Week 4 Project
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Chapter12.pptxFundamentals of Taxation 2020 Edition Cruz, Deschamps, Niswander, Prendergast, Schisler
Chapter 12
Special Property Transactions
“A fool and his money are soon parted.
It takes creative tax laws for the rest.”
--- Bob Thaves (“Frank & Ernest”)
© 2020 McGraw-Hill. All rights reserved. Authorized only for instructor use in the classroom.
No reproduction or further distribution permitted without the prior written consent of McGraw-Hill.
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Learning Objective #1 Like-Kind Exchange Rules
Three criteria for a like-kind exchange:
There must be an exchange;
The property transferred and the property received must be held for productive use in a trade or business or for investment;
The property must be like-kind.
Exchange rules are not elective.
After 2017, like-kinds exchanges only apply to real estate.
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The like-kind exchange rules are not elective. If the three criteria are met, the exchange rules must be used.
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Learning Objective #1 Like-Kind Exchange 1
Dealer does not qualify for like-kind exchange treatment.
Only real property (land and buildings) used in a business or held for investment can receive like-kind treatment.
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Dealers in a product (e.g., a real estate broker) can never exclude gains by using the like-kind rules.
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Learning Objective #1 Like-Kind Exchange 2
What is a like-kind asset?
Same nature or character.
Grade or quality does not matter.
Boot Property – any extra consideration given or received other than the like-kind property.
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A like-kind asset does not have to be an exact duplicate to qualify as a like-kind exchange. “Boot” property is any property given or received in addition to the like-kind asset – usually cash.
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Learning Objective #1 Like-Kind Exchange 3
Recognized gain is the lesser of:
The F M V of the boot received; or
The realized gain on the exchange.
Receipt of boot causes recognition of gain.
Giving boot does not cause gain recognition.
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With like-kind exchanges, gain is recognized to the lesser of the realized gain or the boot received. Giving of boot does not trigger gain recognition.
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Learning Objective #1 Like-Kind Exchange 4
Basis calculation of property received:
Basis of property given.
Plus basis of boot given.
Plus gain recognized.
Less boot received.
Or, F M V of property received less deferred gain.
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The easiest method to calculate basis of the property received is to take the FMV of the property received and subtract any deferred gain. It is a nice check to calculate basis both ways.
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Learning Objective #1 Like-Kind Exchange 5
Time period:
45 days to locate replacement property;
180 days to receive replacement property.
Liabilities assumed:
Release of a liability is considered boot received.
Presence of a liability can trigger gain.
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Like-kind exchanges have limited time periods to first locate the replacement property and then to actually receive the property. The assumption of liability adds complexity to the transaction and could possibly cause the recognition of gain. Release of a liability is treated as boot received.
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Learning Objective #1 Like-Kind Exchange Concept Check 12-1
With a correctly executed like-kind exchange, gain is never recognized unless the taxpayer receives boot. True or false?
True
For a transaction to qualify for a like-kind exchange, an exchange of assets must occur and the assets must be held for trade or business use or investment and be like-kind assets. True or false?
True
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Learning Objective #1 – Concept Check 12-1
A taxpayer has 180 days after relinquishing his or her property to identify a replacement property. True or false?
False
The basis in the replacement property is typically the F M V of the property received less the gain postponed. True or false?
True
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Learning Objective # 2 – Involuntary Conversions 1
Property is destroyed, stolen, condemned and the taxpayer receives similar property or proceeds.
Defer entire gain – replacement property must be purchased for an equal or greater amount than the proceeds.
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A taxpayer can defer a gain caused by an involuntary conversion. The most common involuntary conversion happens when insurance proceeds for a casualty (fire, storm, etc.) exceed the basis of the property.
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Learning Objective # 2 – Involuntary Conversions 2
Replacement Property:
Similar or related in service or use.
More restrictive than the “like-kind” test.
Real property can only be “like-kind.”
Replacement Period:
Two years after the close of tax year.
Three years for real business property.
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Just like like-kind exchanges, there is a limited amount of time to replace property that has been involuntarily converted.
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Learning Objective # 2 – Involuntary Conversions 3
Basis of replacement property:
Basis of converted property.
Less money not used to replace.
Plus money reinvested in excess of proceeds.
Plus gain recognized.
Less loss received.
Holding Period – holding period of replacement property includes holding period of property converted.
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Typically, the basis of the replacement property is the basis of the old property less any money not used to replace the property plus any gain that was recognized.
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Learning Objective #2 – Concept Check 12-2 1
Assume the following facts to answer the following questions. A fire destroyed Andrew’s building used in his wood working business. He had purchased the building several years ago for $75,000 and it now has a $50,000 adjusted basis.
Andrew received $105,000 in insurance proceeds for the replacement cost. If Andrew does not replace the building, what is his taxable gain?
$55,000
Assuming the same facts as above, how many years does Andrew have to replace the building in order to deferred any recognized gain?
3 years – it is business real property
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Learning Objective #2 – Concept Check 12-2 2
Assuming the same facts as above, how much gain would Andrew be required to recognize if he replaced the building (within the replacement period) with another building costing $95,000?
$10,000.
Assuming the same facts as above, how much gain would Andrew be required to recognize if he replaced the building with another building costing $115,000?
$0.
Assuming the same facts as number 4 above, how much would Andrew’s basis be in the new building?
$60,000
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Learning Objective #3 – Installment Sales 1
A disposition of property where at least one payment is to be received after the year of sale.
Installment payments consist of three components:
Interest income.
Return of basis.
Gain on the sale.
Gross Profit Percentage = gross profit divided by contract price.
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The installment sale method allows the taxpayer to spread the gain of a property sale over several years if the receipt of the sales price is collected over several years.
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Learning Objective #3 – Installment Sales 2
Dealers cannot use the installment method.
The installment method cannot be used on the sale of publicly traded stock.
Any depreciation recapture is recognized in the year the asset is disposed of.
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One important aspect of installment sales is that these rules do not apply to dealers. Also, the installment sales cannot be used on sales of publicly traded stock.
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Learning Objective #3 – Concept Check 12-3 1
Tamaria sold a tract of land for $30,000. The land has a basis of $18,000 and she incurred $2,000 of selling expenses. Tamaria received $5,000 down and will receive five additional annual payments of $5,000 each. What is Tamaria’s gross profit percentage on the sale?
a. 33.3%
b. 60.0%
c. 66.7%
d. 100.0%
Answer: A
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Learning Objective #3 – Concept Check 12-3 2
Assume the same facts as above, how much income will Tamaria recognize in year 2 when she receives the first additional payment of $5,000?
a. $0.
b. $1,667.
c. $3,335.
d. $5,000
Answer: B
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Learning Objective #4 – Sale of Residence 1
Married taxpayers can exclude up to $500,000 ($250,000 single) of the gain on the sale of their personal residence.
This provision is an exclusion, not a deferral of gain.
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Most gains on the sale of personal residences are now completely excluded from tax. For married taxpayers, the maximum gain that can be excluded is $500,000.
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Learning Objective #4 – Sale of Residence 2
During a five-year period before the sale, the taxpayer must satisfy:
Ownership Test – owned the home for at least two years.
Use Test – lived in the home as the main home for at least two years.
The tests do not have to be continuous.
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Typically, a taxpayer can exclude the gain from a sale of a personal residence every two years. The taxpayer must pass the ownership and use tests.
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Learning Objective #4 – Sale of Residence 3
Exclusion applies to only one sale every two years.
If for health or employment reasons, a reduced exclusion is available for a second sale based on the ratio of days owned divided by 730.
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In special situations, a reduced exclusion is available for a second sale within two years if the sale is caused by health or employment reasons.
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Learning Objective #4 – Concept Check 12-4
If married taxpayers live in their personal residence for more than two years, the couple can exclude the gain on the sale of their residence up to $500,000. True or false?
True
A taxpayer cannot exclude any gain on the sale of a residence if he or she has lived there less than two years. True or false?
False
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Learning Objective #4 – Concept Check
Sharon and Johnny were recently married and Sharon moved into Johnny’s house. Sharon then sold her home and took the exclusion. Since Sharon took the exclusion, Johnny must forfeit his exclusion if he were to sell his home within the next two years. True or false?
False
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Learning Objective #5 – Related-Party Losses & Wash Sales 1
Losses on sales between related parties are disallowed.
Related parties include family members and more than 50% owned entities.
Constructive ownership rules apply.
The loss disallowance does not affect the basis of the property to the buyer.
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Learning Objective #5 – Related-Party Losses & Wash Sales 2
Wash sale rules disallow a tax loss where the ownership of a company is not reduced.
A wash sale occurs if essentially the same stock is purchased 30 days before or 30 days after the sale.
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Wash sale rules disallow a tax loss where the ownership of a company via stock did not actually change. If a taxpayer sells a stock for a loss on December 31 and then repurchases the same stock within 30 days, the loss is not allowed in the December tax year.
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Learning Objective #5 – Concept Check 12-5 1
Leslie sold 500 shares of Bluff Co. stock to her brother for $5,000. Leslie purchased the stock three years ago for $7,000. How much of the loss can Leslie deduct on her tax return in the current year?
Answer: $0
Would the answer to Question 1 change if Leslie had sold the stock to Leslie Co. instead of to her brother? Explain assuming the following facts.
a. Leslie owns 25% of the outstanding stock in Leslie Co.
b. Leslie owns 75% of the outstanding stock in Leslie Co.
Answer: a. Leslie could deduct $2,000 in capital losses.
Answer: b. $0
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Learning Objective #5 – Concept Check 12-5 2
What is the purpose of the wash sale rules?
Answer: The purpose of the wash sale rules is to disallow a tax loss where the ownership of a company is not reduced. Thus, if a taxpayer buys similar stock within 30 days (before or after) of a stock sale, any loss on the sale is disallowed.
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