Chapter 9 Acquisitions of Property ©2006 South-Western Kevin Murphy Mark Higgins Kevin Murphy Mark Higgins

Transparency 9-2 © 2006 South-Western Preview of Coming Attractions vChapter 9 begins four chapters dealing with property FAcquisition (Chapter 9) FDepreciation (Chapter 10) FDisposition (Chapter 11) FSpecial Issues (Chapter 12)

Transparency 9-3 © 2006 South-Western 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.

Transparency 9-4 © 2006 South-Western Under the capital recovery concept, a property’s basis may be recovered before any taxable income is realized from disposal of property. Concept Review

Transparency 9-5 © 2006 South-Western Classes of Property Property is classified by both its use and its type.

Transparency 9-6 © 2006 South-Western Use of Property qProperty is used for ¶Trade or business, ·Production of income (investment), or ¸Personal purposes qThe same property may be used differently by different taxpayers

Transparency 9-7 © 2006 South-Western Types of Property vAll property may be classified by type as either tangible or intangible FIntangible property lacks physical substance and has only an economic existence FTangible property has physical substance VTangible real property (realty) consists of land and structures permanently attached to land VTangible personal property (personalty) is all other tangible property

Transparency 9-8 © 2006 South-Western Property Investment Cycle Property Acquisition Property Disposition Period of Use Initial Basis Adjusted Basis plus additional capital minus capital recoveries

Transparency 9-9 © 2006 South-Western Increases in Basis vThere are two broad categories of increases ¶Additional capital investments VCapital expenditures VCosts of defending ownership VSpecial assessments ·Reinvestment of income from the property VTaxable income from conduit entities

Transparency 9-10 © 2006 South-Western Decreases in Basis vThere are three broad categories of decreases ¶Annual tax deductions for cost recovery VDepreciation, depletion or amortization VLosses from conduit entities ·Disposition of all or part of the property ¸Capital recovery due to income exclusion

Transparency 9-11 © 2006 South-Western Basis in Conduit Entities vBasis in a conduit entity is adjusted yearly for items passed through to owners FIncreased for additional capital invested, taxable and nontaxable income, and owner’s share of entity liabilities FDecreased for deductible or nondeductible expenses, cash or property distributed to the owner, and owner’s share of liability reductions

Transparency 9-12 © 2006 South-Western Property Dispositions Amount Realized minus :Adjusted Basis Realized Gain Realized Loss Recognized Gain Recognized Loss

Transparency 9-13 © 2006 South-Western 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

Transparency 9-14 © 2006 South-Western Basis in Bargain Purchase vThe all-inclusive income concept requires income recognition equal to the difference between an asset’s FMV and its sales price vThe asset’s basis = amount paid plus the amount of income recognized

Transparency 9-15 © 2006 South-Western Purchase of Multiple Assets vTotal basis is allocated between assets based on the relative FMV of each

Transparency 9-16 © 2006 South-Western Purchase of Assets of a Business vPurchase price is allocated to individual assets by their FMVs or through specific agreement vExcess of purchase price over FMV of assets is considered Goodwill vPurchase of corporate stock does not confer ownership of the business’ assets

Transparency 9-17 © 2006 South-Western Basis in Constructed Assets Basis includes vDirect construction costs FActual costs of physical construction vIndirect construction costs FGeneral costs of the business that support the construction VFor example: interest, taxes, equipment depreciation, general admin., etc.

Transparency 9-18 © 2006 South-Western 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 FBasis in the property is the donor’s basis plus any gift tax paid on net appreciation

Transparency 9-19 © 2006 South-Western Basis of Property Acquired by Gift (continued) If Donor’s basis > FMV vBasis is determined when property is eventually sold FIf sold for more than donor’s basis, use donor’s basis (gain) FIf sold for less than FMV, use FMV as basis (loss) FIf sold for an amount between the two, use sales price as basis (no gain or loss)

Transparency 9-20 © 2006 South-Western Holding Period for Property Acquired by Gift vIf donor’s basis is used, holding period carry’s over and begins on the donor’s acquisition date vIf FMV is used, holding period begins on the date of gift

Transparency 9-21 © 2006 South-Western Basis of Property Acquired by Inheritance vThree dates are important FPrimary valuation date is the date of death FAlternate valuation date is six months after the date of death FDistribution date is the date a beneficiary receives the property

Transparency 9-22 © 2006 South-Western Basis of Property Acquired by Inheritance (continued) vBasis is generally the FMV of the property on the primary valuation date vIf the estate is valued on the alternate valuation date FBasis is the FMV of the property on the earliest date received, either VDate of distribution, or VAlternate valuation date

Transparency 9-23 © 2006 South-Western Holding Period of Property Acquired by Inheritance The holding period for property acquired by inheritance is automatically long term.

Transparency 9-24 © 2006 South-Western Basis in Property Converted From Personal to Business Use On the date of conversion, compare the asset’s personal-use basis to its FMV. vIf FMV > personal basis FPersonal basis is used for depreciation and gain or loss calculations

Transparency 9-25 © 2006 South-Western Basis in Property Converted From Personal to Business Use vIf Personal basis > FMV FUse FMV for depreciation FBasis for sale is determined when the property is sold VIf sold for > personal basis, use personal basis: (gain) VIf sold for < FMV, use FMV: (loss) VIf sold for an amount between the two, no gain or loss is recognized

Transparency 9-26 © 2006 South-Western 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.

Transparency 9-27 © 2006 South-Western Basis in Securities Wash Sales vLoss is not deductible under the substance-over-form doctrine vNondeductible loss amount is added to the basis of the replacement security A wash sale occurs when a security sold at a loss is replaced with a substantially similar security +/- 30 days from the sale.

Transparency 9-28 © 2006 South-Western End of Chapter 9