cch federal taxation basic principles chapter 10 property transactions: determination of basis and...

CCH Federal TaxationBasic Principles

Chapter 10Property Transactions:

Determination of Basis and Gains and Losses

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CCH Federal Taxation Basic Principles 2 of 51

Chapter 10 Exhibits

1. General Rule for Any Type of Disposition

2. Seller's Amount Realized 3. Adjusted Basis 4. Cost of Improvements 5. Holding Period—General Rules 6. Lump-Sum Purchases of Several

Properties 7. Selling Taxable Stock Dividends 8. Selling Identical, Nontaxable Stock

Dividends 9. Selling Nonidentical, Nontaxable Stock

Dividends10. Selling Nontaxable Stock Rights Less

Than 15% FMV Original Stock

Chapter 10, Exhibit Contents

11. Selling Nontaxable Stock Rights 15% FMV Original Stock

12. Exercising Stock Rights—Tax Treatment for New Stock

13. Selling Gifts by Donees14. Selling Property by Related Parties15. Selling Personal-Use Conversions16. Selling Inherited Property17. Selling Common Stock18. Wash Sales—General Rules19. Wash Sales—Example


General Rule for Any Type of Disposition

Amount realized (i.e., fair market value of all consideration received)

– Adjusted basis of all consideration given

= Realized gain or loss (i.e., economic accession to or reduction of wealth)

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., seller’s “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

+ Amount of loan assumption (does NOT include new financing at original purchase date!)

_ 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 Improvements

Repair and Maintenance Deductions vs. Capital Expenditures

Tax Treatment

Repair and Maintenance 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



Holding Period—General Rules

Holding Period Beginning Date. The holding period of property usually begins on the DAY AFTER the acquisition date. Exceptions to the “Day After” Rule. With the six types of property below, holding period begins on the DAY OF acquisition, NOT the day after acquisition.

1. Gifts if basis is determined using FMV2. Nontaxable stock rights if basis is determined under the allocation method3. Taxable stock rights4. Short sales against the box with a tainted holding period 5. Conversions with conversion fees6. Taxable conversions

Chapter 10, Exhibit 5a


Holding Period Computation by Months. Generally, holding period is computed by calendar months and fractions thereof, rather than by days (IT 3985, CB 1949-2 51).

Example: A taxpayer buys an asset on December 2 and sells it on June 2 of the next year. Since the holding period begins on December 3, the day after acquisition, the asset is held for exactly 6 months (i.e., from December 3 to June 2). The actual number of days held, 182 days if the year is a nonleap year, is irrelevant. (L Anderson, TC Memo. 1974-49, aff’d on this point (CA-9) 1975.)


Chapter 10, Exhibit 5b


Examples Illustrating the General Rule for Computing Holding Period

Acquisition Date Sale Date

Holding Period

Actual Days Held

(Generally Irrelevant for Tax

Purposes)Holding Period

for Tax PurposesBeginning

Date Ending Date

Dec. 31, 2002

Jan. 31, 2003

Jan. 1, 2003

Jan. 31, 2003

31 1 mo. Short-term

Jan. 30, 2003

March 1, 2003

Jan. 31, 2003

March 1, 2003

30 1 mo., 1 day

Short-term

March 3, 2002

March 3, 2003

March 4, 2002

March 3, 2003

365 12 mos. Short-term

March 3, 2002

March 4, 2003

March 4, 2002

March 4, 2003

366 12 mos., 1 day

Long-term

Chapter 10, Exhibit 5c




Exceptions to Holding Period Computed by Months. Exceptions for when the holding period is computed in days, instead of months include:

Property tax allocations. (Also, recall that the buyer getsthe property tax allocation on the closing date.)

Interest computations on loans with maturities in days.Loan maturity is stated in the number of days not the number of months or years (e.g., interest on a 180-day loan is basedon the number of days held; interest on a 6-month loan or a2-year loan is based on the number of months held).

Chapter 10, Exhibit 5d


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 (FMV).

Upon sale. The basis of taxable stock dividends is their fair market value. Their holding period begins on the day AFTER receipt (i.e., consistent with the general rule for holding period).


Selling Taxable Stock Dividends—Example

SOLUTION:

March 31, 2003, receipt: the $4,000 stock dividend is taxable income

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

June 30, 2004, sale: $2,000 short-term capital gain

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

(The beginning holding period date is October 1, 2003, the DAY AFTER receipt of the stock dividend. A June 30, 2004, sale results in a short-term holding period.)

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, 2003. On September 30, 2003, the shareholder receives a 20% taxable common stock

dividend; the FMV is $20 per share. On June 30, 2004, 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)

(Holding period of original and new shares begins on DAY AFTER original acquisition.)


SOLUTION:March 31, 2003, receipt: The stock dividends are not taxable.June 30, 2004, sale: $4,000 long-term capital gain ($6,000 – $2,000). $2,000 basis of new shares = $10 per share x 200 new shares, where $10 per share = [$12,000 ÷ (1,000 old shares + 200 new shares)];

(The beginning holding period date is April 1, 2003, the DAY AFTER receipt of the original stock. A June 30, 2004, sale results in a long-term holding period.)

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, 2003.2. On September 30, 2003, the shareholder receives a 20% nontaxable common stock

dividend.3. On June 30, 2004, 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 (i.e., it begins on the DAY AFTER original acquisition). The holding period of the new preferred stock shares begins on the day after receipt.


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

FACTS:1. March 31, 2003: 1,000 shares of common stock are purchased for $12,000.2. September 30, 2003: a 10% preferred stock dividend is issued when the FMV of the common

stock and preferred stock shares is $16 and $80 respectively.3. June 30, 2004: the 1,000 common stock shares and 100 new preferred stock shares are sold for

$20 per share and $100 per share respectively.

Selling Nonidentical, Nontaxable Stock Dividends—Example



Selling Nonidentical, Nontaxable Stock Dividends—Example

SOLUTION:March 31, 2003, receipt: The stock dividends are not taxable.June 30, 2004, sale of common stock: $14,000 long-term capital gain$14,000 capital gain = ($20,000 sales price – $8,000 adjusted basis)$8,000 adjusted basis = $12,000 x [1,000 common stock shares x $16 per share] ÷ [$16,000 + (100 preferred stock shares x $80 per share)] Long-term holding period: The beginning holding period date is April 1, 2003, the DAY AFTER receipt of the original stock. A June 30, 2004, sale results in a long-term holding period. June 30, 2004, sale of preferred stock: $6,000 short-term capital gain$6,000 capital gain = $10,000 sales price – $4,000 adjusted basis)$4,000 adjusted basis = $12,000 x [100 preferred stock shares x $80 per share] ÷ [$16,000 + $8,000] Short-term holding period: The beginning holding period date is October 1, 2003, the DAY AFTER receipt of the preferred stock dividends. A June 30, 2004, sale results in a short-term holding period.



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 15%.

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


CCH Federal Taxation Basic Principles 20 of 51Chapter 10, Exhibit 10b

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

FACTS:1. On March 31, 2003, Frost purchased 100 common stock shares at $88 per share.2. On September 30, 2003, Frost received 100 nontaxable stock rights.3. Each common stock and stock right is worth $100 and $10 respectively on

June 30, 2003.4. One stock right enables Frost to purchase common stock share for $90.

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


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 April 1, 2003.

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.



Selling Nontaxable Stock Rights 15% FMV Original Stock—Example

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, 2004.

FACTS: On March 31, 2003, Frost purchased 100 common stock shares at $88 per share. On September 30, 2003, Frost received 100 nontaxable stock rights. Each common stock and stock right is worth $100 and $20 on September 30, 2003. One stock right enables Frost to purchase 1 common stock share for $90.



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 common stock 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 April 1, 2003 to June 30, 2004).

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” date of exercise

Begins “on” date of exercise

CCH Federal Taxation Basic Principles 26 of 51Chapter 10, Exhibit 12b

FACTS: On September 30, 2003, 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, 2004, the stock payer 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?

June 30, 2004, the date of exercise

June 30, 2004, 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


Selling Gifts by Donees

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.



Gift Tax. The gift tax can be described as an estate tax for the living. It is a transfer tax, not an income tax, and is computed using estate tax rates. For large gifts of cash or other property, the donor (NOT the donee) may be required to pay a gift tax and all or a portion of the gift tax may be added to the donee’s basis.



CCH Federal Taxation Basic Principles 29 of 51Chapter 10, Exhibit 13c

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)] ÷ FMV

at gift date

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)


CCH Federal Taxation Basic Principles 30 of 51Chapter 10, Exhibit 13d

Assumption 1: On December 31, 2005, donee sells the land for $32; the FMV on February 28, 2001, is $35.




FACTS:On June 30, 1984, the donor acquires land for $25.On February 28, 2001, the donor gifts the land to the donee.

Selling Gifts by Donees—Example


Selling Gifts by Donees—Example

Chapter 10, Exhibit 13e

SOLUTION:

Amount realized

Donee's basis for sale

Realized gain or loss

HP beginning date

Basis for depreciation

Assumption 1$32

$25

$7

7/1/84

$25

Assumption 2$24

$25 $25

($1) ($1)

7/1/84

$25

Assumption 3$20

$25 $22

($5) ($2)

2/28/01

$25

Assumption 4

$23

$25 $22 $25

($2) $1 $0

7/1/84

$25

(Note the similarity of gain/loss computations with related party transactions and personal-use conversions.)


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.



Definition of Related Parties. The following are considered related parties: Half-blood relatives (e.g., same mother but different father) Ancestral descendants (e.g., parent, grandparent, great-grandparent) Entities with common owners owning more than 50% of the entities Lineal descendants (e.g., child, grandchild, great-grandchild) Owner of more than 50% of a corporation is related to the corporation Spouse Siblings

(Note that aunts, uncles, and cousins are not included in the definition of related parties.)


Selling Property by Related Parties


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 and holding period 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.)



Selling Personal-Use Conversions

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

HP begins on day AFTER 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)


CCH Federal Taxation Basic Principles 36 of 51Chapter 10, Exhibit 15c

Assumption 1: On December 31, 2005, lawyer sells the house for $32; the FMV on February 28, 2001, is $35.




FACTS:On June 30, 1984, a lawyer buys a house for $30.On February 28, 2001, the lawyer converts the house to law offices.Accumulated depreciation from February 28, 2001, to the date of the sale is $5.

Personal-Use Conversions—Example


Personal-Use Conversions—Example SOLUTION:

Amount realized

Converter's basis for sale

Realized gain or loss

HP beginning date

Basis for depreciation

Assumption 1

$32

$25 (= $30 – $5)

$7

3/1/01

$30

Assumption 2

$24

$25 $25

($1) ($1)

3/1/01

$30

Assumption 3

$20

$25 $22

($5) ($2)

3/1/01

$22

Assumption 4

$23

$25 $22 $25

($2) $1 $0

3/1/01

$22

(Note the similarity of gain/loss computations with gift sales and related party transactions.)



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.



Selling Common Stock

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.)



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.)




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 AFTER the date of sale (i.e., a 61-day period.)



The following shares are NOT affected by the wash sale rules:

1. Gifts

2. Nontaxable stock dividends

3. Stock rights

4. Others not covered in this course: warrants, equity options, and Code Sec. 1256 contracts




Basis of new shares =

Cost of new shares

+

Postponed loss from wash sale of old shares




Holding period. The holding period of new shares begins on the DAY AFTER the date the sold shares were first acquired.




Wash Sales—Example

QUESTIONS:

(a) Is the December 10, 2003, sale a “wash sale”?

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

(c) Determine the basis of the December 20, 2003, shares.

(d) Determine when the holding period of the December 20, 2003, shares begins.

FACTS:

On January 1, 1999, 100 ABC shares are purchased for $200 per share.

On December 10, 2003, 50 ABC shares are sold for $160 per share.

On December 20, 2003, 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, 2003, 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, 2003)




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)




$1,400 [10 shares bought on December 20, 2003 x $140 cost per share]

+ 400 [Postponed loss on December 10, 2003 wash sale, computed

= $1,800 at (b)]

SOLUTION to (c):

Basis of December 20, 2003, shares: $1,800





Chapter 10, Exhibit 19e

What if 60 shares had been purchased on December 20, 2003?

a. 100% wash sale on December 10, 2003.

b. 100% of the ($2,000) realized loss would be postponed.

c. Basis in 50 new shares would be $9,000 [(50 x $140) + $2,000 postponed loss].

Basis in 10 new shares would be $1,400 [10 x $140].

d. Holding period of 50 new shares would begin on January 2, 1999 (i.e., holding period tacks on to holding period of original shares).

Holding period of 10 new shares would begin on December 21, 2003.

SOLUTION to (d):

Beginning holding period of the December 20, 2003 shares: January 2, 1999 (i.e., the holding period “tacks on” to the holding period of the original shares)

cch federal taxation basic principles chapter 10 property transactions: determination of basis and...

Documents

new stock

adjusted basis chapter

fmv original stock chapter

nontaxable stock dividends

common stock

adjusted basis cost

nontaxable stock rights

realized gain