Chapter 9- Character of Gaino 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 adjustmentso Adjusted Basis = Initial Basis + Increases in Basis – Decreases in Basiso 2 Categories of Increases in Basis1. Additional Investment in the Asset- Capital Invested – includes improvement to an asset that enlarge the asset or extend its useful lifeo Eg) adding a room onto a building or putting a on a new roof- Cost of Protecting Ownership- Special property tax assessments for local benefitso Eg) widening the street in front of a building2. Reinvestment of Income- Income taxed to owners of conduit entitieso 3 Categories of Decreases in Basis Annual Tax Deductions Resulting in a Reduction of Tax Liability- Depreciation, depletion, and amortizationo 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- Easementso Insurance premiums are current liabilities and do not affect basis- Conduit Entity Adjusted Basis – use for investment in an S corp or partnershipo 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 partnershipo 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 o Amount Realized – the amount received from the sale, less the expenses incurred to make the saleo Amount Recognized – the amount of gain or loss that will be included in the current year’s taxable income calculationo Long-term Capital Gains for Individuals Taxed at a maximum 20% rateo Net Capital Loss Deductions for Individuals Limited to $3,000 per year Can be carried until the full loss amount is recoveredo 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 valueo Usually only occurs in related party transactionso The difference between the selling price and fair market value is recognized as income Amount of the bargain is added to basiso Basis = Cost + Income Reported on the Asset- Multiple Asset Purchase – when more than one asset is bought for a single priceo 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 Businesso Purchase the assets of the business Results in a direct transfer of ownership of the assets The cost must be allocated to each individual asseto Purchase of corporate stock Ownership is in the entity, not directly of the assets themselves- Basis of Property Acquired by Gifto 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 propertyo 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 dispositiono 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 basiso There is not gain or loss- Holding Period o One yearo 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 - Inheritedo Basis = FMV date of death Automatic step-up in basis to FMVo Primary valuation date – the date of deatho The holding period is always long term for property acquired from a decedento 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 Useo If FMV > than its adjusted basis (date business use begins): general basis rules apply Use adjusted basiso If FMV < adjusted basis Use FMV (date of conversion)o Generally, always used the lesser of the 2o Basis for Gain/Initial Basis – use costo 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 feeso Sale of Stock Formula Amount Realized- Commission/Expenses- Adjusted BasisRealized Gain/Loss(Tax Laws)Recognized Gain/Losso Stock dividends Nontaxable- There is no income until the shares are sold- If the shares of all of the same classo Basis per share = Original cost/total
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