McGraw-Hill Education Copyright © 2015 by the McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website in whole or part. Chapter 12 Special Property Transactions “A fool and his money are soon parted. It takes creative tax laws for the rest.” --- Bob Thaves (“Frank & Ernest”)

LO #1 Like-Kind Exchange Rules 3 criteria for a like-kind exchange: –There must be an exchange; –The property transferred and the property received must be held for productive use in a trade or business or for investment; –The property must be like-kind. Exchange rules are not elective 12-2

LO #1 Like-Kind Exchange Not eligible for like-kind treatment –Inventory –Stocks, bonds, etc. –Debt instruments –Interest in a partnership –Certificates of trust Dealer does not qualify for like-kind exchange treatment 12-3

LO #1 Like-Kind Exchange What is a like-kind asset? –Same nature or character –Grade or quality does not matter –Same depreciation class Boot Property – any extra consideration given or received other than the like-kind property 12-4

LO #1 Like-Kind Exchange Recognized gain is the lesser of: –The FMV of the boot received; or –The realized gain on the exchange. Receipt of boot causes recognition of gain Giving boot does not cause gain recognition 12-5

LO #1 Like-Kind Exchange Basis calculation of property received –Basis of property given –Plus basis of boot given –Plus gain recognized –Less boot received Or, FMV of property received less deferred gain. 12-6

LO #1 Like-Kind Exchange Time period –45 days to locate replacement property; –180 days to receive replacement property. Liabilities assumed –Release of a liability is considered boot received –Presence of a liability can trigger gain 12-7

LO #1 Like-Kind Exchange Concept Check With a correctly executed like-kind exchange, gain is never recognized unless the taxpayer receives boot. True 2. For a transaction to qualify for a like-kind exchange, an exchange of assets must occur and the assets must be held for trade or business use or investment and be like-kind assets. True 12-8

LO #1 – Concept Check A taxpayer has 180 days after relinquishing his or her property to identify a replacement property. False 4. The basis in the replacement property is typically the FMV of the property received less the gain postponed. True 12-9

LO #2 – Involuntary Conversions Property is destroyed, stolen, condemned and the taxpayer receives similar property or proceeds. Defer entire gain – replacement property must be purchased for an equal or greater amount than the proceeds

LO #2 – Involuntary Conversions Replacement Property –Similar or related in service or use –More restrictive than the “like-kind” test –Real property can only be “like-kind” Replacement Period –Two years after the close of tax year –Three years for real business property 12-11

LO #2 – Involuntary Conversions Basis of replacement property –Basis of converted property –Less money not used to replace –Plus money reinvested in excess of proceeds –Plus gain recognized –Less loss received Holding Period – holding period of replacement property includes holding period of property converted 12-12

LO #2 – Concept Check 12-2 Assume the following facts to answer the following questions. A fire destroyed Andrew’s building used in his wood working business. He had purchased the building several years ago for $75,000 and it now has a $50,000 adjusted basis. 1. Andrew received $105,000 in insurance proceeds for the replacement cost. If Andrew does not replace the building, what is his taxable gain? $55, Assuming the same facts as above, how many years does Andrew have to replace the building in order to deferred any recognized gain? 3 years – it is business real property 12-13

LO #2 – Concept Check Assuming the same facts as above, how much gain would Andrew be required to recognize if he replaced the building (within the replacement period) with another building costing $95,000? $10, Assuming the same facts as above, how much gain would Andrew be required to recognize if he replaced the building with another building costing $115,000? $0. 5. Assuming the same facts as number 4 above, how much would Andrew’s basis be in the new building? $60,

LO #3 – Installment Sales A disposition of property where at least one payment is to be received after the year of sale. Installment payments consist of three components: –Interest income –Return of basis –Gain on the sale Gross Profit Percentage = gross profit divided by contract price 12-15

LO #3 – Installment Sales Dealers cannot use the installment method. The installment method cannot be used on the sale of publicly traded stock. Any depreciation recapture is recognized in the year the asset is disposed of

LO #3 – Concept Check Tamaria sold a tract of land for $30,000 in The land has a basis of $18,000 and she incurred $2,000 of selling expenses. Tamaria received $5,000 down (received in 2014) and will receive five additional annual payments of $5,000 each. What is Tamaria’s gross profit percentage on the sale? a. 33.3% b. 60.0% c. 66.7% d % Answer: A 12-17

LO #3 – Concept Check Assume the same facts as above, how much income will Tamaria recognize in 2015 when she receives the first additional payment of $5,000? a. $ 0. b. $1,667. c. $3,335. d. $5,000 Answer: B 12-18

LO #4 – Sale of Residence Married taxpayers can exclude up to $500,000 ($250,000 single) of the gain on the sale of their personal residence This provision is an exclusion, not a deferral of gain

LO #4 – Sale of Residence During a five-year period before the sale, the taxpayer must satisfy: –Ownership Test – owned the home for at least two years. –Use Test – lived in the home as the main home for at least two years. The tests do not have to be continuous

LO #4 – Sale of Residence Exclusion applies to only one sale every two years. If for health or employment reasons, a reduced exclusion is available for a second sale based on the ratio of days owned divided by

LO #4 – Concept Check If married taxpayers live in their personal residence for more than two years, the couple can exclude the gain on the sale of their residence up to $500,000. True 2. A taxpayer cannot exclude any gain on the sale of a residence if he or she has lived there less than two years. False 12-22

LO #4 – Concept Check 3. Sharon and Johnny were recently married and Sharon moved into Johnny’s house. Sharon then sold her home and took the exclusion. Since Sharon took the exclusion, Johnny must forfeit his exclusion if he were to sell his home within the next two years. False 12-23

LO #5 – Related-Party Losses & Wash Sales Losses on sales between related parties are disallowed –Related parties include family members and more than 50% owned entities –Constructive ownership rules apply The loss disallowance does not affect the basis of the property to the buyer

LO #5 – Related Party Losses & Wash Sales Wash sale rules disallow a tax loss where the ownership of a company is not reduced. A wash sale occurs if essentially the same stock is purchased 30 days before or 30 days after the sale

LO #5 – Concept Check Leslie sold 500 shares of Bluff, Co. stock to her brother for $5,000. Leslie purchased the stock three years ago for $7,000. How much of the loss can Leslie deduct on her tax return in the current year? Answer: $0 2. Would the answer to question #1 change if Leslie sold the stock to Leslie Co. instead of her brother? Explain assuming the following facts. a. Assume Leslie owns 25% of the outstanding stock in Leslie Co. b. Assume Leslie owns 75% of the outstanding stock in Leslie Co. Answer: a. Leslie could deduct $2,000 in capital losses. Answer: b. $

LO #5 – Concept Check 3. What is the purpose of the wash sale rules? Answer: The purpose of the wash sale rules is to disallow a tax loss where the ownership of a company is not reduced. Thus, if a taxpayer buys similar stock within 30 days (before or after) of a stock sale, any loss on the sale is disallowed