Chap-3-1C- Property Disposition Howard Godfrey, Ph.D., CPA Professor of Accounting ©Howard...

Chap-3-1C-Property

Disposition Howard Godfrey, Ph.D., CPA

Professor of Accounting ©Howard Godfrey-2016

Amount realized from dispositionless: Adjusted basis of property

Realized gain (loss)less: Gain deferral (not recognized)

Recognized gain (loss)

Property Disposition

Amount RealizedAmount realized is gross sales price less

selling expenses.– Gross sales price is the amount received

by the seller from the buyer and includes:• Cash and FMV of property or services received• Seller’s debt assumed by or paid by the buyer– Gross sales price is decreased by amounts

given to the buyer by the seller:• Buyer’s expenses paid by or assumed by seller

Effect of Debt Assumption• Assumption of debt is treated as a

realization of income similar to paying or receiving cash–Assumption of the seller’s debt

increases sales price (as if buyer paid cash)–Assumption of debt by the seller

decreases the sales price (as if buyer received cash)

Types of Dispositions • Sale – seller receives cash or cash

equivalents in return for asset• Exchange – taxpayer receives property

other than cash or cash equivalents in return for property transferred to the other party

• Involuntary conversion – complete or partial destruction due to events not under control of taxpayer (condemnations, thefts, and casualties)

• Abandonment – property is permanently withdrawn from use (loss = basis of asset)

+ Cash Received+ FMV of property received + Seller’s liabilities assumed by the buyer

- Buyer’s liabilities assumed by the seller

- Selling expenses

= Amount Realized

Amount Realized

Recognized Gain or Loss • Almost all realized gains are

recognized (taxable)• Losses are usually only recognized

(deductible) if they are– Incurred in a business– Incurred in an investment activity– Casualty or theft losses

Allan’s Gains and Losses-1Allan received $5,000 cash and an auto worth $15,000 in exchange for a lot that was encumbered by a $13,000 liability that the buyer assumed. a. What is the amount realized on this sale? b. If Allan had a basis of $34,000 in the land, what is his gain or loss on the sale?

Allan’s Gains and Losses-2c. If Allen has owned the land for five years as an investment, what is the character of the gain or loss?

d. How would your answer to (c) change if the land had been used by Allan’s business as a parking lot?

Allan’s Gains and Losses-3a. $5,000 + $15,000 + $13,000 = $33,000 amount realized.b. $33,000 - $34,000 = $1,000 lossc. Long-term capital loss.d. If the property had been used in a business, it would be Section 1231 property and it would be a Section 1231 loss.

Cash received 5,000$ Other Prop. Received- Auto 15,000 Mortgage assumed by buyer 13,000 Total Consideration Received 33,000 Expenses of sale

Sales commission - Other selling expenses -

Total expenses of sale - Amount Realized 33,000 Cost (basis) of property (34,000)Gain (Loss) (1,000)$

Allan's Transactions

Adjusted Basis: [3] Gifts [3: 36, 37] Inherited property [3: 33] Property converted [3] from personal use

Realized gain or [5: 35]

loss on disposition Recognize gain or [6: 37, 67]

loss (on tax return)

Ordinary Asset [7: 39] Capital Asset Sec. 1231 asset

Slides covering textbook pages 7-20 for Chapter 11 are in a separate file.

Like-Kind Exchange General rule - recognize Sec. 1031-Defer recognition unless boot is received [20: 56]

New asset basis [28: 60]

Concept ReviewUnder all-inclusive income and realization concepts, gains should be recognized as taxable only if realized.A realized gain or loss on disposition of property may be deferred from recognition.Recognition is postponed, not forgiven.

Concept Review• Substance-over-form doctrine

accepts that a trade of assets between taxpayers is a continuation of the asset• If taxpayers have a continuation of

assets, they do not have the wherewithal-to-pay tax

Similarities• All amounts realized must be

reinvested• Gains are deferred, not losses–Exception for like-kind exchanges

• Gain recognized is never more than gain realized

Similarities Deferral is accomplished through

basis adjustment Basis of replacement property is

decreased by deferred gains Basis of replacement property is

“sometimes” increased by deferred losses

Tax attributes carryover to replacement property

2. Like-Kind Exchanges and others

Value received:Cash receivedOther assets receivedDecrease in our debtTotal value received

Basis Given:Cash givenOther assets givenIncrease in our debtTotal basis given

Gain realizedGain Recognized

Formula for Gain or loss

Basis - New Asset Amount

Basis of Old Asset Add: Boot Paid Less: Boot Received Add: Gain Recognized Less: Loss Recognized Basis - New Asset

Basis - New Asset- Method 2 Amount

FMV of Asset Received

Less: Gain not Recognized

Add: Loss not Recognized

Basis - New Asset

Loss is recognized in some transactions.

FMV of Prop. Receivedminus: Deferred Gainplus: Deferred Lossequals: New Basis

Like-Kind Exchanges Basis of Property Received

Tax-Deferred Exchanges• A tax-deferred exchange postpones gain

or loss recognition to the future by adjusting basis of the asset acquired– The longer gain recognition can be

postponed the greater the tax savings– The longer a loss is postponed the

less valuable the loss– A Tax-free exchange defers gain or

loss indefinitely

Like-Kind Exchanges• Taxpayers must defer gain or loss realized on

the exchange of like-kind property. Deferral is not elective.

• Like-kind property is property of the same nature, class, or character held for investment or used in a trade or business

• Some property (boot) is never considered like-kind– Inventory, securities, currency, realty

outside the U.S., partnership interests, intangibles, personal-use property, and livestock of different sex

Basis Adjustments• Gain is deferred by reducing the adjusted

basis of the replacement property by the deferred gain

• Loss is deferred by increasing the adjusted basis of the replacement property by the deferred loss

• When the replacement asset is sold at a later date, the basis adjustment results in the deferred gain or loss being recognized (by changing amount of gain or loss)

Basis • Carryover basis – the basis of the original asset

follows the asset to the new owner• Substituted basis – the basis of the original

asset is substituted for the basis of the asset acquired

• Holding period of the old asset is added to the holding period of the new asset when basis is determined by carryover, substitution or basis adjustment

• Depreciation recapture potential carries over.

Qualifying Like-Kind Exchanges • Realty must be exchanged for realty (can be

land or buildings)• Personalty must be exchanged for personalty in

same class• General asset classes for personalty include

– Office furniture, fixtures & equipment– Computers & info systems equipment– Automobiles & taxis– General-purpose light trucks– General-purpose heavy trucks

Boot’s Effect on a Like-Kind Exchange• The receipt of boot can

cause realized gain to be recognized

• Boot is anything that is not eligible like-kind property and includes– Cash– Properties not of a like-kind– Net liabilities discharged in the

transaction

Determining Basis in Like-Kind Exchanges• Basis in replacement property = FMV of

property received less deferred gain, plus deferred loss

• Alternatively, basis in replacement property = basis of property surrendered plus boot given, plus gain recognized less boot received– Holding period for new property includes

holding period of property surrendered• Basis of Boot = FMV– Holding period begins on date received

Indirect Exchange• In an indirect exchange, the taxpayer

hires a third party to purchase the desired property

• The third party then exchanges the just-purchased property for the taxpayer’s property

• The taxpayer has a qualifying exchange• The seller of the property and the third

party have taxable transactions

Nonsimultaneous Exchange• A taxpayer can sell his property, but a third

party must hold all proceeds so that the taxpayer has no access to any cash or other property received in the sale– The taxpayer has 45 days from the date

the property is transferred to identify like-kind property to be exchanged

– The acquisition of the identified property must be completed within 180 days

Like-Kind Exchanges Effect of BootIf boot is included as part of an exchange–When boot is received, a taxpayer has

the wherewithal-to-pay and must recognize a gain up to the amount of boot –When boot is given, no recognition is

triggeredLiabilities assumed are treated as cash

given or received

Like-Kind Exchanges Between Related Parties

• Replacement property must by held for two years after exchange• Disposal within the two years

will trigger gain recognition

Like-Kind Exchange Planning• Taxpayers with loss assets may want

to sell them so they can deduct their losses in the current year, then buy replacement property

• Alternatively, taxpayers can receive cash tax-free in an exchange if there is a realized loss, as boot can be received without causing gain recognition

Exchanges-Not Like-Kind Ben paid $30,000 for land that is needed by IBM. Ben owes $8,000 on a mortgage on the land. IBM will trade IBM stock worth $100,000 for the land and will assume the mortgage of $8,000. How much is the gain to be recognized by Ben as a result of this exchange?

Asset Exchange by Ben Amount

Value - IBM Stock received

Ben's debt assumed by buyer

Amount Realized by Ben

Basis of Property Given

Gain (Loss) Realized

Gain (Loss) Recognized

Asset Exchange by Ben Amount

Value - IBM Stock received $100,000

Ben's debt assumed by buyer $8,000

Amount Realized by Ben $108,000

Basis of Property Given $30,000

Gain (Loss) Realized $78,000

Gain (Loss) Recognized $78,000

Basis - New Asset Amount

Basis of Old Asset $30,000

Add: Boot Paid

Less: Boot Received ($8,000)

Add: Gain Recognized $78,000

Basis - New Asset $100,000

Basis - New Asset - 2 Amount

FMV of Asset Received $100,000

Less: Gain not Recognized



Exchanges – Not Like-Kind The Post and Rail Partnership traded farm land with an adjusted basis of $4,000 and a FMV of $9,000 for a farm tractor that has a FMV of $8,000 and cash of $1,000. What is the recognized gain or loss?

Exchange - Post & Rail Amount

Value of asset received $8,000 Cash Received 1,000

Amount Realized 9,000 Basis of Asset Given 4,000

Gain (loss) Realized 5,000 Gain (Loss) Recognized $5,000

Like-Kind Exchanges Fred traded a tractor used solely in his construction business for another tractor for the same use. On the date of the trade, the old tractor had an adjusted basis of $3,000 and a FMV of $3,300. He received in exchange $200 in cash and a smaller tractor with a FMV of $3,100. Fred should report a gain on the exchange of: _____

Exchange - Fred Amount

Value of asset received Cash Received

Amount Realized Basis of Asset Given

Gain (loss) Realized Gain (Loss) Recognized

Exchange - Fred Amount

Value of asset received $3,100 Cash received 200

Amount Realized 3,300 Basis of asset given 3,000

Gain (loss) Realized 300 Gain (Loss) Recognized $200

Like-Kind Exchanges-Andee Andee Partnership traded its panel truck with an adjusted basis of $10,000 and MV of $12,000 for a pick-up truck with FMV of $7,000. Andee also received $5,000 cash on the trade. What is the gain, if any?

Exchange - Andee Amount

Value of asset received $7,000 Cash Received

Amount Realized Basis of Asset Given

Gain (loss) Realized Gain (Loss) Recognized

Exchange - Andee Amount

Value of asset received $7,000 Cash Received 5,000

Amount Realized 12,000 Basis of Asset Given 10,000

Gain (loss) Realized 2,000 Gain (Loss) Recognized $2,000

Like-Kind PropertyWhich of the following examples of property may qualify for a like-kind exchange?a. Inventories b. Rental house c. Accounts receivabled. Raw materialsIRS - 1995

Like-Kind Exchange Problem Tony traded a business truck with adjusted basis of $5,000 and a FMV of $9,000, for another truck having a FMV of $12,000. In addition, he paid cash of $3,000. What is Tony's basis in the truck?

FMV - asset received $12,000

Basis of Asset Given Cash Given

Total Consideration given Gain (Loss) Realized Gain (Loss) Recog.

Like-Kind Exchange Gain Recognized

FMV - asset received $12,000

Cash Given 3,000 Basis of Other Asset 5,000

Total Consideration given 8,000 Gain (Loss) Realized 4,000

$0

Like-Kind Exchange Gain Recognized

Gain (Loss) Recognized

Basis - New Asset Amount Basis of Old Asset $5,000 Add: Boot Paid $3,000 Less: Boot Received Add: Gain Recognized Basis - New Asset $8,000

Basis-New Asset- Method 2 Amount


Less: Gain not Recognized (4,000)



Like-Kind Exchange Problem Mike exchanges business equipment with FMV of $100,000 and an adjusted basis of $90,000 for $4,000 cash and like-kind business equipment with a FMV of $96,000.

What is M's recognized gain and basis of new asset?

Mike Amount

FMV-Asset Received $96,000 Cash Received $4,000

Amount Realized $100,000 Basis of Asset Given $90,000

Gain Realized $10,000 Gain Recognized $4,000

Basis - New Asset Amount Basis of Old Asset $90,000 Add: Boot Paid $0 Less: Boot Received ($4,000) Add: Gain Recog. $4,000 Basis - New Asset $90,000

Basis - New Asset- Method 2 Amount


Less: Gain not Recognized ($6,000)



Involuntary Conversion: Recognize loss Gain not recognized [29: 62]

Basis of new asset [32: 62]

Involuntary ConversionsTaxpayers may “elect” to defer gain realized on involuntary conversions if the property–Is replaced within two tax years–At a cost at least equal to the amount

realized from the conversion–With prop. that is “similar or related in

use”• Gain occurs if insurance proceeds or

payment from a government exceeds the property’s basis.

Involuntary Conversions • An involuntary conversion results from–Theft – embezzlement, larceny and

robbery (but not simply losing items)–Casualty – requires a sudden, unexpected,

and unusual event such as a fire, flood, tornado, hurricane or vandalism–Condemnation – lawful taking of property

for its fair market value by a government under the right of eminent domain

Casualty and Theft Losses• For personal use property, the loss is

limited to the lesser of:1. Decline in fair market value (or repair costs

to restore property to pre-casualty condition)

2. The adjusted basis of the property (for business property that is completely destroyed, the loss is always the property’s adjusted basis)

• This loss is then reduced by any insurance proceeds received

Casualty &Theft Loss Deductions• Thefts are deductible in year of discovery• For casualties in designated disaster areas,

taxpayer can elect to deduct loss in preceding year

• A net business loss is deducted from ordinary income; an investment loss is a miscellaneous itemized deduction

• Individuals have additional limits on losses from personal-use property:–$100 floor per casualty (per event) –10% of AGI threshold–Must itemize to deduct loss

Gains on Involuntary Conversions• If the insurance recovery on a

casualty or theft is greater than the loss, the taxpayer has a gain• Condemnations usually result in

gain because proceeds received are often based on fair market value of property lost.

Gains on Involuntary Conversions• If all proceeds are used to acquire qualified

replacement property (or repair the property to its pre-casualty condition) within the required replacement period, the gain is deferred

• Gain may have to be recognized if all proceeds are not used to acquire replacement property (or make repairs to the damaged property) within the required time period

Replacement Period • Extends 2 full tax years after the end

of the taxable year in which the involuntary conversion occurs

• Extended to 3 years if the involuntary conversion involves the condemnation of business or investment realty

Involuntary ConversionsQualified Replacement Property

• Replacement property must meet a strict “functional-use” test–Must perform the same function as the

converted property –Condemned real property must meet

only the easier like-kind test• Replacement property may be bought or

built

Involuntary ConversionsRecognition and Basis

• Gain recognized = amount realized - replacement cost

• Loss recognized = converted property’s basis - amount realized

• Replacement property’s basis =replacement cost - gain deferred

Involuntary Conversions Paul's business building is destroyed in a fire. Paul's adjusted basis was $50,000, and its FMV is $103,000. Paul receives insurance reimbursement of $100,000. In that same year, Paul invests $78,000 in another business building. If an election is made, what is Paul’s recognized gain & basis of new property.

1 Proceeds $100,000 $100,0002 Adjusted Basis ($50,000)3 Gain Realized $50,0004 Cost of New5 Proceeds not reinvested6 Gain Recog. (Lesser of 3 or 5)7 Gain Deferred8 New Basis (Line 4 less Line 7)

Involuntary Conversion

1 Proceeds $100,000 $100,0002 Adjusted Basis ($50,000)3 Gain Realized $50,0004 Cost of New $78,0005 Proceeds not reinvested $22,0006 Gain Recog. (Lesser of 3 or 5) $22,0007 Gain Deferred $28,0008 New Basis (Line 4 less Line 7) $50,000


Involuntary ConversionPam's business building is destroyed in a fire. Pam's adjusted basis in the building is $50,000, and its FMV is $103,000. Pam files received an insurance reimbursement of $100,000. In that same year, Pam invests $101,000 of in another business building. If an election is made, what is Pam’s recognized gain and basis of new property?

1 Proceeds $100,000 $100,0002 Adjusted Basis ($50,000)3 Gain Realized $50,0004 Cost of New $101,0005 Proceeds not reinvested $06 Gain Recog. (Lesser of 3 or 5) $07 Gain Deferred ($50,000)8 New Basis (Line 4 less Line 7) $51,000


Installment sales: Profit percentage Defer recognition [32: 63]

Limit: related party

Installment Method• Gain is recognized proportionately as

proceeds from sale are received• Use severely restricted – generally

available for casual sales only (excludes sales of inventory and securities. Limits for depreciable property)

• May not want to use if–Marginal tax rate is expected to increase–Unused losses are expiring

Installment MethodComputing the gain recognized:–Gain recognized each year is dependent on

the payments received during the year –Recognized Gain =

(Total gain/contract price) X Payments Received

–Total gain = selling price less selling expenses less adjusted basis of property–Contract price = Sales price less liabilities

assumed by buyer • Generally is equal to amount (other than interest)

seller will receive from purchaser

Selling price $100,000Mike's adjusted basis 60,000Down payment (1-1-2015) 20,000Sue's payment (1-1-2016) 40,000Sue's payment (1-1-2017) 40,000

Mike's capital gain in 2015?

Mike's Installment Sale [1]Mike sold land to Sue on 1-1-2015.

Sue also pays applicable interest.

a. $8,000 b. $12,000 c. $20,000

Selling price $100,000Mike's adjusted basisGross ProfitGross Profit PercentageCollections in 2015Capital gain for 2015

Mike's Installment Method [2]

Selling price $100,000Mike's adjusted basis 60,000Gross Profit 40,000Gross Profit Percentage 40%Collections in 2015 20,000Capital gain for 2015 $8,000

Mike's Installment Method [3]

Continue preceding slideAssume the taxpayer is a Mike

Corporation and the tax rate is 40%.

What is the balance in the deferred tax asset or liability account (related to this transaction) at year-end?

Asset or liability?

Bold Co. Installment Sale [1]On 1-1-2015, Bold, Inc., sold for $800,000 a parcel of land which it owned for five years. The land had a basis of $700,000. Under the agreement $200,000 of the selling price plus appropriate interest will be received each year for four years, beginning on 12-31-2015. The amount of gain reported on the installment basis for 2015 is:a. $100,000 b. $75,000 c. $25,000 d. $15,000 e. none of these

On 1-1-2015, Bold, Inc. sold land on installment basis. Selling Price $800,000Basis of land 700,000Profit on sale 100,000Profit % Payment in 2015Profit for 2015

Bold Co. Installment Sale [2]

On 1-1-2015, Bold, Inc. sold land on installment basis. Selling Price $800,000Basis of land 700,000Profit on sale 100,000Profit % 12.50%Payment in 2015 $200,000Profit for 2015 $25,000Answer C

Bold Co. Installment Sale [3]

Sale to Related Party• Losses on sales to related parties are

disallowed– Related parties include brothers, sisters,

spouse, ancestors and lineal descendents, as well as a more-than 50% owned corporation

• If related buyer later sells property at a gain, this gain can be reduced (not below zero) by the seller’s previously disallowed loss

Loss on Sale to Relative - 1In April 2015, Pam sold stock with a cost basis of $17,000, to Lisa, her sister, for $10,000. In September 2015, Lisa sold the same shares of stock to her neighbor, Niki, for $20,000. What is Lisa's gain for 2015?a. $0 b. $3,000 c. $7,000 d. $10,000

Price received by Pam $10,000Pam's basis in stock 17,000Loss realized by PamLoss Disallowed on sale by PamLoss recognized by Pam

Loss on Sale to Relative - 2

Price received by Pam $10,000Basis to Pam 17,000Loss realized by Pam (7,000)Loss Disallowed on sale by Pam (7,000)Loss recognized by Pam $0


Price received by LisaBasis to LisaGain realized by LisaLess Loss Disallowed on sale by PamGain recognized by Lisa


Price received by Lisa $20,000Basis to Lisa 10,000Gain realized by Lisa 10,000Less Loss Disallowed on sale by Pam (7,000)Gain recognized by Lisa $3,000


Chap-3-1C- Property Disposition Howard Godfrey, Ph.D., CPA Professor of Accounting ©Howard...

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Transcript of Chap-3-1C- Property Disposition Howard Godfrey, Ph.D., CPA Professor of Accounting ©Howard...