Chapter 9 Character of Gain o 2 types Ordinary Gain Capital Gain gets special tax treatment Adjusted Basis equal to the initial basis plus or minus the cumulative effects of the adjustments o Adjusted Basis Initial Basis Increases in Basis Decreases in Basis o 2 Categories of Increases in Basis 1 Additional Investment in the Asset Capital Invested includes improvement to an asset that enlarge the asset or extend its useful life o Eg adding a room onto a building or putting a on a new roof Cost of Protecting Ownership Special property tax assessments for local benefits o Eg widening the street in front of a building 2 Reinvestment of Income Income taxed to owners of conduit entities o 3 Categories of Decreases in Basis Annual Tax Deductions Resulting in a Reduction of Tax Liability Depreciation depletion and amortization o Must be reduced by the larger of the depreciation allowable or the amount actually deducted on the taxpayer s return Losses from conduit entities Dispositions of All or Part of Interest in an Asset Casualty loss Sale or gift of part of an asset Capital Recovery Resulting from Excluded Income Nontaxable dividends Easements o Insurance premiums are current liabilities and do not affect basis Conduit Entity Adjusted Basis use for investment in an S corp or partnership o 3 Increases in Basis Additional capital invested during the year Taxable and nontaxable income allocated to the owner for the current year Liability Adjustment A partner s share of any increase in liabilities related to the partnership o 4 Decreases in Basis Cash received from the entity Property received from the entity If a partnership subtract the partnership s basis for the property If an S corporation subtract the fair market value of the property Deductions losses and nondeductible expenses allocated to the owner for the current year Liability Adjustment A partner s share of any decrease in liabilities related to the partnership Property Dispositions make the sale o Amount Realized the amount received from the sale less the expenses incurred to o Amount Recognized the amount of gain or loss that will be included in the current year s taxable income calculation o Long term Capital Gains for Individuals Taxed at a maximum 20 rate o Net Capital Loss Deductions for Individuals Limited to 3 000 per year Can be carried until the full loss amount is recovered o Real Property Tax Year in the year real estate is acquired property taxes must be allocated between the buyer and the seller The taxes should be allocated according to the number of days each owns the property during the period covered by the tax assessment Bargain Purchase buying an asset for less than fair market value o Usually only occurs in related party transactions o The difference between the selling price and fair market value is recognized as income Amount of the bargain is added to basis o Basis Cost Income Reported on the Asset Multiple Asset Purchase when more than one asset is bought for a single price o The cost must be allocated to the individual assets in proportion to their fair market value on the date purchased Must be done for depreciation and disposition on each individual asset Purchase of a Business o Purchase the assets of the business Results in a direct transfer of ownership of the assets The cost must be allocated to each individual asset o Purchase of corporate stock Ownership is in the entity not directly of the assets themselves Basis of Property Acquired by Gift o Gift a transfer of property proceeding from a detached and disinterested generosity out of affection respect admiration charity or like impulses o Neither the donor nor the done recognizes any income or pays income tax on the transfer of gift property o Gift Basis If Property was acquired before 1921 Basis FMV If FMV date of gift donor s basis Basis donor s carryover basis If gift tax is paid it is paid by the donor on net appreciation in value and ADDED to donee s basis If FMV date of gift donor s basis use split basis rule Split Basis Rule basis depends on sale price of the asset upon disposition o Based on whether it is sold for a gain or loss If sold for a gain use donor s basis If sold for a loss use FMV on the date of the gift If sold for an amount between FMV and donor s basis use the selling price as basis o There is not gain or loss Holding Period o One year o Follows basis If using donor s basis the holding period includes the period of time the property was owned by both the donor and the donee If using FMV holding period starts at the date of the gift Property acquired from a decedent Inherited o Basis FMV date of death Automatic step up in basis to FMV o Primary valuation date the date of death o The holding period is always long term for property acquired from a decedent o Alternate Valuation Date six months after the date of the decedent s death Basis FMV 6 months after death is executor of estate elects the alternate valuation date Must meet 2 criteria to do this need both Value of the total estate is less than the primary valuation date Total estate tax liability is less than the primary valuation date If property is distributed before the end of the 6 month period the basis of that property is the distribution date The basis of the rest of the estate is still the alternate valuation date o Death Bed Provision if you give away an asset and then have it willed back to you and the person dies within 6 months you do not get the step up in basis Personal Use Property Converted to Business Use o If FMV than its adjusted basis date business use begins general basis rules apply Use adjusted basis o If FMV adjusted basis Use FMV date of conversion o Generally always used the lesser of the 2 o Basis for Gain Initial Basis use cost o Basis for Depreciation and Losses use FMV date of conversion Basis in Securities o Initial basis is the cost paid to acquire the security plus commission fees o Sale of Stock Formula Amount Realized Commission Expenses Adjusted Basis Realized Gain Loss Tax Laws Recognized Gain Loss o Stock dividends Nontaxable There is no income until the shares are sold If the shares of all of the same class o Basis per share Original cost total shares held after dividend If the shares are of a different class o Basis of Preferred stock FMV preferred FMV preferred FMV common original common stock basis o Basis of Common stock FMV common FMV preferred FMV common original common stock basis Whenever the shareholder has the option