Essentials of taxation 2016 cengage chapter 07

Chapter Property Transactions: Basis, Gain and Loss, and Nontaxable Exchanges Essentials of Taxation © 2016 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part The Big Picture (slide of 5) • Alice owns land that she received from her father 10 years ago as a gift • The land was purchased by her father in 1992 for $2,000 and was worth $10,000 at the time of the gift – Alice’s father did not owe gift taxes upon making the transfer • The property is currently worth about $50,000 • Alice is considering selling the land and purchasing a piece of undeveloped property in the mountains The Big Picture (slide of 5) • Alice also owns 500 shares of AppleCo stock – 300 of which were acquired as an inheritance when her grandfather died in 1996 • Alice’s grandfather paid $12,000 for the shares, and • The shares were worth $30,000 at the time of his death – The other 200 shares of AppleCo were purchased by Alice two months ago for $28,000 • The stock is currently worth $120 per share, and Alice is considering selling the shares The Big Picture (slide of 5) • Alice owns a house that she inherited from her grandmother years ago • A developer has recently offered Alice $600,000 for the property – The fair market value of the house at the date of her grandmother’s death was $475,000 – Her grandmother’s basis for the house was $275,000 • Alice is considering selling the house – She expects any selling expenses to be minimal, The Big Picture (slide of 5) • The building Alice used in her business, adjusted basis of $50,000, was destroyed by a fire on October 5, 2015 – On November 17, 2015 she receives an insurance reimbursement of $100,000 for the loss – Alice intends to invest $80,000 of the insurance proceeds in a new building and use the other $20,000 to pay off credit card debt The Big Picture (slide of 5) • Alice has come to you for tax advice with respect to the property she owns – What is the recognized gain or loss for the land, stock, and house if they are sold? – Can Alice avoid paying taxes on any of the sales? • Alice’s objectives are to minimize the recognition of any realized gain and to maximize the recognition of any realized loss • Read the chapter and formulate your response Determination of Gain or Loss (slide of 7) • Realized gain or loss – Difference between amount realized from sale or other disposition of the asset and its adjusted basis – Sale or other disposition • Includes trade-ins, casualties, condemnations, thefts, bond retirements Determination of Gain or Loss (slide of 7) • Amount realized from disposition – Total consideration received, including cash, FMV of property received, mortgages/loans transferred to buyer • Fair market value (FMV): Value of asset determined by arms-length transaction, i.e., amount set by transaction between willing buyer and seller with neither obligated to enter into transaction – Reduced by any selling expenses Determination of Gain or Loss (slide of 7) • Adjusted basis – Original cost (or other adjusted basis) plus capital additions less capital recoveries Determination of Gain or Loss (slide of 7) • Capital additions – Cost of improvements and betterments to the property that are capital in nature and not currently deductible 10 The Big Picture - Example 38 Involuntary Conversion • Assume the same facts as in the previous example, except that Alice receives only $45,000 of insurance proceeds – She has a realized and recognized loss of $5,000 – The basis of the new building is the building’s cost of $80,000 70 Other Nonrecognition Provisions (slide of 7) • Several additional nonrecognition provisions are available: – Under § 351, taxpayers can transfer assets to corporations in exchange for stock without recognizing gain or loss – A similar provision (§ 721) allows the nontaxable transfer of assets to a partnership in exchange for a partnership interest 71 Other Nonrecognition Provisions (slide of 7) Under Đ1032, a corporation does not recognize gain or loss on the receipt of money or other property in exchange for its stock (including treasury stock) 72 Other Nonrecognition Provisions (slide of 7) • Under §1035, no gain or loss is recognized from the exchange of certain insurance contracts or policies 73 Other Nonrecognition Provisions (slide of 7) Under Đ1036, a shareholder does not recognize gain or loss on the exchange of common stock for common stock or preferred stock for preferred stock in same corporation 74 Other Nonrecognition Provisions (slide of 7) Under Đ1044, if the amount realized from the sale of publicly traded securities is reinvested in common stock or a partnership interest of a specialized small business investment company, realized gain is not recognized – Amounts not reinvested will trigger recognition of gain to extent of deficiency – Statutory limits are imposed on the amount of gain qualified for this treatment – Only individuals and C corporations qualify 75 Other Nonrecognition Provisions (slide of 7) • §121 provides for exclusion of up to $250,000 of gain on the sale of a principal residence ($500,000 on joint return) • Taxpayer must own and use as principal residence for at least years during the year period ending on date of sale 76 Other Nonrecognition Provisions (slide of 7) Under Đ1041, transfers of property between spouses or former spouses incident to divorce are nontaxable 77 Refocus On The Big Picture (slide of 6) • Alice’s basis in the land acquired as a gift is a carryover basis of $2,000 – If Alice sells the land outright, she will realize and recognize a gain of $48,000 • However, if she replaces the property with other real property, she should be able to qualify for favorable like-kind exchange treatment under § 1031 and defer the gain on the property disposition – However, if Alice receives any cash from the exchange, realized gain would be recognized to the extent of the cash (boot) received 78 Refocus On The Big Picture (slide of 6) • Alice’s basis in the 300 shares of stock received as an inheritance is the property’s $30,000 fair market value at the date of death – If Alice sells the 300 shares, she will realize and recognize a $6,000 gain • $36,000 sales price (300 shares X $120) - $30,000 basis • Alice’s basis in the 200 shares of stock purchased is her purchase price of $28,000 – Those shares are currently worth $24,000 (200 shares X $120) – Consequently, if she sells those shares, she will realize and recognize a $4,000 loss 79 Refocus On The Big Picture (slide of 6) • You advise Alice that her basis in the house is its $475,000 fair market value on the date of her grandmother’s death – If Alice sells the house for $600,000, her realized and recognized gain would be $125,000 80 Refocus On The Big Picture (slide of 6) • Regarding the involuntary conversion of Alice’s business building, a $50,000 realized gain occurs upon the receipt of the $100,000 of insurance proceeds – Because she intends to invest only $80,000 of the insurance proceeds in a qualifying property, Alice’s recognized gain is $20,000 • She reinvested $20,000 less than the insurance proceeds received ($100,000 proceeds - $80,000 reinvested) – Therefore, her realized gain is recognized to that extent 81 Refocus On The Big Picture (slide of 6) What If? • Alice is leaning toward selling the house • However, she knows that her grandmother would not want her to have to pay income taxes on the sale • Alice asks whether there is any way that she could avoid paying taxes on the sale • You inform Alice of the exclusion provision under § 121 – Alice can qualify for this exclusion of up to $250,000 of realized gain if she owns and occupies the house as her principal residence for at least of the years prior to a sale 82 Refocus On The Big Picture (slide of 6) What If? • From a tax planning perspective, what could Alice have done so that none of the $50,000 of realized gain in Example 37 from the involuntary conversion was recognized? – Alice would have to reinvest all of the $100,000 of insurance proceeds received in another qualified building • Under this circumstance, the basis of the replacement building would be $50,000 – $100,000 cost of replacement building – $50,000 deferred gain 83 If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr Donald R Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta © 2016 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 84 ... Determination of Gain or Loss (slide of 7) • Recognized gain or loss – Amount of realized gain (loss) that is included in (deducted from) gross income 12 Determination of Gain or Loss (slide of 7) •... (slide of 2) • Example of gift tax: – Cathy received a gift from Darren on June 15 of this year – FMV on June 15 was $34,000 – Darren had a basis in the asset of $29,000 – Darren paid gift tax of. .. Determination of Gain or Loss (slide of 7) • Adjusted basis – Original cost (or other adjusted basis) plus capital additions less capital recoveries Determination of Gain or Loss (slide of 7) • Capital