1. Chapter-10-1A- Property- Acquisition Howard Godfrey, Ph.D., CPA Professor of Accounting ©Howard Godfrey-2015

3. Use of Property Property is classified by both its use and its type. Property is used for 1.Trade or business, 2.Production of income (investment), or 3.Personal purposes The same property (an auto) may be used differently by different taxpayers.

4. Types of Property All property may be classified by type as either tangible or intangible – Intangible property lacks physical substance and has only an economic existence – Tangible property has physical substance Tangible real property (realty) consists of land and structures permanently attached to land Tangible personal property (personalty) is all other tangible property

5. Basis of Property Basis is the taxpayer’s unrecovered investment in an asset that can be recovered without tax cost As the asset’s basis is recovered (through depreciation, depletion or amortization deductions), basis is reduced and is called adjusted basis

6. Basis of Property The original basis of an asset includes – Cash plus fair market value of property given up by the buyer – Money borrowed and used to pay for the property – Liabilities of the seller assumed by the buyer – Expenses of the purchase such as attorney fees or brokerage commissions

7. Capital Expenditures The cost of a business asset with a useful life extending beyond the current year (depending on the applicable rule) may be: – Deducted currently – Capitalized until disposal or – Capitalized with the cost allocated to the years the asset’s use benefits (cost recovery period)

8. Increases in Basis Two categories of increases Additional capital investments Capital expenditures Costs of defending ownership Special assessments Reinvestment of income from property Taxable income from conduit entities

9. Decreases in Basis Three broad categories of decreases Annual tax deductions for cost recovery Depreciation, depletion or amortization Losses from conduit entities Disposition of all or part of the property Capital recovery due to income exclusion

10. What costs to capitalize – Best Co. Best Co. purchased a new machine with an invoice cost of $100,000. A 2% discount was received for early payment. Delivery charges were $500 for moving the machine to the factory owned by Best. The company paid $300 in wages to employees while installing the machine. What is the cost of this machine? a. $98,000 b. $100,000 c. $98,500 d. $98,800 e. $99,000

13. Multiple Asset Purchase If more than one asset is acquired in a single transaction, the cost is apportioned to each using their relative fair market values (FMV) – If the purchase price exceeds the value of the assets, the excess is goodwill Alternatively, the buyer and seller can agree to a written allocation of the purchase price to individual assets

16. Purchase of Assets of a Business Purchase price is allocated to individual assets by their FMVs or through specific agreement Excess of purchase price over FMV of assets is considered Goodwill Purchase of corporate stock does not confer ownership of the business’ assets (owned in the corporation)

18. Basis in Property Converted From Personal to Business Use On the date of conversion, compare the asset’s personal-use basis to its FMV. If FMV > personal basis – Personal basis is used for depreciation and gain or loss calculations

19. Basis in Property Converted From Personal to Business Use If Personal basis > FMV – Use FMV for depreciation – Basis for sale is determined when the property is sold If sold for an amount > personal basis, use personal basis: (gain) If sold for amount < FMV, use FMV: (loss) If sold for an amount between the two, no gain or loss is recognized

20. Basis of Converted Property If the property is converted from personal use to business use, the basis for depreciation is the lesser of the property’s FMV or adjusted basis at the date of conversion – Prevents taxpayers from depreciating the portion of the property’s decline in value that occurred while it was used for personal purposes

21. Basis for Depreciation – Anne -1 Anne purchased a condo unit for $125,000 last year. She used condo as a personal residence. In the current year, when the condo unit appraises at $132,000, Anne moves out and converts condo to rental property. What basis can Anne use when computing her depreciation on the rental condo unit?

22. Basis for Depreciation – Anne -2 $125,000. Anne uses the lower of her basis or FMV at the date the condo is converted from personal to rental property.

26. Acquisition in Taxable Exchange Basis of acquired asset equals the FMV of the property given up or FMV of the services performed Gain or loss is recognized as if cash had been exchanged for the property surrendered

27. Basis in Bargain Purchase-1 The all-inclusive income concept requires income recognition equal to the difference between an asset’s FMV and its sales price The asset’s basis = amount paid plus the amount of income recognized

28. Basis in Bargain Purchase-2 Your employer purchased land a few years ago for $30,000. Today it is worth $50,000. Your employer appreciates your fine work and sells the land to you for $45,000. How much income do you recognize? What is your basis in the land?

29. Basis in Bargain Purchase-3 How much income do you recognize? $5,000 What is your basis in the land? $50,000

30. Asset Acquired in Tax-free Exchange-1 An individual (Jan) owns an office building with a value of $500,000 and a basis after depreciation of $400,000 (cost $600,000 & accumulated deprec. of $200,000). If Jan sells the building for cash (for it FMV of $500,000) she will recognize again of $100,000.

31. Asset Acquired in Tax-free Exchange-2 Assume the Jan trades the building for another office building that is also worth $500,000, Jan has a gain realized on the exchange of $100,000. The gain will not be recognized because this qualifies as a like-kind exchange (rules covered in later chapter). The new building has a value of $500,000, but the Jan will have a basis of only $400,000 (the basis in the first building.

33. Basis of Asset Acquired by Gift (continued) If Donor’s basis > FMV Basis is determined when property is eventually sold – If sold for more than donor’s basis, use donor’s basis (gain) – If sold for less than FMV on date of gift, use FMV as basis (loss) – If sold for an amount between the two, use sales price as basis (no gain or loss)

34. Jan’s Basis in Gift Received Jan received a gift of stock valued at $10,000. The stock had an adjusted basis of $6,000 to the donor. No gift tax was paid on the transfer. Several months later, Jan sold the stock for $11,000. What is Jan's gain or (loss) on sale?

37. Dan’s Basis in Gift Received Dan received a gift of stock valued at $6,000. The stock had an adjusted basis of $10,000 to the donor. No gift tax was paid on the transfer. Several months later, Dan sold the stock for $5,000. What is Dan's gain or (loss) the sale?

43. Holding Period for Asset Acquired by Gift If donor’s basis is used, holding period carry’s over and begins on the donor’s acquisition date If FMV is used, holding period begins on the date of gift

44. Acquisition by Gift Donee’s basis is the donor’s basis + portion of gift taxes due to appreciation (but total cannot exceed FMV at date of gift) Fraction for portion of gift tax: FMV at gift date – Donor’s Basis FMV at gift date

47. Gift Basis – David -1 Ted bought stock for $18,000 five years ago. David received a gift of stock from Ted this year when the stock was worth $24,000. Ted paid $2,000 of gift taxes on the gift. What is David’s basis for the stock?

48. Gift Basis – David -2 $18,500. David uses Ted’s basis increased by a portion of the gift tax related to the appreciation on the gift determined as follows: $2,000 gift tax x [($24,000 -$18,000)/$24,000] = $500 gift tax related to appreciation. $18,000 carryover basis from donor + $500 gift tax = $18,500.

49. Gift Basis – Ellen -1 Ellen received a gift of stock from Gisela this year when the stock was worth $50,000. Gisela purchased the stock for $60,000 four years ago. Calculate Ellen’s basis for the stock if she sells it: a. for $65,000? b. for $45,000? c. for $55,000?

50. Gift Basis – Ellen -2 a. $60,000. The donor’s basis is always used to determine a gain. b. $50,000. Fair market value (when it is lower than the donor’s basis) is used to determine basis for loss. c. $55,000. When the selling price is between the donor’s basis and the lower fair market value, there is no gain or loss. Effectively, basis equals the selling price.

52. Acquisition by Inheritance Use date-of-death Fair Market Value as basis for inherited property (or alternate valuation date, if elected) Will

53. Basis of Property Acquired by Inheritance Three dates are important – Primary valuation date is the date of death – Alternate valuation date is six months after the date of death – Distribution date is the date a beneficiary receives the property

54. Basis of Property Acquired by Inheritance (continued) Basis is generally the FMV of the property on the primary valuation date If the estate is valued on the alternate valuation date – Basis is the FMV of the property on the earliest date received, either Date of distribution, or Alternate valuation date Holding period for inherited asset is long term

57. The End