Chapter 9Chapter 9

Acquisitions of PropertyAcquisitions of Property

©2006 South-Western©2006 South-Western©2006 South-Western©2006 South-Western

Kevin MurphyKevin MurphyMark HigginsMark Higgins

Kevin MurphyKevin MurphyMark HigginsMark Higgins

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Preview of Coming Attractions

Preview of Coming Attractions

Chapter 9 begins four chapters dealing with propertyAcquisition (Chapter 9)Depreciation (Chapter 10)Disposition (Chapter 11)Special Issues (Chapter 12)

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Tax Definition of PropertyTax 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.

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Under the capital recovery concept, a property’s basis may be recovered before any taxable income is realized from disposal of property.

Concept ReviewConcept Review

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Classes of PropertyClasses of Property

Property is classified by both its use and its type.

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Use of PropertyUse 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

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Types of PropertyTypes of Property

All property may be classified by type as either tangible or intangibleIntangible property lacks physical substance

and has only an economic existenceTangible 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

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Property Investment CycleProperty Investment Cycle

PropertyAcquisition

PropertyDisposition

Period of Use

InitialBasis

AdjustedBasis

plusadditional

capital

minus capitalrecoveries

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Increases in BasisIncreases in Basis

There are two broad categories of increasesAdditional capital investments

Capital expenditures Costs of defending ownership Special assessments

Reinvestment of income from the property Taxable income from conduit entities

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Decreases in BasisDecreases in Basis

There are three broad categories of decreasesAnnual tax deductions for cost recovery

Depreciation, depletion or amortization Losses from conduit entities

Disposition of all or part of the propertyCapital recovery due to income exclusion

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Basis in Conduit EntitiesBasis in Conduit Entities

Basis in a conduit entity is adjusted yearly for items passed through to ownersIncreased 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

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Property DispositionsProperty Dispositions

Amount Realizedminus: Adjusted Basis

RealizedGain

RealizedLoss

RecognizedGain

RecognizedLoss

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Initial BasisInitial 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

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Basis in Bargain PurchaseBasis 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

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Purchase of Multiple AssetsPurchase of Multiple Assets

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

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Purchase of Assets of a Business

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

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Basis in Constructed AssetsBasis in Constructed Assets

Basis includes Direct construction costs

Actual costs of physical construction

Indirect construction costsGeneral costs of the business that support

the construction For example: interest, taxes, equipment

depreciation, general admin., etc.

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Basis of Property Acquired by Gift

Basis of Property Acquired by Gift

On the date of gift, compare FMV of property to the donor’s basis.

If FMV > donor’s basisBasis in the property is the donor’s basis

plus any gift tax paid on net appreciation

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Basis of Property Acquired by Gift (continued)

Basis of Property Acquired by Gift (continued)

If Donor’s basis > FMV Basis is determined when property is

eventually soldIf 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)

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Holding Period for PropertyAcquired by Gift

Holding Period for PropertyAcquired 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

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Basis of Property Acquired by Inheritance

Basis of Property Acquired by Inheritance

Three dates are important Primary valuation date is the date of

deathAlternate valuation date is six months

after the date of deathDistribution date is the date a

beneficiary receives the property

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Basis of PropertyAcquired by Inheritance

(continued)

Basis of PropertyAcquired 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 dateBasis is the FMV of the property on the

earliest date received, either Date of distribution, or Alternate valuation date

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Holding Period of Property Acquired by Inheritance

Holding Period of Property Acquired by Inheritance

The holding period for property acquired by inheritance is automatically

long term.

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Basis in Property Converted From Personal to Business

Use

Basis in Property Converted From Personal to Business

UseOn the date of conversion, compare the asset’s personal-use basis to its FMV.

If FMV > personal basisPersonal basis is used for depreciation and

gain or loss calculations

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Basis in Property Converted From Personal to Business

Use

Basis in Property Converted From Personal to Business

Use If Personal basis > FMV

Use FMV for depreciationBasis 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

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Basis in SecuritiesStock Dividends

Basis in SecuritiesStock 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.

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Basis in SecuritiesWash Sales

Basis in SecuritiesWash Sales

Loss is not deductible under the substance-over-form doctrine

Nondeductible 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.

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End of Chapter 9End of Chapter 9