chapter-10-1a- property- acquisition howard godfrey, ph.d., cpa professor of accounting ©howard...
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Chapter-10-1A-Property-
Acquisition Howard Godfrey, Ph.D., CPA
Professor of Accounting ©Howard Godfrey-2015
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Basis: Cost Recovery Adj. Basis. Depreciation [2: 39]
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Use of PropertyProperty is classified by both its use
and its type.
Property is used for 1. Trade or business,
2. Production of income (investment), or
3. Personal purposes
The same property (an auto) may be used differently by different taxpayers.
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Types of Property• All property may be classified by type as
either tangible or intangible–Intangible property lacks physical
substance and has only an economic existence–Tangible 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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Basis of Property • Basis is the taxpayer’s unrecovered
investment in an asset that can be recovered without tax cost• As the asset’s basis is recovered
(through depreciation, depletion or amortization deductions), basis is reduced and is called adjusted basis
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Basis of Property • The original basis of an asset includes–Cash plus fair market value of property
given up by the buyer–Money borrowed and used to pay for
the property–Liabilities of the seller assumed by the
buyer–Expenses of the purchase such as
attorney fees or brokerage commissions
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Capital Expenditures • The cost of a business asset with a
useful life extending beyond the current year (depending on the applicable rule) may be:–Deducted currently–Capitalized until disposal or–Capitalized with the cost allocated to
the years the asset’s use benefits (cost recovery period)
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Increases in BasisTwo categories of increases
Additional capital investments•Capital expenditures•Costs of defending ownership• Special assessments
Reinvestment of income from property• Taxable income from conduit entities
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Decreases in Basis• Three broad categories of decreases
Annual tax deductions for cost recovery•Depreciation, depletion or
amortization• Losses from conduit entities
Disposition of all or part of the property Capital recovery due to income exclusion
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What costs to capitalize – Best Co.Best Co. purchased a new machine with an invoice cost of $100,000. A 2% discount was received for early payment. Delivery charges were $500 for moving the machine to the factory owned by Best. The company paid $300 in wages to employees while installing the machine. What is the cost of this machine?a. $98,000 b. $100,000 c. $98,500 d. $98,800 e. $99,000
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Invoice cost $100,000
Less: 2% - early payment (2,000)
Delivery charges 500
Wages for installation 300
Cost of asset $98,800
What Costs to Capitalize
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Basket Purchase of Assets [4]
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Multiple Asset Purchase • If more than one asset is acquired in a
single transaction, the cost is apportioned to each using their relative fair market values (FMV)–If the purchase price exceeds the value
of the assets, the excess is goodwill• Alternatively, the buyer and seller can
agree to a written allocation of the purchase price to individual assets
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Company purchased for $540,000a building and land.
Appraised Seller's Value Original Cost
Land $200,000 $140,000Building 400,000 280,000 Total $600,000 $420,000
a. $140,000 b. $180,000 c. $200,000The land should be recorded at:
Lump-Sum Purchases
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Company bought building & land for $540,000.
Appraised Value Percent
Land $200,000 33.33%Building 400,000 66.67%Total $600,000 100.00%
$540,000$180,000
Lump-Sum Purchases
Cost of landTotal amount paid
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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 (owned in the corporation)
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Assets Converted from Personal to Business Use [4: 41]
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Basis in Property Converted From Personal to Business Use
On the date of conversion, compare the asset’s personal-use basis to its FMV.If FMV > personal basis–Personal basis is used for
depreciation and gain or loss calculations
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Basis in Property Converted From Personal to Business Use
If Personal basis > FMV–Use FMV for depreciation–Basis for sale is determined when the
property is sold• If sold for an amount > personal basis, use
personal basis: (gain)• If sold for amount < FMV, use FMV: (loss)• If sold for an amount between the two, no
gain or loss is recognized
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Basis of Converted Property If the property is converted from
personal use to business use, the basis for depreciation is the lesser of the property’s FMV or adjusted basis at the date of conversion–Prevents taxpayers from depreciating
the portion of the property’s decline in value that occurred while it was used for personal purposes
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Basis for Depreciation – Anne -1Anne purchased a condo unit for $125,000 last year. She used condo as a personal residence. In the current year, when the condo unit appraises at $132,000, Anne moves out and converts condo to rental property. What basis can Anne use when computing her depreciation on the rental condo unit?
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Basis for Depreciation – Anne -2
$125,000. Anne uses the lower of her basis or FMV at the date the condo is converted from personal to rental property.
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Adjusted basis of asset $40,000FMV of asset when converted 38,000 Deprecation taken 5,000 Selling Price 44,000
Basis for deprec. (loss basis)
Initial basis for gain
Depreciation taken
Adjusted basis for gain
Selling price
Gain on sale
Convert asset to businessor investment use.
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Adjusted basis of asset $40,000FMV of asset when converted 38,000 Deprecation taken 5,000 Selling Price 44,000 Basis for depreciation $38,000Initial basis for gain 40,000Depreciation taken (5,000)Adjusted basis for gain 35,000Selling price 44,000Gain on sale $9,000
Convert asset to businessor investment use.
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Assets acquired in Tax-Deferred Transaction [4: 40]
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Acquisition in Taxable Exchange • Basis of acquired asset equals
the FMV of the property given up or FMV of the services performed• Gain or loss is recognized as if
cash had been exchanged for the property surrendered
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Basis in Bargain Purchase-1• 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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Basis in Bargain Purchase-2Your employer purchased land a few
years ago for $30,000. Today it is worth $50,000. Your employer appreciates your fine work and sells the land to you for $45,000.
How much income do you recognize? What is your basis in the land?
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Basis in Bargain Purchase-3How much income do you recognize?$5,000What is your basis in the land?$50,000
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Asset Acquired in Tax-free Exchange-1• An individual (Jan) owns an office
building with a value of $500,000 and a basis after depreciation of $400,000 (cost $600,000 & accumulated deprec. of $200,000).• If Jan sells the building for cash (for it
FMV of $500,000) she will recognize again of $100,000.
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Asset Acquired in Tax-free Exchange-2• Assume the Jan trades the building for another
office building that is also worth $500,000,• Jan has a gain realized on the exchange of
$100,000.• The gain will not be recognized because this
qualifies as a like-kind exchange (rules covered in later chapter).
• The new building has a value of $500,000, but the Jan will have a basis of only $400,000 (the basis in the first building.
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Prop. received as Gift
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Basis of Asset Acquired by Gift (continued)If Donor’s basis > FMV• Basis is determined when property is
eventually sold–If sold for more than donor’s basis, use
donor’s basis (gain)–If sold for less than FMV on date of gift,
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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Jan’s Basis in Gift Received Jan received a gift of stock valued at $10,000. The stock had an adjusted basis of $6,000 to the donor. No gift tax was paid on the transfer. Several months later, Jan sold the stock for $11,000. What is Jan's gain or (loss) on sale?
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Basis of asset received as giftBasis to donor $6,000 FMV at date of gift $10,000 Basis for gain or lossSelling priceGain realized
Jan’s Basis in Gift Received
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Basis of asset received as giftBasis to donor $6,000 FMV at date of gift 10,000 Basis for gain or loss 6,000 Selling price 11,000 Gain realized $5,000
Jan’s Basis in Gift Received
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Dan’s Basis in Gift Received Dan received a gift of stock valued at $6,000. The stock had an adjusted basis of $10,000 to the donor. No gift tax was paid on the transfer. Several months later, Dan sold the stock for $5,000. What is Dan's gain or (loss) the sale?
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Basis of asset received as giftBasis to donor $10,000 FMV at date of gift $6,000 Basis for lossSelling priceGain (loss) realized
Dan’s Basis in Gift Received
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Basis of asset received as giftBasis to donor $10,000 FMV at date of gift 6,000 Basis for lossSelling price 5,000 Gain (loss) realized
Dan’s Basis in Gift Received
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Basis of asset received as giftBasis to donor $10,000 FMV at date of gift 6,000 Basis for loss 6,000 Selling price 5,000 Gain (loss) realized ($1,000)
Dan’s Basis in Gift Received
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Gift BasisGift received Facts Gain Loss
Basis to donor $11,000
FMV-date of gift $7,000
Selling price $8,000 $8,000
Basis for gain
Basis for loss
Gain (loss) realized
Dual Basis
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Gift BasisGift received Facts Gain Loss
Basis to donor $11,000
FMV-date of gift $7,000
Selling price $8,000 $8,000
Basis for gain $11,000
Basis for loss $7,000
Gain (loss) realized $0 $0
Dual Basis
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Holding Period for Asset Acquired 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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Acquisition by Gift Donee’s basis is the donor’s basis + portion of gift taxes due to appreciation (but total cannot exceed FMV at date of gift)Fraction for portion of gift tax:
FMV at gift date – Donor’s Basis FMV at gift date
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Donor made gift with FMV of$100,000 and a cost of $60,000. Donor paid gift tax of $20,000.FMV at date of gift $100,000
Basis to donor $60,000
Appreciation $40,000 Percentage appreciationGift Tax paidGift tax added to basisBasis to donee
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Donor made gift with FMV of$100,000 and a cost of $60,000. Donor paid gift tax of $20,000.FMV at date of gift $100,000 Basis to donor 60,000 Appreciation 40,000 Percentage appreciation 40%
Gift Tax paid $20,000 Gift tax added to basis $8,000 Basis to donee $68,000
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Gift Basis – David -1Ted bought stock for $18,000 five years ago. David received a gift of stock from Ted this year when the stock was worth $24,000. Ted paid $2,000 of gift taxes on the gift. What is David’s basis for the stock?
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Gift Basis – David -2$18,500. David uses Ted’s basis increased by a portion of the gift tax related to the appreciation on the gift determined as follows:$2,000 gift tax x [($24,000 -$18,000)/$24,000] = $500 gift tax related to appreciation.$18,000 carryover basis from donor + $500 gift tax
= $18,500.
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Gift Basis – Ellen -1Ellen received a gift of stock from Gisela this year when the stock was worth $50,000. Gisela purchased the stock for $60,000 four years ago. Calculate Ellen’s basis for the stock if she sells it:a. for $65,000? b. for $45,000? c. for $55,000?
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Gift Basis – Ellen -2a. $60,000. The donor’s basis is always used to determine a gain.b. $50,000. Fair market value (when it is lower than the donor’s basis) is used to determine basis for loss.c. $55,000. When the selling price is between the donor’s basis and the lower fair market value, there is no gain or loss. Effectively, basis equals the selling price.
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InhertedProperty
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Acquisition by Inheritance • Use date-of-death Fair
Market Value as basis for inherited property (or alternate valuation date, if elected)
WillWill
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Basis of Property Acquired by Inheritance
•Three dates are important –Primary valuation date is the date of
death–Alternate valuation date is six
months after the date of death–Distribution date is the date a
beneficiary receives the property
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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 date–Basis is the FMV of the property on the earliest
date received, either• Date of distribution, or• Alternate valuation date Holding period for inherited asset is long term
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Cost of land to decedent. 5,000
Value of land-date of death. 8,000 Value - 6 mo. after death. 11,000 Heir's selling price of land. 15,000
Valuation date chosen DeathBasis for gain or lossSelling price
Gain or (Loss) for Heir
Inherited Property
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Cost of land to decedent. 5,000 Value of land-date of death. 8,000 Value - 6 mo. after death. 11,000 Heir's selling price of land. 15,000
Valuation date chosen DeathBasis for gain or loss 8,000 Selling price 15,000
Gain or (Loss) for Heir 7,000
Inherited Property
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The End