2013 cch basic principles ch10

Chapter 10

Property Transactions: Determination of Basis and

Gains and Losses©2012 CCH. All Rights Reserved.

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CCH Federal Taxation Basic Principles 2 of 36

1. General Rule for Any Type of Disposition

2. Seller's Amount Realized

3. Adjusted Basis

4. Cost of Improvements

5. Lump-Sum Purchases of Several Properties

6. Selling Taxable Stock Dividends—Rules

7. Selling Taxable Stock Dividends—Example

8. Selling Identical, Nontaxable Stock Dividends—Rules

9. Selling Identical, Nontaxable Stock Dividends—Example

Chapter 10 Exhibits

Chapter 10, Exhibit Contents A


10. Selling Nonidentical, Nontaxable Stock Dividends—Rules

11. Selling Nontaxable Stock Rights Less Than 15% FMV Original Stock—Rules

12. Selling Nontaxable Stock Rights Less Than 15% FMV Original Stock—Example

13. Selling Nontaxable Stock Rights ≥ 15% FMV Original Stock

14. Selling Nontaxable Stock Rights ≥ 15% FMV Original Stock— Example

15. Exercising Stock Rights—Tax Treatment for New Stock

16. Exercising Stock Rights—Example

Chapter 10 Exhibits

Chapter 10, Exhibit Contents B


17. Selling Gifts by Donees

18. Selling Property by Related Parties

19. Selling Personal-Use Conversions

20. Selling Inherited Property

21. Selling Common Stock

22. Wash Sales—General Rules

23. Wash Sales—Example

Chapter 10 Exhibits

Chapter 10, Exhibit Contents C


General Rule for Any Type of Disposition

Amount realized

– Adjusted basis of all consideration given

= Realized gain or loss

Recognized (i.e., taxable) gain or loss

or Deferred (i.e., postponed) gain or loss

or Exempt (i.e., tax-free) gain or disallowed loss

Chapter 10, Exhibit 1


Seller's Amount Realized

Cash received

+ Fair market value (FMV) of property received

+ FMV of services received

+ Liabilities of seller assumed by buyer (i.e., “debt relief”)

– Selling expenses (includes brokerage, advertising, and legal fees paid by seller)

= Amount realized



Adjusted Basis

Cost (or other adjusted basis) on date of acquisition

+ Cost of improvements

+ Buying expenses, including commissions, legal, title search, surveys and appraisal fees paid at date of original purchase

_ Depreciation (allowable depreciation reduces basis, even if not taken)

– Insurance proceeds received on partial destruction casualties

– Deductible loss on partial destruction casualties

+ Capital gain on partial destruction casualties

= Adjusted basis



Cost of ImprovementsRepair and Maintenance Deductions vs. Capital Expenditures

Tax Treatment

Deductible Unless Personal Use Capitalized

Roofing Patching leaks Adding new roof

Wiring Mending Major replacement

Plumbing Replacing segments Replacing systems

Plastering Filling cracks Installation, renovation, and remodeling

Paving and resurfacing

Patching potholes Initial paving, major resurfacing

Fire damage Cleanup, removal, and temporary facilities Modernization incident to restoring former facilities

Land clearing Ordinary maintenance, bush-hogging Preparing building site for construction



Lump-Sum Purchases of Several Properties

General Rule. Allocate total cost according to the relative fair market value of each property.

FACTS: A buyer pays a seller a lump-sum amount of $800,000 for land tracts A, B, and C valued at $200,000, $300,000, and $500,000 respectively. ($1,000,000 is the total value of the three tracts.)

SOLUTION: A: $160,000 ($800,000 x [$200,000 $1,000,000]) B: $240,000 ($800,000 x [$300,000 $1,000,000]) C: $400,000 ($800,000 x [$500,000 $1,000,000])

Example

QUESTION: What is the buyer’s basis in the three tracts?



Selling Taxable Stock Dividends—Rules

Upon receipt. Stock dividends are taxable as ordinary income at their fair market value.

Upon sale. The basis of new shares of stock received in a taxable stock dividend is their fair market value on the date of receipt . The holding period begins on the day following the date of receipt of the stock dividend.



Selling Taxable Stock Dividends—Example

SOLUTION:

September 30, 2011, receipt: the $4,000 stock dividend is taxable income

$20 per share x (1,000 shares x 20%)

June 30, 2012, sale: $2,000 short-term capital gain

$6,000 sales proceeds – $4,000 basis of new shares

QUESTION: Determine the tax treatment for the receipt and sale of the stock dividends.

FACTS: 1,000 shares of common stock are purchased for $12,000 on March 31, 2011. On September 30, 2011, the shareholder receives a 20% taxable common stock dividend; the

FMV is $20 per share. On June 30, 2012, the 200 new dividend shares are sold for $30 per share.



Selling Identical, Nontaxable Stock Dividends—Rules

Upon receipt. Stock dividends are not taxable.

Upon sale. Allocate old basis over original and new shares using the following formula:

Basis per share = old basis / (number of original shares + number of new shares)

The holding period begins on the day following the date of the original acquisition.



SOLUTION:September 30, 2011, receipt: The stock dividends are not taxable.

June 30, 2012, sale results is a $4,000 long term capital gain. Amount realized = 200 shares x $30 = $6,000 Adjusted basis = 200 shares x $10 = $2,000

**Basis per share = [$12,000 ÷ (1,000 old shares + 200 new shares)] = $10

QUESTION: Determine the tax treatment for the receipt and sale of the stock dividends.

FACTS:1. 1,000 shares of common stock are purchased for $12,000 on March 31, 2011.2. On September 30, 2011, the shareholder receives a 20% nontaxable common stock dividend.3. On June 30, 2012, the 200 new dividend shares are sold for $30 per share.

Selling Identical, Nontaxable Stock Dividends—Example



Selling Nonidentical, Nontaxable Stock Dividends—Rules

Upon receipt. Stock dividends are not taxable.

Upon sale. Allocate the original common stock basis between the number of original common stock shares and the number of new preferred stock shares using relative FMVs as of the date of receipt.

The holding period of the original common stock does not change. The holding period of the new preferred stock shares includes the holding period of the original shares.



Selling Nontaxable Stock Rights Less Than 15% FMV Original Stock—Rules

Basis of the stock rights = 0, but the taxpayer may elect to special allocation rules as if greater than or equal to 15%.

Holding period of nontaxable stock rights is same as the holding period of the original stock.



QUESTIONS:Determine (a) the adjusted basis of the new stock rights and the original common stock shares; and (b) the holding period beginning date and the basis of the new stock rights and original common stock shares.

FACTS:1. On March 31, 2011, Frost purchased 100 common stock shares at $88 per share.2. On September 30, 2011, Frost received 100 nontaxable stock rights.3. Each common stock and stock right is worth $100 and $10 respectively on September

30, 2011.4. One stock right enables Frost to purchase common stock share for $90.

Selling Nontaxable Stock Rights Less Than 15% FMV Original Stock—Example

Chapter 10, Exhibit 12a


SOLUTION to (a):Adjusted basis of new stock rights: $0, since their value is < 15% FMV of common stock [100 stock rights x $10 FMV per share] < [15% x (100 common stock shares x $100 FMV per share)];Adjusted basis of original common stock shares: $8,800 (i.e., no change).

SOLUTION to (b):Holding period of the stock rights and original common stock shares begins on the day following March 31, 2011.

Chapter 10, Exhibit 12b

Selling Nontaxable Stock Rights Less Than 15% FMV Original Stock—Example


Selling Nontaxable Stock Rights 15% FMV Original Stock

Basis of stock rights =

original basis of common stock x FMV stock rights

(FMV stock rights + FMV of common stock)

Basis of common stock =

original basis of common stock x FMV of common stock

(FMV stock rights + FMV of common stock)

Holding period of nontaxable stock rights is same as the holding period of the original stock.



QUESTIONS: Determine (a) the adjusted basis of the new stock rights and the original common stock shares; and (b) the holding period of the new stock rights if sold on June 30, 2012.

FACTS: On March 31, 2011, Frost purchased 100 common stock shares at $88 per share. On September 30, 2011, Frost received 100 nontaxable stock rights. Each common stock and stock right is worth $100 and $20 on September 30, 2011. One stock right enables Frost to purchase 1 common stock share for $90.


Selling Nontaxable Stock Rights 15% FMV Original Stock—Example


SOLUTION to (a):

Basis of stock rights: $1,467 or $14.67 per stock right.

$1,467 = (100 common stock shares x $88 per share) x 100 stock rights x $20 per right

$2,000 + $10,000

SOLUTION to (b):

Basis of common stock: $7,333 or $73.33 per share of stock.

$7,333 = (100 shares x $88 per share) x 100 common stock shares x $100 per share

($2,000 + $10,000)

Holding period of nontaxable stock rights is long-term (i.e., from the day following March 31, 2011 to June 30, 2012).

Selling Nontaxable Stock Rights 15% FMV Original Stock—Example



Exercising Stock Rights—Tax Treatment for New Stock

New Stock Taxable Stock Rights Nontaxable Stock Rights

Basis FMV of rights

when received

+

Exercise price

Adjusted basis ofrights, if any

+

Exercise price

Beginning Holding Period

Begins on the day following date of exercise

Begins on the day following date of exercise



FACTS: On September 30, 2011, a taxpayer receives at no cost 100 stock rights valued at $3

per share. The stock rights enable the taxpayer to purchase common stock at $15 per share. On June 30, 2012, the taxpayer exchanges 100 stock rights plus the $1,500 exercise

price for 100 shares of common stock.

Exercising Stock Rights—Example

QUESTION: What is the tax treatment for the new stock if the stock rights are (a) taxable upon receipt; and (b) nontaxable on receipt?

The day following June 30, 2012, the date of exercise

The day following June 30, 2012, the date of exercise

Beginning Holding Period

$15 per share($0 cost of rights when received + $15 exercise price)

$18 per share($3 FMV of rights when received + $15 exercise price)

Basis

Nontaxable Stock RightsTaxable Stock RightsNew Stock



Gift Sales. When a donor gives a donee a gift, the value of the gift is excluded from the donee’s income. When the donee later sells the gift property to third party, special rules govern the determination of the donee’s basis for computing gain or loss.


Selling Gifts by Donees


Gift tax rule. When a donee assumes a donor's basis, the basis includes:

[Gift tax paid by donor x (FMV at gift date - Donor's basis at gift date)] taxable amount of the gift

Same HP for GAIN basis.For depreciation, use GAIN basis.“No gain or loss” basis

If donor's basis is used,

HP = donor's HP.

If FMV is used,

HP begins on gift date.

Lesser of: Donor's basis or FMV at gift date (but use GAIN

basis for depreciation.).

“Loss” basis

Same as donor's HP.Same as donor's AB. “Gain” basis

Donee's Holding Period (HP)Donee's Adjusted Basis (AB)

Selling Gifts by Donees



Selling Property by Related Parties

Related-party Sales. When a related party sells to a second related party at a loss, the related-party loss (but not the gain) is disallowed, regardless of the reasonableness of the amount.

When the second related party later sells the property to an unrelated third party, special rules govern the determination of the second related party’s gain or loss.



Selling Personal-Use Conversions

Personal-use Conversions. A “personal-use conversion” is a property that has changed in function from personal use to business or investment use (e.g., a principal residence converted into a rental house or into business offices).

Special rules must be applied to determine the basis of a personal-use conversion when it is sold. These rules are intended to prevent a taxpayer from converting a personal-use property that has declined in value, to business (or investment) use and then selling the property to recognize a business or capital loss. (Recall that personal-use losses are generally not deductible.)



* Accumulated depreciation is determined from the conversion date to the sale date.

HP begins on day of conversion.

For depreciation, use lesser of AB at conversion date or FMVat conversion date

“No gain or loss” basis


Lesser of AB at conversion date less accumulated

depreciation* or FMVat conversion date

“Loss” basis


AB at conversion date less accumulated depreciation (but use LOSS basis for depreciation.)

“Gain” basis

Holding Period (HP)Adjusted Basis (AB)


Selling Personal-Use Conversions


Selling Inherited Property

Heir's basis = “Step-up” or “step-down” basis using FMV of property as of either: 1. Date of death or

2. If elected by executor (not heir), the earlier of: a. 6 months after date of death or

b. Date received by heir if before 6 months. The FMV at the 6-month date may not be greater than the value at the date of death.



Selling Inherited Property

Holding period = ALWAYS long-term, even if held by heir for 1 day and then sold.

Special rule. If a donee wills “appreciated” property back to donor and dies within 1 year of receipt from donor, then the donor/heir's basis is the donee/decedent's BASIS as of the date of death (i.e., the original basis), NOT the FMV at date of death.



Three methods may be used to determine basis:

Specific identification may be used if the certificate numbers can be identified. (With this method, taxpayers may select specific shares based on FIFO, LIFO, highest basis, lowest basis, etc. Average cost is also available if the shares were bought and sold through a broker or agent.)


Selling Common Stock


First-In, First-Out may be used if specific shares cannot be identified. (However, average cost is also available if the shares were bought and sold through a broker or agent.)

Average cost may be used if the shares were bought and sold through a broker or agent. (Specific identification is also allowed if the shares are bought and sold through a broker or agent, provided that the certificate numbers can be identified.)

Selling Common Stock



Wash Sales—General Rules

Purpose. To prevent investors from avoiding taxes by selling at a loss, then buying back identical shares.

Definition. A wash sale is a sale of shares that:

Realizes a LOSS, and Where substantially IDENTICAL SHARES are

BOUGHT within 30 days BEFORE or AFTERthe date of sale (i.e., a 61-day period.)

Basis of new shares = Cost of new shares + Postponed loss from wash sale of old shares



Wash Sales—Example

QUESTIONS:

(a) Is the December 10, 2012, sale a “wash sale”?

(b) If so, how much loss is postponed? How much is recognized?

(c) Determine the basis of the December 20, 2012, shares.

(d) Determine when the holding period of the December 20, 2012, shares begins.

FACTS:

On January 1, 2008, 100 ABC shares are purchased for $200 per share.

On December 10, 2012, 50 ABC shares are sold for $160 per share.

On December 20, 2012, 10 ABC shares are purchased for $140 per share.



SOLUTION to (a):

Yes, this is a wash sale because two events occurred:

1. The December 10, 2012, sale resulted in a ($2,000) realized

loss: ($160 x 50 shares) – ($200 x 50 shares)

2. Identical shares were purchased within 30 days of the sale (i.e., the 10 ABC shares bought on December 20, 2012)




Only that portion of loss attributable to the wash sale is postponed as shown below:

Portion attributable to wash sale: ($400) postponed loss

[10 shares/50 shares x (2,000) = (400)]

Portion NOT attributable to wash sale: ($1,600) recognized loss

[40 shares/50 shares x (2,000) = (1,600)]

SOLUTION to (b):

Loss postponed: ($400); Loss recognized: ($1,600)

Chapter 10, Exhibit 23c



$1,400 [10 shares bought on December 20, 2012 x $140 cost per share]

+ 400 [Postponed loss on December 10, 2012 wash sale, computed

= $1,800 at (b)]

SOLUTION to (c):

Basis of December 20, 2012, shares: $1,800

SOLUTION to (d):

Beginning holding period of the December 20, 2012 shares: the day following January 1, 2008 (i.e., the holding period “tacks on” to the holding period of the original shares)

Chapter 10, Exhibit 23d


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2013 cch basic principles ch10