1. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Chapter 9 Acquisition of Property Murphy & Higgins Concepts in Federal Taxation, 2012 edition

2. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Concept Review  Capital recovery concept: Property’s basis may be recovered before any taxable income is realized from disposal of property  Property is classified by both its use and its type

3. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Property  Tax definition of property Term property refers to long-lived assets owned by a taxpayer Amount invested in an asset is the property’s basis  Use of Property Property is used for  Trade or business,  Production of income (investment), or  Personal purposes The same property may be used differently by different taxpayers

4. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Types of Property  Personal property (personalty) Has a physical existence Has form, shape and substance Examples: Machinery, equipment, automobiles, trucks, computers, furniture, etc.,  Real property Land and any structures that are permanently attached to land Examples: Land and land improvements such as landscaping, shrubbery, parking lots, and fences; barns, sheds Has form, shape and substance  Intangible property Property that lacks a physical existence Rights to the property exist only on paper Have no form, shape or physical substance  Personal use property Used purely for personal purposes Example: Personal residence, clothing, furniture, home computer, lawnmower, personal automobile

5. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Property Acquisition Property Disposition Period of Use Initial Basis Adjusted Basis plus additional capital minus capital recoveries Property Investment Cycle

6. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Adjusted Basis  Adjusted basis = initial basis +/- the cumulative effects of the adjustments  Roughly corresponds to the book-value concept studied in financial accounting

7. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Increases and Decreases in Basis  Increases in basis Two broad categories of increases  Additional capital investments  Capital expenditures  Costs of defending ownership  Special assessments  Reinvestment of income from the property  Taxable income from conduit entities  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

8. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Basis in Conduit Entities  Adjusted yearly for items passed through to owners Increased for additional capital invested, taxable and nontaxable income, and owner’s share of entity liabilities Decreased for deductible or nondeductible expenses, cash or property distributed to the owner, and owner’s share of liability reductions

9. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Property Dispositions Amount Realized minus :Adjusted Basis Realized Gain Realized Loss Recognized Gain Recognized Loss

10. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Initial Basis Amount invested = Cash paid, + FMV of property or services given + Increases in liabilities related to the purchase + Any cost incurred to get the asset ready for its intended use

11. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Purchase of Assets: Amount Invested Purchase price of an asset = Cash paid, + FMV of other property given to another entity in the exchange + FMV of the taxpayer’s services given to another entity in the exchange + Increases in the taxpayer’s liabilities related to the purchase (i.e., increases in debts owed by the taxpayer)

12. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Basis in Bargain Purchase  All-inclusive income concept requires income recognition equal to the difference between an asset’s FMV and its sales price  Asset’s basis = amount paid plus the amount of income recognized

13. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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

14. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Constructed Assets: Basis  Basis includes: Direct construction costs  Actual costs of physical construction Indirect construction costs  General costs of the business that support the construction  Examples:  Interest  Taxes  Equipment depreciation  General administrative costs

15. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Basis of Property: Acquired by Gift  On the date of gift, compare FMV of property to the donor’s basis If FMV > donor’s basis  Basis in the property is the donor’s basis plus any gift tax paid on net appreciation 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, use FMV as basis (loss)  If sold for an amount between the two, use sales price as basis (no gain or loss)

16. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Holding Period: Property Acquired by Gift  If donor’s basis is used Holding period carries over and begins on the donor’s acquisition date  If FMV is used Holding period begins on the date of gift

17. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Basis of Property: Acquired by Inheritance  Important dates: Primary valuation date: The date of death Alternate valuation date: Six months after the date of death Distribution date: The date a beneficiary receives the property  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

18. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Basis of 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 If Personal basis > FMV  Use FMV for depreciation  Basis for sale is determined when the property is sold  If sold for > personal basis, use personal basis: (gain)  If sold for < FMV, use FMV: (loss)  If sold for an amount between the two, no gain or loss is recognized

19. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Basis in Securities: Stock Dividends  Stock dividends: Generally non-taxable dividends  Basis per share = Original cost / Total shares held after dividend  Stock dividends become taxable when taxpayers may choose to receive cash instead of shares. Income = FMV of stock at distribution

20. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Basis in Securities: Wash Sales  A wash sale occurs when a security sold at a loss is replaced with a substantially similar security +/- 30 days from the sale  Loss is not deductible under the substance-over-form doctrine  Nondeductible loss amount is added to the basis of the replacement security