1. © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Comprehensive Volume 1 Chapter 13 Property Transactions: Determination of Gain or Loss, Basis Considerations, and Nontaxable Exchanges

2. 2 The Big Picture (slide 1 of 4) Alice owns a house that she inherited from her grandmother 7 months ago. –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 The house currently is worth $600,000.

3. 3 The Big Picture (slide 2 of 4) Alice is considering two options. –The first is to give the house to her son, Michael. Michael, his wife Sandra, and their daughter Peggy would live in the house. –The second option is to sell the house. Projected selling expenses would be about 7% of the selling price.

4. 4 The Big Picture (slide 3 of 4) Alice would also like to know the tax consequences of selling her boat. –She paid $22,000 for the boat 4 months ago and has used it exclusively for personal use. –Based on listings in the area, she anticipates that she can sell it for $20,000 to $23,000. In addition, earlier this year Alice sold some stock at a realized loss of $2,000 and subsequently repurchased some shares of the same stock for $7,000.

5. 5 The Big Picture (slide 4 of 4) Alice also has owned a building (adjusted basis $50,000) used in her business that was recently destroyed by a fire. –The insurance company paid Alice $100,000 to compensate her for the loss. Now she is looking to acquire suitable replacement property. –If possible, she would like to claim a casualty loss, but does not want to recognize any taxable gain from this event. She has asked you about the tax consequences of these transactions. –Read the chapter and formulate your response.

6. 6 Determination of Gain or Loss (slide 1 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

7. 7 Determination of Gain or Loss (slide 2 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

8. 8 Determination of Gain or Loss (slide 3 of 7) Adjusted basis –Original cost (or other adjusted basis) plus capital additions less capital recoveries

9. 9 Determination of Gain or Loss (slide 4 of 7) Capital additions –Cost of improvements and betterments to the property that are capital in nature and not currently deductible

10. 10 Determination of Gain or Loss (slide 5 of 7) Capital recoveries –Amount of basis recovered through: Depreciation or cost recovery allowances Casualty and theft losses (and insurance proceeds) Certain corporate distributions Amortizable bond premium Easements

11. 11 Determination of Gain or Loss (slide 6 of 7) Recognized gain or loss –Amount of realized gain (loss) that is included in (deducted from) gross income

12. 12 Determination of Gain or Loss (slide 7 of 7) Realized gains and losses are not always recognized –Realized gains may be deferred or excluded –Realized losses may be deferred or disallowed Realized losses from the sale, exchange, or condemnation of personal use assets (e.g., a personal residence) are not recognized for tax purposes –Exception - casualty or theft losses from personal use assets In contrast, any gain realized from the sale or other disposition of personal use assets is, generally, fully taxable

13. 13 The Big Picture - Example 7 Gain On Sale of Personal Use Assets Return to the facts of The Big Picture on p. 13-1. Assume Alice sells the boat, which she has held exclusively for personal use, for $23,000. –Recall that her adjusted basis of the boat is $22,000. Alice has a realized and recognized gain of $1,000.

14. 14 The Big Picture - Example 8 Loss On Sale of Personal Use Assets Return to the facts of The Big Picture on p. 13-1. Assume Alice sells the boat in Example 7 for $20,000. –She has a realized loss of $2,000, but the loss is not recognized.

15. 15 Recovery of Capital Doctrine Taxpayer is entitled to recover cost or other original basis of property acquired and is not taxed on that amount To extent receive only investment back upon disposition of an asset, taxpayer has no gain

16. 16 Basis Considerations (slide 1 of 6) Original basis of an asset is generally its cost Bargain purchase assets have a basis equal to their FMV –Bargain amount may be income to purchaser (e.g., employee = compensation; shareholder = dividend)

17. 17 Basis Considerations (slide 2 of 6) Identification problems –Security sales where specific identification not possible, use FIFO to compute basis

18. 18 Basis Considerations (slide 3 of 6) Allocation problems: lump-sum purchase –Must allocate basis to each asset obtained –Allocation usually based on relative FMV of assets

19. 19 Basis Considerations (slide 4 of 6) Allocation problems: Going concern purchase –Assign purchase price to assets (excluding goodwill) to extent of their total FMV –Then allocate among assets based on FMV –Residual amount is goodwill Goodwill is an amortizable § 197 asset –Allocation applies to both purchaser and seller

20. 20 Basis Considerations (slide 5 of 6) Allocation problems: Nontaxable stock dividends –Basis of original shares is allocated over the original and new shares Based on number of shares (common on common), or Based on relative FMV (preferred on common) –Holding period includes the holding period of the original shares

21. 21 Basis Considerations (slide 6 of 6) Allocation problems: Nontaxable stock rights –Basis in rights is zero unless taxpayer is required or elects to allocate basis from stock Required to allocate if FMV of rights is at least 15% of the FMV of the stock Allocation is based on relative FMV of rights and stock –Holding period includes holding period of the stock on which the rights were distributed However, if the rights are exercised, holding period of newly acquired stock begins with date the rights are exercised

22. 22 Gift Basis (slide 1 of 10) Gift property may have a dual basis, i.e., basis for gain and loss may differ Basis is dependent on relationship between FMV at date of gift and donor’s adjusted basis

23. 23 Gift Basis (slide 2 of 10) Gift basis for cost recovery –The donee's basis for cost recovery is the donor’s basis (donee's gain basis)

24. 24 Gift Basis (slide 3 of 10) Gift basis for subsequent gain –When a gifted asset is disposed of by the donee, the basis for calculating any gain is the donor’s adjusted basis (carryover basis) –This basis is called the “gain basis” Gain basis may be increased if donor incurred gift tax on gift –Holding period for donee includes that of donor

25. 25 Gift Basis (slide 4 of 10) Gift basis for subsequent loss –When a gifted asset is disposed of by a donee, the basis for calculating any loss is the lesser of FMV at the date of gift or the donor’s adjusted basis –This basis is called the “loss basis”

26. 26 Gift Basis (slide 5 of 10) Gift basis for subsequent loss –If FMV < donor’s basis on the date of the gift, a dual basis will exist for the asset Gain basis = donor’s basis Loss basis = FMV on date of gift –If dual basis and sold for loss, holding period for donee starts on date of gift

27. 27 Gift Basis (slide 6 of 10) Gift basis when no gain or loss –If a dual basis exists and the amount realized from the disposition of a gifted asset falls between the gain basis and the loss basis No gain or loss is realized –Holding period for donee is not needed since there is no gain or loss

28. 28 Gift Basis (slide 7 of 10) Example of gift basis determination –Alex received a gift from Beth on June 15 this year –FMV of asset on June 15 was $8,000 –Beth bought the asset on May 5, 1985 for $10,000

29. 29 Gift Basis (slide 8 of 10) Example of gift basis determination (cont’d) –If Alex sells the asset for $11,000, there is a $1,000 gain ($11,000 – $10,000) –If Alex sells the asset for $7,000, there is a $1,000 loss ($7,000 – $8,000) –If Alex sells the asset for $9,000, there is no gain or loss ($9,000 – $9,000)

30. 30 Gift Basis (slide 9 of 10) Adjustment for gift taxes –The proportion of gift tax paid (on gifts after 1976) by the donor on appreciation of asset can be added to basis of donee –The donee's basis is equal to: Donor’s basis + [(unrealized appreciation/taxable gift) × gift tax]

31. 31 Gift Basis (slide 10 of 10) 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 $800 –Cathy’s basis in the gifted property is $29,200 [$29,000 + ($5,000/($34,000 – $14,000) × $800)]

32. 32 Property Acquired from a Decedent (slide 1 of 7) Generally, beneficiary’s basis in inherited assets will be the FMV of the asset at decedent’s date of death –Exception: If the executor/administrator of estate elects alternate valuation date, basis is FMV on such date Inherited property is always treated as long- term property

33. 33 Property Acquired from a Decedent (slide 2 of 7) Inherited property valuation date –Date assets valued for estate tax is either: Date of decedent’s death, which is called the primary valuation date (PVD), or 6 months after date of decedent’s death, which is called the alternate valuation date (AVD) –Can only be elected if both the value of gross estate and the estate tax liability are lower than if PVD was used

34. 34 Property Acquired from a Decedent (slide 3 of 7) Inherited property valuation date –When PVD is used, beneficiary’s basis will be the FMV at date of decedent’s death –When AVD is used, beneficiary’s basis will be the FMV at the earliest of: Date asset is distributed from estate, or 6 months after date of decedent’s death

35. 35 Property Acquired from a Decedent (slide 4 of 7) Example of inherited property valuation: –At Rex’s date of death, April 30 of this year, his assets had an adjusted basis of $200,000, and a FMV of $700,000 PVD selected and assets distributed June 30; beneficiary’s basis is $700,000

36. 36 Property Acquired from a Decedent (slide 5 of 7) Example of inherited property valuation (cont’d) –October 30 this year (six months after date of Rex’s death), the assets had a FMV of $650,000 AVD selected and assets distributed November 10; beneficiary’s basis is $650,000 AVD selected and assets distributed June 30 when FMV of assets is $670,000; beneficiary’s basis is $670,000

37. 37 Property Acquired from a Decedent (slide 6 of 7) Deathbed gifts –Property inherited by taxpayer (or spouse) which was both appreciated and gifted by same taxpayer to decedent within 1 year of decedent's death –Beneficiary’s basis in property is carryover of decedent’s basis (not date of death FMV) –Generally the same basis taxpayer had on date of gift

38. 38 Property Acquired from a Decedent (slide 7 of 7) Survivor’s share of community property –Both decedent’s share and surviving spouse’s share of community property receives basis of FMV on date of death Surviving spouse’s share deemed to be acquired from decedent Survivor’s share in common law state –Only 1/2 of jointly held property of spouses is included in the estate In such a case, no adjustment of the basis is permitted for the excluded property interest (the surviving spouse’s share)

39. 39 The Big Picture - Example 22 Property Acquired From A Decedent Return to the facts of The Big Picture on p. 13-1. Alice inherited her grandmother’s house. –At the date of death, the adjusted basis for the house was $275,000. –The house’s fair market value at the date of death was $475,000. –The alternate valuation date was not elected. –Alice’s basis for income tax purposes is $475,000. This is commonly referred to as a stepped-up basis.

40. 40 The Big Picture - Example 23 Property Acquired From A Decedent Return to the facts of The Big Picture on p. 13-1. Assume the same facts as in Example 22, except the house’s fair market value at the date of death was $260,000. Alice’s basis for income tax purposes is $260,000. –This is commonly referred to as a stepped-down basis.

41. 41 Disallowed Losses (slide 1 of 5) Related parties (§ 267) –Losses on sale of assets between related parties are disallowed –For income-producing or business property, any loss disallowed can be used to reduce gain recognition on subsequent disposition of asset to unrelated party Only available to original transferee Not available for sales of personal use assets

42. 42 Disallowed Losses (slide 2 of 5) Related parties include: –Family members, –Corporation and a shareholder who owns greater than 50% (directly or indirectly) of the corporation, and –Partnership and a partner who owns greater than 50% (directly or indirectly) of the partnership

43. 43 Disallowed Losses (slide 3 of 5) Wash sales –Losses from wash sales are disallowed –Wash sale occurs when taxpayer disposes of stock or securities at loss and acquires substantially identical stock or securities within 30 days before or after the date of the loss sale

44. 44 Disallowed Losses (slide 4 of 5) Wash sales –Disallowed loss is added to the basis of the substantially identical stock or securities that caused the disallowance –Does not apply to gains realized on disposition of securities

45. 45 The Big Picture - Example 31 Wash Sale Return to the facts of The Big Picture on p. 13-1. Alice owned 100 shares of Green Corporation stock (adjusted basis of $20,000). –She sold 50 shares for $8,000. –Ten days later, she purchased 50 shares of the same stock for $7,000. Alice’s realized loss of $2,000 ($8,000 amount realized - $10,000 adjusted basis) is not recognized because it resulted from a wash sale. Alice’s basis in the newly acquired stock is $9,000 ($7,000 purchase price + $2,000 unrecognized loss from the wash sale).

46. 46 Disallowed Losses (slide 5 of 5) Personal use assets –Loss on the disposition of personal use assets is disallowed –Personal use asset loss cannot be converted into a business (or production of income) use deductible loss Original loss basis for an asset converted is the lower of personal use basis or FMV at date of conversion Cost recovery basis similarly limited

47. 47 Nontaxable Transactions (slide 1 of 4) In a nontaxable transaction, realized gain or loss is not currently recognized –Recognition is postponed to a future date (via a carryover basis) rather than eliminated

48. 48 Nontaxable Transactions (slide 2 of 4) In a tax-free transaction, nonrecognition of realized gain is permanent

49. 49 Nontaxable Transactions (slide 3 of 4) Holding period for new asset –The holding period of the asset surrendered in a nontaxable transaction carries over to the new asset acquired

50. 50 Nontaxable Transactions (slide 4 of 4) Depreciation recapture –Potential recapture from the asset surrendered carries over to the new asset acquired in the transaction

51. 51 Like-Kind Exchanges (slide 1 of 11) §1031 requires nontaxable treatment for gains and losses when: –Form of transaction is an exchange –Assets involved are used in trade or business or held for production of income However, inventory, securities, and partnership interests do not qualify –Asset exchanged must be like-kind in nature or character as replacement property

52. 52 Like-Kind Exchanges (slide 2 of 11) Like-kind property defined –Interpreted very broadly Real estate for real estate –Improved for unimproved realty qualifies –U.S. realty for foreign realty does not qualify Tangible personalty for tangible personalty –Must be within the same general business asset or product class –Personalty used mainly in the U.S. for personalty used mainly outside the U.S. does not qualify –Livestock of different sexes does not qualify

53. 53 Like-Kind Exchanges (slide 3 of 11) When taxpayers involved in an exchange are related parties –To qualify for nontaxable exchange treatment, related parties must not dispose of property exchanged within the 2 year period following exchange –If such early disposition occurs, postponed gain is recognized as of date of early disposition Dispositions due to death, involuntary conversions, and certain non-tax avoidance transactions are not treated as early dispositions

54. 54 Like-Kind Exchanges (slide 4 of 11) Exchange requirement –The transaction must involve a direct exchange of property to qualify as a like-kind exchange –If the exchange is a delayed (nonsimultaneous) exchange, there are time limits on its completion The new property must be identified within 45 days of date old property was transferred The new property must be received by the earlier of the following: –Within 180 days of date old property was transferred –The due date (including extensions) for tax return covering year of transfer

55. 55 Like-Kind Exchanges (slide 5 of 11) Boot –Any property involved in the exchange that is not like-kind property is “boot” –The receipt of boot causes gain recognition equal to the lesser of boot received (FMV) or gain realized No loss is recognized even when boot is received

56. 56 Like-Kind Exchanges (slide 6 of 11) Boot –The transferor of boot property may recognize gain or loss on that property Gain or loss is recognized to the extent of the difference between the adjusted basis and the fair market value of the boot

57. 57 Like-Kind Exchanges (slide 7 of 11) Basis in like-kind asset received: FMV of new asset – Gain not recognized + Loss not recognized = Basis in new asset Basis in boot received is FMV of property

58. 58 Like-Kind Exchanges (slide 8 of 11) Basis in like-kind property using Code approach Adjusted basis of like-kind asset given +Adjusted basis of boot given +Gain recognized –FMV of boot received –Loss recognized =Basis in new asset

59. 59 Like-Kind Exchanges (slide 9 of 11) Example of an exchange with boot: –Zak and Vira exchange equipment of same general business asset class –Zak: Basis = $25,000; FMV = $40,000 –Vira: Basis = $20,000; FMV = $30,000 –Vira also gives securities: Basis = $7,000; FMV = $10,000

60. 60 Like-Kind Exchanges (slide 10 of 11) Example (Cont’d) Zak Vira FMV Property Rec’d$30,000$40,000 +Securities 10,000 -0- Total FMV Rec’d$40,000$40,000 Less: Basis Property Given 25,000 30,000 * Realized Gain$15,000$10,000 Boot Rec’d$10,000$ -0- Gain Recognized$10,000$ -0- *$20,000 Equip. + $10,000 Securities = $30,000 Securities: ($10,000 FMV - $7,000 basis) = $3,000 gain recognized by Vira

61. 61 Like-Kind Exchanges (slide 11 of 11) Example (Cont’d) Zak Vira FMV Property Rec’d$30,000$40,000 Postponed Gain -5,000-10,000 Basis Property Rec’d$25,000$30,000

62. 62 Involuntary Conversions (slide 1 of 13) §1033 permits (i.e., not mandatory) nontaxable treatment of gains if the amount reinvested in replacement property ≥ the amount realized If the amount reinvested in replacement property is < amount realized, realized gain is recognized to the extent of the deficiency

63. 63 Involuntary Conversions (slide 2 of 13) Involuntary conversion –Results from the destruction, theft, seizure, requisition, condemnation, or sale or exchange under threat of condemnation of property A voluntary act by taxpayer is not an involuntary conversion

64. 64 Involuntary Conversions (slide 3 of 13) §1033 requirements –Replacement property must be similar or related in service or use as involuntarily converted property –Replacement property must be acquired within a specified time period

65. 65 Involuntary Conversions (slide 4 of 13) Replacement property defined –Must be similar or related in service or use as the converted property Definition is interpreted very narrowly and differently for owner-investor than for owner-user –For business or investment real estate that is condemned, replacement property has same meaning as for like-kind exchanges

66. 66 Involuntary Conversions (slide 5 of 13) Taxpayer use test (owner-investor) –The properties must be used by the owner in similar endeavors Example: Rental apartment building can be replaced with a rental office building because both have same use to owner (the production of rental income)

67. 67 Involuntary Conversions (slide 6 of 13) Functional use test (owner-user) –The property must have the same use to the owner as the converted property Example: A manufacturing plant is not replacement property for a wholesale grocery warehouse because each has a different function to the owner-user

68. 68 Involuntary Conversions (slide 7 of 13) Time period for replacement –Taxpayer normally has a 2 year period after the close of the taxable year in which gain is realized to replace the property Replacement time period starts when involuntary conversion or threat of condemnation occurs Replacement time period ends 2 years (3 years for condemnation of realty) after the close of the taxable year in which gain is realized

69. 69 Involuntary Conversions (slide 8 of 13) Example of time period for replacement –Taxpayer’s office building is destroyed by fire on November 4, 2012 –Taxpayer receives insurance proceeds on February 10, 2013 –Taxpayer is a calendar-year taxpayer –Taxpayer’s replacement period is from November 4, 2012 to December 31, 2015

70. 70 Involuntary Conversions (slide 9 of 13) Nonrecognition of gain: Direct conversions –Involuntary conversion rules mandatory –Basis and holding period in replacement property same as converted property

71. 71 Involuntary Conversions (slide 10 of 13) Nonrecognition of gain: Indirect conversions –Involuntary conversion rules elective –Gain recognized to extent amount realized (usually insurance proceeds) exceeds investment in replacement property

72. 72 Involuntary Conversions (slide 11 of 13) Nonrecognition of gain: Indirect conversions –Basis in replacement property is its cost less deferred gain –Holding period includes that of converted property

73. 73 Involuntary Conversions (slide 12 of 13) Involuntary conversion rules do not apply to losses –Losses related to business and production of income properties are recognized –Personal casualty and theft losses are recognized (subject to $100 floor and 10% AGI limit); personal use asset condemnation losses are not recognized or postponed

74. 74 Involuntary Conversions (slide 13 of 13) Involuntary conversion of personal residence –Gain from casualty, theft, or condemnation may be deferred as involuntary conversion (§1033) or excluded as sale of residence (§121) –Loss from casualty recognized (limited); loss from condemnation not recognized

75. 75 The Big Picture - Example 54 Involuntary Conversion (slide 1 of 3) Return to the facts of The Big Picture on p. 13-1. Alice’s business building (adjusted basis $50,000) is destroyed by fire on October 5, 2014. –Alice is a calendar year taxpayer. On November 17, 2014, she receives an insurance reimbursement of $100,000 for the loss. –Alice invests $80,000 in a new building. –Alice uses the other $20,000 of insurance proceeds to pay off credit card debt.

76. 76 The Big Picture - Example 54 Involuntary Conversion (slide 2 of 3) Alice has until December 31, 2016, to make the new investment and qualify for the nonrecognition election. Alice’s realized gain is $50,000 –$100,000 insurance proceeds received − $50,000 adjusted basis of old building Assuming that the replacement property qualifies, Alice’s recognized gain is $20,000. –$100,000 insurance proceeds − $80,000 reinvested

77. 77 The Big Picture - Example 54 Involuntary Conversion (slide 3 of 3) Alice’s basis in the new building is $50,000. –This is the building’s cost of $80,000 less postponed gain of $30,000 $50,000 realized gain − $20,000 recognized gain

78. 78 The Big Picture - Example 55 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. If the destroyed building had been held for personal use, the recognized loss would have been subject to the following additional limitations. –The loss of $5,000 would have been limited to the decline in fair market value of the property, and –The amount of the loss would have been reduced first by $100 and then by 10% of AGI (refer to Chapter 7).

79. 79 Sale of Residence (slide 1 of 7) Loss on sale –As with other personal use assets, a realized loss on the sale of a personal residence is not recognized

80. 80 Sale of Residence (slide 2 of 7) Gain on sale –Realized gain on sale of principal residence is subject to taxation –Realized gain may be partly or wholly excluded under §121

81. 81 Sale of Residence (slide 3 of 7) §121 provides for exclusion of up to $250,000 of gain on the sale of a principal residence Taxpayer must own and use as principal residence for at least 2 years during the 5 year period ending on date of sale

82. 82 Sale of Residence (slide 4 of 7) Amount of Exclusion –$250,000 maximum –Realized gain is calculated in normal manner –Amount realized on sale is reduced by selling expenses such as advertising, broker’s commissions, and legal fees

83. 83 Sale of Residence (slide 5 of 7) Amount of Exclusion (cont’d) –For a married couple filing jointly, the $250,000 max is increased to $500,000 if the following requirements are met: Either spouse meets the 2 year ownership req’t, Both spouses meet the 2 year use req’t, Neither spouse is ineligible due to the sale of another principal residence within the prior 2 years –Starting in 2008, a surviving spouse can continue to use the $500,000 exclusion amount on the sale of a personal residence for the next two years following the year of the deceased spouse’s death

84. 84 Sale of Residence (slide 6 of 7) §121 cannot be used within 2 years of its last use except in special situations, such as: Change in place of employment, Health, Other unforeseen circumstances Under these circumstances, only a portion of the exclusion is available, calculated as follows: Max Exclusion amount × number of qualifying months 24 months

85. 85 Sale of Residence (slide 7 of 7) The Housing Assistance Tax Act of 2008 reduces the gain eligible for the § 121 exclusion for a vacation home converted to a principal residence –§ 121 exclusion is reduced by the proportion of the periods of nonqualified use compared to the period the property was owned by the taxpayer –Applies to sales and exchanges occurring after December 31, 2008

86. 86 Other Nonrecognition Provisions (slide 1 of 6) Several additional nonrecognition provisions are available: –Under §1032, a corporation does not recognize gain or loss on the receipt of money or other property in exchange for its stock (including treasury stock)

87. 87 Other Nonrecognition Provisions (slide 2 of 6) Under §1035, no gain or loss is recognized from the exchange of certain insurance contracts or policies

88. 88 Other Nonrecognition Provisions (slide 3 of 6) Under §1036, 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

89. 89 Other Nonrecognition Provisions (slide 4 of 6) Under §1038, no loss is recognized from the repossession of real property sold on an installment basis –Gain is recognized to a limited extent

90. 90 Other Nonrecognition Provisions (slide 5 of 6) Under §1041, transfers of property between spouses or former spouses incident to divorce are nontaxable

91. 91 Other Nonrecognition Provisions (slide 6 of 6) Under §1044, 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

92. 92 Refocus On The Big Picture (slide 1 of 5) Gift of Inherited House Alice says that this is the only gift that she would make to Michael this year. –She has made no prior gifts to any individual that exceeded the annual exclusion amount (i.e., currently $14,000). With this information, you inform Alice that no gift tax would be due on the gift of the house to Michael. –However, she would use up $586,000 ($600,000 - $14,000) of her lifetime gift tax exclusion. –Michael’s basis for the house would be a carryover of Alice’s basis of $475,000. The fair market value at the date of the decedent’s death.

93. 93 Refocus On The Big Picture (slide 2 of 5) Sale of Inherited House Alice’s adjusted basis for the house is $475,000 –The fair market value on the date of her grandmother’s death. If Alice sells the house for $600,000, her projected selling expenses would be $42,000 ($600,000 X 7%).

94. 94 Refocus On The Big Picture (slide 3 of 5) She would have a recognized gain of $83,000 as calculated below. Amount realized ($600,000 - $42,000) $ 558,000 Less: Adjusted basis (475,000) Realized and recognized gain$ 83,000 The house is a capital asset, and Alice’s holding period is long term since she inherited the house. –Thus, the gain would be classified as a long-term capital gain (i.e., eligible for a 15% or 20% tax rate). –The Federal income tax due would be $12,450 ($83,000 X 15%).

95. 95 Refocus On The Big Picture (slide 4 of 5) 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 inquires as to whether there is any way that she could reduce the Federal income tax on the sale to $0. You inform Alice of the exclusion provision under § 121 of the Code. –She can qualify for this exclusion of realized gain provision if she satisfies the at least two-out-of-five-years ownership and use requirements. –This would necessitate her moving into the house for 2 years and occupying it as her principal residence.

96. 96 Refocus On The Big Picture (slide 5 of 5) What If? From a tax planning perspective, what could Alice have done so that none of the $50,000 of realized gain in Example 54 from the involuntary conversion was recognized? –To postpone all of the $50,000 realized gain, Alice would have to reinvest all of the $100,000 of insurance proceeds received in another building. –Under this circumstance, the basis of the replacement building would be a carryover basis of $50,000 ($100,000 cost – $50,000 deferred gain).

97. © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 97 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