gain increases the A.B of the property.

Question 13

Certain capital distributions (capital recovery)

Answer 13

a corporate distribution to a shareholder that is not taxable is treated as a return of capital, and it reduces, the basis of the shareholder’s stock in corporation. Once the basis of the stock is reduced to zero, the amount of any subsequent distribution is a capital gain if the stock in the hands of the shareholder is a capital asset.

Question 14

Amortizable bond premium (capital recovery)

Answer 14

the basis in a bond purchased at a premium is reduced by the amortizable portion of the bond premium.

Investors in taxable bonds may elect to amortize the bond premium. The amount of the amortized premium on taxable bonds is allowed as an interest deduction.

therefore, the election enables the taxpayer to take an annual interest deduction to offset ordinary income in exchange for a larger capital gain or smaller capital loss on the disposition of the bond ( due to the basis in reduction)

Question 15

Tax exempt bonds and amortization (capital recovery)

Answer 15

the premium on tax-exempt bonds must be amortized, and no interest deduction is permitted. The basis of tax-exempt bonds is reduced even though the amortization is not allowed as a deduction.

Question 16

Why aren’t amortization deductions permitted on tax exempt bonds?

Answer 16

Because the interest income is exempt from tax, and the amortization of the bond premium merely represents an adjustment of the effective amount of such income.

Question 17

Easements (capital recovery)

Answer 17

Easement: legal right to use another’s land for a special purpose

popular for a means of obtaining charitable contribution deductions and reducing the value of real estate for transfer tax purposes.

Likewise, scenic easements are used to reduce the value of land as assessed for ad valorem property tax purposes.

If the taxpayer does not retain any right to use of the land, all of the basis is assigned to the easement. However, if the use of the land is only partially restricted, an allocation of some of the basis to the easement is appropriate.

Question 18

Recognized gain

Answer 18

the amount of the realized gain that is included in the taxpayer’s gross income.

Question 19

Recognized loss

Answer 19

The amount of realized loss that is deductible for tax purposes.

Question 20

Recognized gain and loss general rule?

Answer 20

the entire amount of a realized gain or loss is recognized when it is realized.

Question 21

Nonrecognition of gain or loss

Answer 21

In certain cases, a realized gain or loss is not recognized upon the sale or other disposition of property.

(Ex: nontaxable exchanges, realized loss from the sale or exchange of property between certain related parties)

Question 22

Disposition of personal use assets (Nonrecognition of gain or loss)

Answer 22

A loss from the sale, exchange, or condemnation of such assets is not recognized for tax purposes. An exception exists for casualty or theft losses from personal-use assets

Any gain realized from the disposition of personal-use assets is generally taxable.

Question 23

Determination of cost basis

Answer 23

Basis is generally the property’s cost, which is the amount paid for the property in cash or other property.

Question 24

Recovery of capital doctrine

Answer 24

The cost or other basis of property is to be recovered tax free by the taxpayer.

Question 25

Bargin purchase and cost base

Answer 25

General exception to determining basis.

Transfer of property for less than the property’s fair market value. Transfer creates taxable income for the purchaser equal to the difference between fair market value and purchase price. The basis of property acquired is the fair market value, if basis not increased by the bargain element, the taxpayer would be taxed on this amount again at disposition.

Question 26

Identification problems with stock

Answer 26

if the taxpayer cannot identify the specific shares being sold, the stock is sold on the first-in, first-out basis.

The holding period and the cost of stock sold are determined by the purchase date and cost of the first lit of stock acquired.

Question 27

Adequate identification with stock

Answer 27

the basis and the holding period of the specific stock sold are used in determining the nature and the amount of the gain and loss.

Question 28

Allocation Problems

Answer 28

When a taxpayer acquires several assets in a lump-sum purchase, the total cost must be allocated among the individual assets.

Question 29

Why is allocation necessary?

Answer 29

1. some of the assets acquired may be depreciable (buildings), while others may not (land)
2. Only a Portion of the assets acquired may be sold
3. some of the assets may be capital or depreciable assets that receive special tax treatment upon subsequent sale or other disposition.

Question 30

Goodwill and allocation

Answer 30

1. Purchase price is assigned to the assets at total fair market value.
2. this amount is allocated among the assets on the basis of the individual assets acquired.
3. goodwill assigned to the residual amount in the purchase price.

Allocation is applicable to both the buyer and the seller

Question 31

nontaxable stock dividends and allocation

Answer 31

the allocation depends on whether the dividend is a common stock dividend on a common stock or a preferred stock dividend on common stock.

common on common: the cost of the original shares is allocated to the total shares owned after the dividend

Preferred stock on common: cost of the original common shares is allocated between the common and preferred shares on the basis of their relative fair market value.

Question 32

Gift basis

Answer 32

When a taxpayer receives property as a gift, there is no cost to the donee. thus, under the cost basis provision, the donee’s basis would be zero. With a zero basis, if the donee sold the property, the entire amount realized would be treated as a taxable gain. Instead the code assigns a basis to the property.

Question 33

Basis of property assigned to gifts

Answer 33

Depends on

1. Date of the gift
2. the basis of the property to the donor
3. the fair market value of the property
4. Amount of gift tax paid if any.

Question 34

FMV > Donor’s basis (Gift tax rule if no gift tax is paid)

Answer 34

fmv on date of gift > donor’s basis in the property=basis carries over to the new property (carryover basis and is used in determining the donee’s gain or loss)

Question 35

FMV

Answer 35

Basis cannot be determined until the donee disposes of the property.

determining the gain: the donor’s basis will carry over

determining loss: fair market value when the gift is made (prevents the donee from receiving a tax benefit from a decline in value that incurred while the donor held the property)

Question 36

FMV

Answer 36

No gain or loss

Question 37

Gift basis with gift tax

Answer 37

For gifts made before 1977, the full amount of the gift tax paid is added to the donor’s basis, with basis capped at the donor’s fair market value at the date of the gift

Question 38

Holding period (Gift)

Answer 38

Holding period for property acquired by gift begins on the date the donor acquired the property, unless the special circumstance requiring use of the property’s fair market value at the date of the gift applies. If so it starts on the date of the gift.

Question 39

Basis for depreciation (gift)

Answer 39

donee’s basis for determining gain

Question 40

Property acquired from a descendent (General rule)

Answer 40

Property’s fair market value at the date of death (primary valuation amount). The property’s basis is the fair market value six months after the date of death if the executor or administrator of the estate elects that alternative valuation date for estate tax purposes (alternative valuation amount)

Question 41

Who can use the alternative valuation amount (property form a descendant)

Answer 41

1. Estates for which an estate tax return must be filed (estates with a valuation in excess of 5.43 million in 2015)
2. If distributed before the alternative valuation date, you cannot use this
3. as a result of the election, both the value of the gross estate and the estate tax liability are lower than they would have been of the primary valuation date had been used.

Question 42

Holding period (property from a descendant)

Answer 42

deemed to be long term, regardless of gain or loss at disposal

Question 43

disallowed losses occur commonly in?

Answer 43

Transactions between related partied and wash sales

Question 44

related tax payers (disallowed loss)

Answer 44

Section 267 says that realized losses from sales or exchanges or property between certain related parties ( members of a family? individual and a corporation where one directly or indirectly owns 50% outstanding stock) are not recognized.

Question 45

Income producing property transferred to a related party

Answer 45

loss is disallowed, the basis of the property to the recipient is the property’s cost to the transferee.

gain, the amount of gain is reduced by the loss that was previously disallowed.

The right of offset is not applicable of the original sale involved the sale of a personal-use asset. Right of offset is available only to the original transferee

Question 46

Wash sales

Answer 46

if a taxpayer sells or exchanges stock or securities and within 30 days before or after the date of the sale or exchange acquires substantially identical stock or securities, any loss realized from the sale or exchange is not recognized because the transaction is a wash sale.
DOES NOT APPLY TO GAINS

Disallowed recognition of loss because you are considered to be in substantially the same economic position after the sales and repurchase.
Doesn’t apply to businesses in the business of buying and selling securities.

A realized loss that is not recognized is added to the basis of the substantially identical stock or securities whose acquisition resulted in the nonrecognition of loss

see page 7-15

Question 47

Conversion of property from personal use to business or income producing use

Answer 47

loss from sale of personal-use: not deductible
loss form sale of business and income-producing assets: deductible

the basis for determining loss on personal use assets converted to business or income-producing use is the lower of the property’s adjusted basis or its fair market value on the date of conversion.

The gain basis for converted property is the adjusted basis on the date of conversion, regardless of whether the property’s use is business, income producing, or personal in nature

Question 48

Basis for depreciating the converted property

Answer 48

same as the basis for determining loss

This is an exception to the general rule that the basis for depreciation is the basis for determining gain. This repents the taxpayer from recovering a personal loss indirectly through depreciation if the higher original basis.

Once property is converted, both its basis for loss and gain are adjusted for depreciation deductions from the date of conversion to the date of disposition.

Question 49

Constructive Ownership

Answer 49

stocked owned by certain relatives or related entities is deemed to be owned by the taxpayer for purposes of applying the loss and expense deduction dis-allowance provisions

Question 50

Right of Offset

Answer 50

equal to the disallowed loss between related parties.

When property is eventually sold, if at gain, the gain will be reduced by the right of offset.

cannot create or increase a loss