Chapter 9Property Acquisitions
Howard Godfrey, Ph.D., CPAUNC Charlotte
Copyright © 2013, Dr. Howard GodfreyEdited August 14, 2013
Preview of Coming Attractions• Chapter 9 is the first of four
chapters dealing with property–Acquisition (Chapter 9)–Depreciation (Chapter 10)–Disposition (Chapter 11)–Special Issues (Chapter 12)
Acquisitions of Property. Basis of Gift PropertyIntroduction Gift Property BasisClasses of Property Split Basis-Loss PropertyProp. Investment Cycle Holding Period Adjusted Basis Inherited PropertyBasis in Conduit Entities Primary Valuation DateProperty Dispositions Alt. Valuation Date
Initial Basis Distribution DatePurchase of Assets Other ConsiderationsAmount Invested Prop. Converted to BusinessBargain Purchase General Rule for BasisBasket Purchase Split Basis RulePurchase of a Business Basis in SecuritiesConstructed Assets Stock Dividends
Special Acquisiton Wash Sale-Basisof Property. Summary
PROPERTY TRANSACTIONS
Acquisitions of Property
Classes of Property
Property Investment Cycle
Adjusted Basis
Basis in Conduit Entities
Property Dispositions
Tax Definition of PropertyThe term property refers to long-lived
assets owned by a taxpayer. The amount invested in an asset is the
property’s basis.
Under the capital recovery concept, a property’s basis may be recovered before any taxable income is realized from disposal of property.
Use of PropertyProperty is classified by both its use
and its type.
Property is used for 1. Trade or business,
2. Production of income (investment), or
3. Personal purposes
The same property may be used differently by different taxpayers
Types of Property• All property may be classified by type as
either tangible or intangible–Intangible property lacks physical
substance and has only an economic existence
–Tangible property has physical substance• Tangible real property (realty) consists of land
and structures permanently attached to land• Tangible personal property (personalty) is all
other tangible property
Property Investment CyclePropertyAcquisition
PropertyDisposition
Period of Use
InitialBasis
AdjustedBasis
plusadditional
capitalminus capital
recoveries
Basis of Property • Basis is the taxpayer’s unrecovered
investment in an asset that can be recovered without tax cost
• As the asset’s basis is recovered (through depreciation, depletion or amortization deductions), basis is reduced and is called adjusted basis
Acquisition in Taxable Exchange • Basis of acquired asset equals
the FMV of the property given up or FMV of the services performed
• Gain or loss is recognized as if cash had been exchanged for the property surrendered
Basis of Property • The original basis of an asset includes
–Cash plus fair market value of property given up by the buyer
–Money borrowed and used to pay for the property
–Liabilities of the seller assumed by the buyer
–Expenses of the purchase such as attorney fees or brokerage commissions
Capital Expenditures • The cost of a business asset with a
useful life extending beyond the current year may be:–Deducted currently–Capitalized until disposal or–Capitalized with the cost allocated
to the years the asset’s use benefits (cost recovery period)
Increases in BasisTwo categories of increases
Additional capital investments• Capital expenditures• Costs of defending ownership• Special assessments
Reinvestment of income from property• Taxable income from conduit entities
Decreases in Basis• Three broad categories of decreases
Annual tax deductions for cost recovery
• Depreciation, depletion or amortization
• Losses from conduit entitiesDisposition of all or part of the property Capital recovery due to income exclusion
What costs to capitalize – Best Co.Best Co. purchased a new machine with an invoice cost of $100,000. A 2% discount was received for early payment. Delivery charges were $500 for moving the machine to the factory owned by Best. The company paid $300 in wages to employees while installing the machine. What is the cost of this machine?a. $98,000 b. $100,000 c. $98,500 d. $98,800 e. $99,000
Invoice cost $100,000
Less: 2% - early payment (2,000)
Delivery charges 500
Wages for installation 300
Cost of asset $98,800
What Costs to Capitalize
Basis in Conduit Entities• Basis in a conduit entity is adjusted
yearly for items passed through to owners– Increased for additional capital invested,
taxable and nontaxable income, and owner’s share of entity liabilities
– Decreased for deductible or nondeductible expenses, cash or property distributed to the owner, and owner’s share of liability reductions
On 1-1-Yr-1, Ben invested $30,000 to become a 25% partner in a partnership that owns rental property. In Yr-1, the partnership had revenue of $90,000 and expenses of $60,000. No salary or guaranteed payment was made to any partner. Ben withdrew $4,000 from the partnership in Yr-1. What is Ben’s basis in his partnership interest at end of Yr-1?
Ben's Partnerhip Basis BasisInvestment in Partnership $30,000
Partnership revenue 90,000
Partnership expense 60,000
Partnership net income 30,000
Ownership
Ben's share of Income
Withdrawal
Ben's Ending basis
Ben's Partnerhip Basis BasisInvestment in Partnership $30,000
Partnership revenue 90,000
Partnership expense 60,000
Partnership net income 30,000
Ownership 25%
Ben's share of Income 7,500
Withdrawal (4,000)
Ben's Ending basis $33,500
Property DispositionsAmount Realized
minus: Adjusted Basis
RealizedGain
RealizedLoss
RecognizedGain
RecognizedLoss
Purchase of AssetsAmount InvestedBargain PurchaseBasket PurchasePurchase BusinessConstruct Assets
Initial BasisAmount invested =
Cash paid, + FMV of property or services given + Increases in liabilities related to the
purchase + Any cost incurred to get the asset
ready for its intended use
Basis in Bargain Purchase-1• The all-inclusive income concept
requires income recognition equal to the difference between an asset’s FMV and its sales price
• The asset’s basis = amount paid plus the amount of income recognized
Basis in Bargain Purchase-2Your employer purchased land a few
years ago for $30,000. Today it is worth $50,000. Your employer appreciates your fine work and sells the land to you for $45,000.
How much income do you recognize? What is your basis in the land?
Basis in Bargain Purchase-3How much income do you recognize?$5,000What is your basis in the land?$50,000
Multiple Asset Purchase • If more than one asset is acquired in a
single transaction, the cost is apportioned to each using their relative fair market values (FMV)–If the purchase price exceeds the value
of the assets, the excess is goodwill• Alternatively, the buyer and seller can
agree to a written allocation of the purchase price to individual assets
Company purchased for $540,000a building and land.
Appraised Seller's Value Original Cost
Land $200,000 $140,000Building 400,000 280,000 Total $600,000 $420,000
a. $140,000 b. $180,000 c. $200,000The land should be recorded at:
Lump-Sum Purchases
Company bought building & land for $540,000.
Appraised Value Percent
Land $200,000 33.33%Building 400,000 66.67%Total $600,000 100.00%
$540,000$180,000
Lump-Sum Purchases
Cost of landTotal amount paid
Purchase of Assets of a Business• Purchase price is allocated to
individual assets by their FMVs or through specific agreement
• Excess of purchase price over FMV of assets is considered Goodwill
• Purchase of corporate stock does not confer ownership of the business’ assets
Basis in Constructed AssetsBasis includes •Direct construction costs
–Actual costs of physical construction•Indirect construction costs
–General costs of the business that support the construction•For example: interest, taxes, equipment depreciation, general admin., etc.
Basis-Gift Property
Split Basis Rule
Holding Period
Donor paid gift tax
Basis of Asset Acquired by GiftOn the date of gift, compare FMV of property to the donor’s basis.If FMV > donor’s basis
–Basis in the property is the donor’s basis plus any gift tax paid on net appreciation
Basis of Asset Acquired by Gift (continued)If Donor’s basis > FMV• Basis is determined when property is
eventually sold–If sold for more than donor’s basis, use
donor’s basis (gain)–If sold for less than FMV, use FMV as
basis (loss)–If sold for an amount between the two,
use sales price as basis (no gain or loss)
Jan’s Basis in Gift Received Jan received a gift of stock valued at $10,000. The stock had an adjusted basis of $6,000 to the donor. No gift tax was paid on the transfer. Several months later, Jan sold the stock for $11,000. What is Jan's gain or (loss) on sale?
Basis of asset received as giftBasis to donor $6,000 FMV at date of gift $10,000 Basis for gain or lossSelling priceGain realized
Jan’s Basis in Gift Received
Basis of asset received as giftBasis to donor $6,000 FMV at date of gift 10,000 Basis for gain or loss 6,000 Selling price 11,000 Gain realized $5,000
Jan’s Basis in Gift Received
Dan’s Basis in Gift Received Dan received a gift of stock valued at $6,000. The stock had an adjusted basis of $10,000 to the donor. No gift tax was paid on the transfer. Several months later, Dan sold the stock for $5,000. What is Dan's gain or (loss) the sale?
Basis of asset received as giftBasis to donor $10,000 FMV at date of gift $6,000 Basis for lossSelling priceGain (loss) realized
Dan’s Basis in Gift Received
Basis of asset received as giftBasis to donor $10,000 FMV at date of gift 6,000 Basis for loss 6,000 Selling price 5,000 Gain (loss) realized ($1,000)
Dan’s Basis in Gift Received
Gift BasisGift received Facts Gain Loss
Basis to donor $11,000
FMV-date of gift $7,000
Selling price $8,000 $8,000
Basis for gain $11,000
Basis for loss $7,000
Gain (loss) realized $0 $0
Dual Basis
Holding Period for Asset Acquired by Gift
•If donor’s basis is used, holding period carry’s over and begins on the donor’s acquisition date
•If FMV is used, holding period begins on the date of gift
Acquisition by Gift Donee’s basis is the donor’s basis + portion of gift taxes due to appreciation (but total cannot exceed FMV at date of gift)Fraction for portion of gift tax:
FMV at gift date – Donor’s Basis FMV at gift date
Donor made gift with FMV of$100,000 and a cost of $60,000. Donor paid gift tax of $20,000.FMV at date of gift $100,000
Basis to donor $60,000
Appreciation $40,000 Percentage appreciationGift Tax paidGift tax added to basisBasis to donee
Donor made gift with FMV of$100,000 and a cost of $60,000. Donor paid gift tax of $20,000.FMV at date of gift $100,000 Basis to donor 60,000 Appreciation 40,000 Percentage appreciation 40%
Gift Tax paid $20,000 Gift tax added to basis $8,000 Basis to donee $68,000
Gift Basis – David -1Ted bought stock for $18,000 five years ago. David received a gift of stock from Ted this year when the stock was worth $24,000. Ted paid $2,000 of gift taxes on the gift. What is David’s basis for the stock?
Gift Basis – David -2$18,500. David uses Ted’s basis increased by a portion of the gift tax related to the appreciation on the gift determined as follows:$2,000 gift tax x [($24,000 -$18,000)/$24,000] = $500 gift tax related to appreciation.$18,000 carryover basis from donor + $500 gift tax
= $18,500.
Gift Basis – Ellen -1Ellen received a gift of stock from Gisela this year when the stock was worth $50,000. Gisela purchased the stock for $60,000 four years ago. Calculate Ellen’s basis for the stock if she sells it:a. for $65,000? b. for $45,000? c. for $55,000?
Gift Basis – Ellen -2a. $60,000. The donor’s basis is always used to determine a gain.b. $50,000. Fair market value (when it is lower than the donor’s basis) is used to determine basis for loss.c. $55,000. When the selling price is between the donor’s basis and the lower fair market value, there is no gain or loss. Effectively, basis equals the selling price.
Inherited PropertyValuation Date - Death
Alternate Valuation Date
Distribution Date
Planning Stragtegy
Acquisition by Inheritance • Use date-of-death Fair
Market Value as basis for inherited property (or alternate valuation date, if elected)
WillWill
Basis of Property Acquired by Inheritance
•Three dates are important –Primary valuation date is the date of
death–Alternate valuation date is six
months after the date of death–Distribution date is the date a
beneficiary receives the property
Basis of PropertyAcquired by Inheritance (continued)
•Basis is generally the FMV of the property on the primary valuation date•If the estate is valued on the alternate valuation date
– Basis is the FMV of the property on the earliest date received, either• Date of distribution, or• Alternate valuation date Holding period for inherited asset is long term
Cost of land to decedent. 5,000
Value of land-date of death. 8,000 Value - 6 mo. after death. 11,000 Heir's selling price of land. 15,000
Valuation date chosen DeathBasis for gain or lossSelling price
Gain or (Loss) for Heir
Inherited Property
Cost of land to decedent. 5,000 Value of land-date of death. 8,000 Value - 6 mo. after death. 11,000 Heir's selling price of land. 15,000
Valuation date chosen DeathBasis for gain or loss 8,000 Selling price 15,000
Gain or (Loss) for Heir 7,000
Inherited Property
Convert to Business
General Rule
Split Basis
Basis in Property Converted From Personal to Business Use
On the date of conversion, compare the asset’s personal-use basis to its FMV.If FMV > personal basis
–Personal basis is used for depreciation and gain or loss calculations
Basis in Property Converted From Personal to Business Use
If Personal basis > FMV– Use FMV for depreciation– Basis for sale is determined when the
property is sold• If sold for an amount > personal basis, use
personal basis: (gain)• If sold for amount < FMV, use FMV: (loss)• If sold for an amount between the two, no
gain or loss is recognized
Basis of Converted Property If the property is converted from
personal use to business use, the basis for depreciation is the lesser of the property’s FMV or adjusted basis at the date of conversion– This prevents taxpayers from
depreciating the portion of the property’s decline in value while it was used for personal purposes
Basis for Depreciation – Anne -1Anne purchased a condo unit for $125,000 last year. She used condo as a personal residence. In the current year, when the condo unit appraises at $132,000, Anne moves out and converts condo to rental property. What basis can Anne use when computing her depreciation on the rental condo unit?
Basis for Depreciation – Anne -2
$125,000. Anne uses the lower of her basis or FMV at the date the condo is converted from personal to rental property.
Adjusted basis of asset $40,000FMV of asset when converted 38,000 Deprecation taken 5,000 Selling Price 44,000
Basis for deprec. (loss basis)
Initial basis for gain
Depreciation taken
Adjusted basis for gain
Selling price
Gain on sale
Convert asset to businessor investment use.
Adjusted basis of asset $40,000FMV of asset when converted 38,000 Deprecation taken 5,000 Selling Price 44,000 Basis for depreciation $38,000Initial basis for gain 40,000Depreciation taken (5,000)Adjusted basis for gain 35,000Selling price 44,000Gain on sale $9,000
Convert asset to businessor investment use.
Basis - Stock
Stock Dividend
Wash Sale
Stock dividend – Common on Common
Taxpayer bought 1,000 shares of common stock for a total cost of $66,000. Taxpayer received a 10% stock dividend, payable in common shares.What is basis of common stock?
Cost of shares $66,000
Number of shares purchased 1,000
Cost per share
Shares received as Stock Div.
Revised total no. of shares
Revised basis per share
Stock Dividend on CommonPayable in Common shares
Cost of shares $66,000
Number of shares purchased 1,000
Cost per share $66
Shares received as Stock Div. 100
Revised total no. of shares 1,100
Revised basis per share $60
Stock Dividend on CommonPayable in Common shares
Stock Div – Preferred on Common
T/P bought 1,000 shares of Big Co. common stock at $100 per share. T/P received 100 shares of preferred stock as a dividend on the common stock.
What is basis of common and preferred stock?
Total
Cost of common shares (before dividend) $100,000
Common Pfd.
Shares owned before div. 1,000
Shares received as div. 100
FMV per share $250 $50
Total FMV $250,000 $5,000 $255,000
Common value (%)
Preferred value (%)
Cost allocated to Preferred
Cost allocated to Common
Stock dividend- Preferred on Common
Total
Cost of common shares (before dividend) $100,000
Common Pfd.
Shares owned before div. 1,000
Shares received as div. 100
FMV per share $250 $50
Total FMV $250,000 $5,000 $255,000
Common value (%) 98.04%
Preferred value (%) 1.96%
Cost allocated to Preferred $1,960.78
Cost allocated to Common $98,039.22
Stock dividend- Preferred on Common
Basis in Securities- Wash Sales•A wash sale occurs when a security sold at a loss is replaced with a substantially similar security +/- 30 days from the sale.
•Loss is not deductible under the substance-over-form doctrine•Nondeductible loss amount is added to the basis of the replacement security
Wash SaleOn 12-1-Yr-1, T/P buys 200 shares of BigCorp common stock, for $2,000. 12-23-Yr-2, T/P buys 200 shares for $1,800.12-28-Yr-2, T/P sells the first 200 shares for $1,700. 12-15-Yr-3, T/P sells the last 200 for $1,600.What is (are) the amount(s) and the year of recognition of losses that T/P can recognize?
No. Block-1 Block-2
Purchase Block 1 12-10-Yr-1 200 $2,000
Purchase Block 2 12-23-Yr-2 200 $1,800
Sell. Price Block 1 12-28-Yr-2 200 $1,700
Loss Block 1 12-28-Yr-2
Loss disallowed
Loss deducted
Basis Block 2
Sell. Price Block 2 12-15-Yr-3
Loss Block 2 12-15-Yr-3
Wash Sale - Stock
No. Block-1 Block-2
Purchase Block 1 12-10-Yr-1 200 $2,000
Purchase Block 2 12-23-Yr-2 200 $1,800
Sell. Price Block 1 12-28-Yr-2 200 $1,700
Loss Block 1 12-28-Yr-2 ($300)
Loss disallowed $300 $300
Loss deducted $0
Basis Block 2 $2,100
Sell. Price Block 2 12-15-Yr-3 $1,600
Loss Block 2 12-15-Yr-3 ($500)
Wash Sale - Stock
Gift and Estate PlanningMaude has asked you to give her advice on which asset to 1.Give away now, 2.Sell and give proceeds to charity3.Leave in will
See next slide
Cost FMVLot # 1 $2,000 $20,000 Lot # 2 $20,000 $20,000 Lot # 3 $70,000 $20,000
Maude - Slide 1 of 1Maude has large salary & capital gains.She has three lots. She wants to · give one lot to son, who will sell it & buy a home.· sell one lot & give the money to a charity· leave one lot to her daughter in her willThe property is as follows.
Lot # 1 Lot # 2 Lot # 3a. Give Sell Leave
to Son in willb. Sell Give Leave
to Son in willc. Leave Sell Give
in will to Sond. Leave Give Sell
in will to Son
Maude - Slide 2 of 2What is the best way to proceed?
For preceding slide:1. What do you know about basis
of gift property vs. inherited property.
2. What do you know about “loss” basis of gift property with a value higher than basis at time of gift, and vice versa?
For preceding slide:1. Would it be a good idea to give lot
no. 1 to the son who will soon sell it?2. Would it be a good idea to give lot
no. 3 to the son who will soon sell it?3. Would it be a good idea to give lot
no. 3 to charity (not an option presented in the problem)?
4. Would it be a good idea to leave lot no. 3 to daughter in the will?
5. Would it be a good idea to leave lot no. 1 to daughter in the will?
The End