Acquisitions of Property Chapter 9 Acquisitions of Property Kevin Murphy Mark Higgins ©2007 South-Western 1

Preview of Coming Attractions Chapter 9 begins four chapters dealing with property Acquisition (Chapter 9) Depreciation (Chapter 10) Disposition (Chapter 11) Special Issues (Chapter 12)

Tax Definition of Property The term property refers to long-lived assets owned by a taxpayer. The amount invested in an asset is the property’s basis.

Concept Review Under the capital recovery concept, a 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. Classes of Property Property is classified by both its use and its type.

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

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

Property Investment Cycle Period of Use Property Acquisition Property Disposition plus additional capital minus capital recoveries Adjusted Basis Initial Basis

Increases in Basis There are 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 There are 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

Basis in Conduit Entities Basis in a conduit entity is 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

Property Dispositions Amount Realized minus: Adjusted Basis Realized Gain Realized Loss Recognized Gain Recognized Loss

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

Basis in Bargain Purchase 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

Purchase of Multiple Assets Total basis is allocated between assets based on the relative FMV of each

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

Basis in Constructed Assets Basis includes Direct construction costs Actual costs of physical construction Indirect construction costs General costs of the business that support the construction For example: interest, taxes, equipment depreciation, general admin., etc.

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

Basis of Property 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, use FMV as basis (loss) If sold for an amount between the two, use sales price as basis (no gain or loss)

Holding Period for Property 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

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

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 of Property Acquired by Inheritance The holding period for property acquired by inheritance is automatically long term.

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

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 > 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

Basis in Securities Stock Dividends Stock dividends are generally non-taxable dividends. Basis per share = Original cost Total shares held after dividend Stock dividends become taxable when taxpayers may receive cash instead of shares. Income = FMV of stock at distribution.

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

End of Chapter 9