Chapter 13

Property Transactions:
Determination of Gain or Loss,
Basis Considerations, and
Nontaxable Exchanges
Comprehensive Volume
2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Big Picture (slide 1 of 4)

Alice owns a house that she inherited
from her grandmother 7 months ago.
The fair market value of the house at the date of
her grandmothers death was $475,000.
Her grandmothers basis for the house was
$275,000

The house currently is worth $600,000.

The Big Picture (slide 2 of 4)

Alice is considering two options.
The first is to give the house to her son,
Michael.
Michael, his wife Sandra, and their
daughter Peggy would live in the house.

The second option is to sell the house.

Projected selling expenses would be
about 7% of the selling price.
3

The Big Picture (slide 3 of 4)

Alice would also like to know the tax consequences
of selling her boat.
She paid $22,000 for the boat 4 months ago and has used it
exclusively for personal use.
Based on listings in the area, she anticipates that she can
sell it for $20,000 to $23,000.

In addition, earlier this year Alice sold some stock at

a realized loss of $2,000 and subsequently
repurchased some shares of the same stock for
$7,000.

The Big Picture (slide 4 of 4)

Alice also has owned a building (adjusted basis
$50,000) used in her business that was recently
destroyed by a fire.
The insurance company paid Alice $100,000 to compensate
her for the loss.
Now she is looking to acquire suitable replacement property.

If possible, she would like to claim a casualty loss, but does

not want to recognize any taxable gain from this event.

She has asked you about the tax consequences of

these transactions.
Read the chapter and formulate your response.

Determination of Gain or Loss

(slide 1 of 7)

Realized gain or loss

Difference between amount realized from sale or
other disposition of the asset and its adjusted basis
Sale or other disposition
Includes trade-ins, casualties, condemnations, thefts,
bond retirements

Determination of Gain or Loss

(slide 2 of 7)

Amount realized from disposition

Total consideration received, including cash, FMV
of property received, mortgages/loans transferred
to buyer
Fair market value (FMV): Value of asset determined by
arms-length transaction, i.e., amount set by transaction
between willing buyer and seller with neither obligated
to enter into transaction

Reduced by any selling expenses

Determination of Gain or Loss

(slide 3 of 7)

Adjusted basis
Original cost (or other adjusted basis) plus capital
additions less capital recoveries

Determination of Gain or Loss

(slide 4 of 7)

Capital additions
Cost of improvements and betterments to the
property that are capital in nature and not currently
deductible

Determination of Gain or Loss

(slide 5 of 7)

Capital recoveries
Amount of basis recovered through:

Depreciation or cost recovery allowances

Casualty and theft losses (and insurance proceeds)
Certain corporate distributions
Amortizable bond premium
Easements

10

Determination of Gain or Loss

(slide 6 of 7)

Recognized gain or loss

Amount of realized gain (loss) that is included in
(deducted from) gross income

11

Determination of Gain or Loss

(slide 7 of 7)

Realized gains and losses are not always recognized

Realized gains may be deferred or excluded
Realized losses may be deferred or disallowed

Realized losses from the sale, exchange, or

condemnation of personal use assets (e.g., a personal
residence) are not recognized for tax purposes
Exception - casualty or theft losses from personal use assets

In contrast, any gain realized from the sale or other

disposition of personal use assets is, generally, fully
taxable
12

The Big Picture - Example 7

Gain On Sale of Personal Use Assets

Return to the facts of The Big Picture on p. 13-1.

Assume Alice sells the boat, which she has

held exclusively for personal use, for $23,000.
Recall that her adjusted basis of the boat is
$22,000.

Alice has a realized and recognized gain of

$1,000.

13

The Big Picture - Example 8

Loss On Sale of Personal Use Assets

Return to the facts of The Big Picture on p. 13-1.

Assume Alice sells the boat in Example 7 for

$20,000.
She has a realized loss of $2,000, but the loss is
not recognized.

14

Recovery of Capital Doctrine

Taxpayer is entitled to recover cost or other
original basis of property acquired and is not
taxed on that amount
To extent receive only investment back upon
disposition of an asset, taxpayer has no gain

15

Basis Considerations
(slide 1 of 6)

Original basis of an asset is generally its cost

Bargain purchase assets have a basis equal to
their FMV
Bargain amount may be income to purchaser (e.g.,
employee = compensation; shareholder =
dividend)

16

Basis Considerations
(slide 2 of 6)

Identification problems
Security sales where specific identification not
possible, use FIFO to compute basis

17

Basis Considerations
(slide 3 of 6)

Allocation problems: lump-sum purchase

Must allocate basis to each asset obtained
Allocation usually based on relative FMV of assets

18

Basis Considerations
(slide 4 of 6)

Allocation problems: Going concern

purchase
Assign purchase price to assets (excluding goodwill)
to extent of their total FMV
Then allocate among assets based on FMV
Residual amount is goodwill
Goodwill is an amortizable 197 asset

Allocation applies to both purchaser and seller

19

Basis Considerations
(slide 5 of 6)

Allocation problems: Nontaxable stock

dividends
Basis of original shares is allocated over the
original and new shares
Based on number of shares (common on common), or
Based on relative FMV (preferred on common)

Holding period includes the holding period of the

original shares

20

Basis Considerations
(slide 6 of 6)

Allocation problems: Nontaxable stock rights

Basis in rights is zero unless taxpayer is required
or elects to allocate basis from stock
Required to allocate if FMV of rights is at least 15% of
the FMV of the stock
Allocation is based on relative FMV of rights and stock

Holding period includes holding period of the

stock on which the rights were distributed
However, if the rights are exercised, holding period of
newly acquired stock begins with date the rights are
exercised
21

Gift Basis
(slide 1 of 10)

Gift property may have a dual basis, i.e., basis

for gain and loss may differ
Basis is dependent on relationship between
FMV at date of gift and donors adjusted basis

22

Gift Basis
(slide 2 of 10)

Gift basis for cost recovery

The donee's basis for cost recovery is the donors
basis (donee's gain basis)

23

Gift Basis
(slide 3 of 10)

Gift basis for subsequent gain

When a gifted asset is disposed of by the donee,
the basis for calculating any gain is the donors
adjusted basis (carryover basis)
This basis is called the gain basis
Gain basis may be increased if donor incurred gift tax
on gift

Holding period for donee includes that of donor

24

Gift Basis
(slide 4 of 10)

Gift basis for subsequent loss

When a gifted asset is disposed of by a donee, the
basis for calculating any loss is the lesser of FMV
at the date of gift or the donors adjusted basis
This basis is called the loss basis

25

Gift Basis
(slide 5 of 10)

Gift basis for subsequent loss

If FMV < donors basis on the date of the gift, a
dual basis will exist for the asset
Gain basis = donors basis
Loss basis = FMV on date of gift

If dual basis and sold for loss, holding period for

donee starts on date of gift

26

Gift Basis
(slide 6 of 10)

Gift basis when no gain or loss

If a dual basis exists and the amount realized from
the disposition of a gifted asset falls between the
gain basis and the loss basis
No gain or loss is realized

Holding period for donee is not needed since there

is no gain or loss

27

Gift Basis
(slide 7 of 10)

Example of gift basis determination

Alex received a gift from Beth on June 15 this year
FMV of asset on June 15 was $8,000
Beth bought the asset on May 5, 1985 for $10,000

28

Gift Basis
(slide 8 of 10)

Example of gift basis determination (contd)

If Alex sells the asset for $11,000, there is a $1,000
gain ($11,000 $10,000)
If Alex sells the asset for $7,000, there is a $1,000
loss ($7,000 $8,000)
If Alex sells the asset for $9,000, there is no gain
or loss ($9,000 $9,000)

29

Gift Basis
(slide 9 of 10)

Adjustment for gift taxes

The proportion of gift tax paid (on gifts after 1976)
by the donor on appreciation of asset can be added
to basis of donee
The donee's basis is equal to: Donors basis +
[(unrealized appreciation/taxable gift) gift tax]

30

Gift Basis
(slide 10 of 10)

Example of gift tax:

Cathy received a gift from Darren on June 15 of
this year
FMV on June 15 was $34,000
Darren had a basis in the asset of $29,000
Darren paid gift tax of $800
Cathys basis in the gifted property is $29,200
[$29,000 + ($5,000/($34,000 $14,000) $800)]

31

Property Acquired
from a Decedent (slide 1 of 7)
Generally, beneficiarys basis in inherited
assets will be the FMV of the asset at
decedents date of death
Exception: If the executor/administrator of estate
elects alternate valuation date, basis is FMV on
such date

Inherited property is always treated as longterm property

32

Property Acquired
from a Decedent (slide 2 of 7)
Inherited property valuation date
Date assets valued for estate tax is either:
Date of decedents death, which is called the primary
valuation date (PVD), or
6 months after date of decedents death, which is called
the alternate valuation date (AVD)
Can only be elected if both the value of gross estate and the
estate tax liability are lower than if PVD was used

33

Property Acquired
from a Decedent (slide 3 of 7)
Inherited property valuation date
When PVD is used, beneficiarys basis will be the
FMV at date of decedents death
When AVD is used, beneficiarys basis will be the
FMV at the earliest of:
Date asset is distributed from estate, or
6 months after date of decedents death

34

Property Acquired
from a Decedent (slide 4 of 7)
Example of inherited property valuation:
At Rexs date of death, April 30 of this year, his
assets had an adjusted basis of $200,000, and a
FMV of $700,000
PVD selected and assets distributed June 30;
beneficiarys basis is $700,000

35

Property Acquired
from a Decedent (slide 5 of 7)
Example of inherited property valuation
(contd)
October 30 this year (six months after date of
Rexs death), the assets had a FMV of $650,000
AVD selected and assets distributed November 10;
beneficiarys basis is $650,000
AVD selected and assets distributed June 30 when FMV
of assets is $670,000; beneficiarys basis is $670,000

36

Property Acquired
from a Decedent (slide 6 of 7)
Deathbed gifts
Property inherited by taxpayer (or spouse) which
was both appreciated and gifted by same taxpayer
to decedent within 1 year of decedent's death
Beneficiarys basis in property is carryover of
decedents basis (not date of death FMV)
Generally the same basis taxpayer had on date of gift

37

Property Acquired
from a Decedent (slide 7 of 7)
Survivors share of community property
Both decedents share and surviving spouses share of
community property receives basis of FMV on date of
death
Surviving spouses share deemed to be acquired from decedent

Survivors share in common law state

Only 1/2 of jointly held property of spouses is included in
the estate
In such a case, no adjustment of the basis is permitted for the
excluded property interest (the surviving spouses share)

38

The Big Picture - Example 22

Property Acquired From A Decedent

Return to the facts of The Big Picture on p. 13-1.

Alice inherited her grandmothers house.

At the date of death, the adjusted basis for the
house was $275,000.
The houses fair market value at the date of death
was $475,000.
The alternate valuation date was not elected.
Alices basis for income tax purposes is $475,000.
This is commonly referred to as a stepped-up basis.
39

The Big Picture - Example 23

Property Acquired From A Decedent

Return to the facts of The Big Picture on p. 13-1.

Assume the same facts as in Example 22,

except the houses fair market value at the date
of death was $260,000.
Alices basis for income tax purposes is
$260,000.
This is commonly referred to as a stepped-down
basis.
40

Disallowed Losses
(slide 1 of 5)

Related parties ( 267)

Losses on sale of assets between related parties are
disallowed
For income-producing or business property, any
loss disallowed can be used to reduce gain
recognition on subsequent disposition of asset to
unrelated party
Only available to original transferee
Not available for sales of personal use assets

41

Disallowed Losses
(slide 2 of 5)

Related parties include:

Family members,
Corporation and a shareholder who owns greater
than 50% (directly or indirectly) of the
corporation, and
Partnership and a partner who owns greater than
50% (directly or indirectly) of the partnership

42

Disallowed Losses
(slide 3 of 5)

Wash sales
Losses from wash sales are disallowed
Wash sale occurs when taxpayer disposes of stock
or securities at loss and acquires substantially
identical stock or securities within 30 days before
or after the date of the loss sale

43

Disallowed Losses
(slide 4 of 5)

Wash sales
Disallowed loss is added to the basis of the
substantially identical stock or securities that
caused the disallowance
Does not apply to gains realized on disposition of
securities

44

The Big Picture - Example 31

Wash Sale

Return to the facts of The Big Picture on p. 13-1.

Alice owned 100 shares of Green Corporation stock (adjusted

basis of $20,000).
She sold 50 shares for $8,000.
Ten days later, she purchased 50 shares of the same stock for $7,000.

Alices realized loss of $2,000 ($8,000 amount realized $10,000 adjusted basis) is not recognized because it resulted
from a wash sale.
Alices basis in the newly acquired stock is $9,000 ($7,000
purchase price + $2,000 unrecognized loss from the wash
sale).

45

Disallowed Losses
(slide 5 of 5)

Personal use assets

Loss on the disposition of personal use assets is
disallowed
Personal use asset loss cannot be converted into a
business (or production of income) use deductible
loss
Original loss basis for an asset converted is the lower of
personal use basis or FMV at date of conversion
Cost recovery basis similarly limited

46

Nontaxable Transactions
(slide 1 of 4)

In a nontaxable transaction, realized gain or

loss is not currently recognized
Recognition is postponed to a future date (via a
carryover basis) rather than eliminated

47

Nontaxable Transactions
(slide 2 of 4)

In a tax-free transaction, nonrecognition of

realized gain is permanent

48

Nontaxable Transactions
(slide 3 of 4)

Holding period for new asset

The holding period of the asset surrendered in a
nontaxable transaction carries over to the new
asset acquired

49

Nontaxable Transactions
(slide 4 of 4)

Depreciation recapture
Potential recapture from the asset surrendered
carries over to the new asset acquired in the
transaction

50

Like-Kind Exchanges
(slide 1 of 11)

1031 requires nontaxable treatment for gains

and losses when:
Form of transaction is an exchange
Assets involved are used in trade or business or
held for production of income
However, inventory, securities, and partnership
interests do not qualify

Asset exchanged must be like-kind in nature or

character as replacement property
51

Like-Kind Exchanges
(slide 2 of 11)

Like-kind property defined

Interpreted very broadly
Real estate for real estate
Improved for unimproved realty qualifies
U.S. realty for foreign realty does not qualify

Tangible personalty for tangible personalty

Must be within the same general business asset or product
class
Personalty used mainly in the U.S. for personalty used mainly
outside the U.S. does not qualify
Livestock of different sexes does not qualify
52

Like-Kind Exchanges
(slide 3 of 11)

When taxpayers involved in an exchange are

related parties
To qualify for nontaxable exchange treatment,
related parties must not dispose of property
exchanged within the 2 year period following
exchange
If such early disposition occurs, postponed gain is
recognized as of date of early disposition
Dispositions due to death, involuntary conversions, and
certain non-tax avoidance transactions are not treated as
early dispositions
53

Like-Kind Exchanges
(slide 4 of 11)

Exchange requirement
The transaction must involve a direct exchange of
property to qualify as a like-kind exchange
If the exchange is a delayed (nonsimultaneous)
exchange, there are time limits on its completion
The new property must be identified within 45 days of
date old property was transferred
The new property must be received by the earlier of the
following:
Within 180 days of date old property was transferred
The due date (including extensions) for tax return covering
year of transfer
54

Like-Kind Exchanges
(slide 5 of 11)

Boot
Any property involved in the exchange that is not
like-kind property is boot
The receipt of boot causes gain recognition equal
to the lesser of boot received (FMV) or gain
realized
No loss is recognized even when boot is received

55

Like-Kind Exchanges
(slide 6 of 11)

Boot
The transferor of boot property may recognize gain
or loss on that property
Gain or loss is recognized to the extent of the difference
between the adjusted basis and the fair market value of
the boot

56

Like-Kind Exchanges
(slide 7 of 11)

Basis in like-kind asset received:

FMV of new asset
Gain not recognized
+ Loss not recognized
= Basis in new asset

Basis in boot received is FMV of property

57

Like-Kind Exchanges
(slide 8 of 11)

Basis in like-kind property using Code

approach
+
+

Adjusted basis of like-kind asset given

Adjusted basis of boot given
Gain recognized
FMV of boot received
Loss recognized
Basis in new asset

58

Like-Kind Exchanges
(slide 9 of 11)

Example of an exchange with boot:

Zak and Vira exchange equipment of same general
business asset class
Zak: Basis = $25,000; FMV = $40,000
Vira: Basis = $20,000; FMV = $30,000
Vira also gives securities: Basis = $7,000;
FMV = $10,000

59

Like-Kind Exchanges
(slide 10 of 11)

Example (Contd)
Zak
Vira
FMV Property Recd$30,000
+Securities 10,000
-0Total FMV Recd $40,000
Less: Basis Property Given
Realized Gain
$15,000
Boot Recd $10,000 $ -0Gain Recognized

$40,000
$40,000
25,000
$10,000

$10,000 $

30,000 *

-0-

*$20,000 Equip. + $10,000 Securities = $30,000

Securities: ($10,000 FMV - $7,000 basis) = $3,000 gain
recognized by Vira
60

Like-Kind Exchanges
(slide 11 of 11)

Example (Contd)
FMV Property Recd
Postponed Gain
Basis Property Recd

Zak
$30,000
-5,000
$25,000

Vira
$40,000
-10,000
$30,000

61

Involuntary Conversions
(slide 1 of 13)

1033 permits (i.e., not mandatory) nontaxable

treatment of gains if the amount reinvested in
replacement property the amount realized
If the amount reinvested in replacement
property is < amount realized, realized gain is
recognized to the extent of the deficiency

62

Involuntary Conversions
(slide 2 of 13)

Involuntary conversion
Results from the destruction, theft, seizure,
requisition, condemnation, or sale or exchange
under threat of condemnation of property
A voluntary act by taxpayer is not an involuntary
conversion

63

Involuntary Conversions
(slide 3 of 13)

1033 requirements
Replacement property must be similar or related in
service or use as involuntarily converted property
Replacement property must be acquired within a
specified time period

64

Involuntary Conversions
(slide 4 of 13)

Replacement property defined

Must be similar or related in service or use as the
converted property
Definition is interpreted very narrowly and differently
for owner-investor than for owner-user

For business or investment real estate that is

condemned, replacement property has same
meaning as for like-kind exchanges

65

Involuntary Conversions
(slide 5 of 13)

Taxpayer use test (owner-investor)

The properties must be used by the owner in
similar endeavors
Example: Rental apartment building can be replaced
with a rental office building because both have same use
to owner (the production of rental income)

66

Involuntary Conversions
(slide 6 of 13)

Functional use test (owner-user)

The property must have the same use to the owner
as the converted property
Example: A manufacturing plant is not replacement
property for a wholesale grocery warehouse because
each has a different function to the owner-user

67

Involuntary Conversions
(slide 7 of 13)

Time period for replacement

Taxpayer normally has a 2 year period after the
close of the taxable year in which gain is realized
to replace the property
Replacement time period starts when involuntary
conversion or threat of condemnation occurs
Replacement time period ends 2 years (3 years for
condemnation of realty) after the close of the taxable
year in which gain is realized

68

Involuntary Conversions
(slide 8 of 13)

Example of time period for replacement

Taxpayers office building is destroyed by fire on
November 4, 2012
Taxpayer receives insurance proceeds on February
10, 2013
Taxpayer is a calendar-year taxpayer
Taxpayers replacement period is from November
4, 2012 to December 31, 2015

69

Involuntary Conversions
(slide 9 of 13)

Nonrecognition of gain: Direct conversions

Involuntary conversion rules mandatory
Basis and holding period in replacement property
same as converted property

70

Involuntary Conversions
(slide 10 of 13)

Nonrecognition of gain: Indirect conversions

Involuntary conversion rules elective
Gain recognized to extent amount realized (usually
insurance proceeds) exceeds investment in
replacement property

71

Involuntary Conversions
(slide 11 of 13)

Nonrecognition of gain: Indirect conversions

Basis in replacement property is its cost less
deferred gain
Holding period includes that of converted property

72

Involuntary Conversions
(slide 12 of 13)

Involuntary conversion rules do not apply to

losses
Losses related to business and production of
income properties are recognized
Personal casualty and theft losses are recognized
(subject to $100 floor and 10% AGI limit);
personal use asset condemnation losses are not
recognized or postponed

73

Involuntary Conversions
(slide 13 of 13)

Involuntary conversion of personal residence

Gain from casualty, theft, or condemnation may be
deferred as involuntary conversion (1033) or
excluded as sale of residence (121)
Loss from casualty recognized (limited); loss from
condemnation not recognized

74

The Big Picture - Example 54

Involuntary Conversion (slide 1 of 3)
Return to the facts of The Big Picture on p. 13-1.

Alices business building (adjusted basis $50,000) is

destroyed by fire on October 5, 2014.
Alice is a calendar year taxpayer.

On November 17, 2014, she receives an insurance

reimbursement of $100,000 for the loss.
Alice invests $80,000 in a new building.
Alice uses the other $20,000 of insurance proceeds to pay
off credit card debt.

75

The Big Picture - Example 54

Involuntary Conversion (slide 2 of 3)
Alice has until December 31, 2016, to make
the new investment and qualify for the
nonrecognition election.
Alices realized gain is $50,000
$100,000 insurance proceeds received $50,000
adjusted basis of old building

Assuming that the replacement property

qualifies, Alices recognized gain is $20,000.
$100,000 insurance proceeds $80,000 reinvested
76

The Big Picture - Example 54

Involuntary Conversion (slide 3 of 3)

Alices basis in the new building is

$50,000.
This is the buildings cost of $80,000 less
postponed gain of $30,000
$50,000 realized gain $20,000 recognized
gain

77

The Big Picture - Example 55

Involuntary Conversion
Assume the same facts as in the previous example, except that
Alice receives only $45,000 of insurance proceeds.
She has a realized and recognized loss of $5,000.
The basis of the new building is the buildings cost of $80,000.

If the destroyed building had been held for personal use, the
recognized loss would have been subject to the following
additional limitations.
The loss of $5,000 would have been limited to the decline in fair
market value of the property, and
The amount of the loss would have been reduced first by $100 and
then by 10% of AGI (refer to Chapter 7).

78

Sale of Residence
(slide 1 of 7)

Loss on sale
As with other personal use assets, a realized loss
on the sale of a personal residence is not
recognized

79

Sale of Residence
(slide 2 of 7)

Gain on sale
Realized gain on sale of principal residence is
subject to taxation
Realized gain may be partly or wholly excluded
under 121

80

Sale of Residence
(slide 3 of 7)

121 provides for exclusion of up to $250,000

of gain on the sale of a principal residence
Taxpayer must own and use as principal residence for at
least 2 years during the 5 year period ending on date of
sale

81

Sale of Residence
(slide 4 of 7)

Amount of Exclusion
$250,000 maximum
Realized gain is calculated in normal manner
Amount realized on sale is reduced by selling
expenses such as advertising, brokers
commissions, and legal fees

82

Sale of Residence
(slide 5 of 7)

Amount of Exclusion (contd)

For a married couple filing jointly, the $250,000 max is
increased to $500,000 if the following requirements are
met:
Either spouse meets the 2 year ownership reqt,
Both spouses meet the 2 year use reqt,
Neither spouse is ineligible due to the sale of another principal
residence within the prior 2 years

Starting in 2008, a surviving spouse can continue to use the

$500,000 exclusion amount on the sale of a personal
residence for the next two years following the year of the
deceased spouses death
83

Sale of Residence
(slide 6 of 7)

121 cannot be used within 2 years of its last use

except in special situations, such as:
Change in place of employment,
Health,
Other unforeseen circumstances

Under these circumstances, only a portion of the

exclusion is available, calculated as follows:
Max Exclusion amount number of qualifying months
24 months

84

Sale of Residence
(slide 7 of 7)

The Housing Assistance Tax Act of 2008

reduces the gain eligible for the 121
exclusion for a vacation home converted to a
principal residence
121 exclusion is reduced by the proportion of the
periods of nonqualified use compared to the period
the property was owned by the taxpayer
Applies to sales and exchanges occurring after
December 31, 2008
85

Other Nonrecognition Provisions

(slide 1 of 6)

Several additional nonrecognition provisions

are available:
Under 1032, a corporation does not recognize
gain or loss on the receipt of money or other
property in exchange for its stock (including
treasury stock)

86

Other Nonrecognition Provisions

(slide 2 of 6)

Under 1035, no gain or loss is recognized

from the exchange of certain insurance
contracts or policies

87

Other Nonrecognition Provisions

(slide 3 of 6)

Under 1036, a shareholder does not recognize

gain or loss on the exchange of common stock
for common stock or preferred stock for
preferred stock in same corporation

88

Other Nonrecognition Provisions

(slide 4 of 6)

Under 1038, no loss is recognized from the

repossession of real property sold on an
installment basis
Gain is recognized to a limited extent

89

Other Nonrecognition Provisions

(slide 5 of 6)

Under 1041, transfers of property between

spouses or former spouses incident to divorce
are nontaxable

90

Other Nonrecognition Provisions

(slide 6 of 6)

Under 1044, if the amount realized from the

sale of publicly traded securities is reinvested
in common stock or a partnership interest of a
specialized small business investment
company, realized gain is not recognized
Amounts not reinvested will trigger recognition of
gain to extent of deficiency
Statutory limits are imposed on the amount of gain
qualified for this treatment
Only individuals and C corporations qualify
91

Refocus On The Big Picture (slide 1 of 5)

Gift of Inherited House
Alice says that this is the only gift that she would
make to Michael this year.
She has made no prior gifts to any individual that exceeded
the annual exclusion amount (i.e., currently $14,000).

With this information, you inform Alice that no gift

tax would be due on the gift of the house to Michael.
However, she would use up $586,000 ($600,000 - $14,000)
of her lifetime gift tax exclusion.
Michaels basis for the house would be a carryover of
Alices basis of $475,000.
The fair market value at the date of the decedents death.
92

Refocus On The Big Picture (slide 2 of 5)

Sale of Inherited House
Alices adjusted basis for the house is
$475,000
The fair market value on the date of her
grandmothers death.

If Alice sells the house for $600,000, her

projected selling expenses would be $42,000
($600,000 X 7%).
93

Refocus On The Big Picture (slide 3 of 5)

She would have a recognized gain of $83,000 as calculated
below.
Amount realized ($600,000 - $42,000)
Less: Adjusted basis
Realized and recognized gain

$ 558,000
(475,000)
$ 83,000

The house is a capital asset, and Alices holding period is long

term since she inherited the house.
Thus, the gain would be classified as a long-term capital gain (i.e.,
eligible for a 15% or 20% tax rate).
The Federal income tax due would be $12,450 ($83,000 X 15%).
94

Refocus On The Big Picture (slide 4 of 5)

What If?
Alice is leaning toward selling the house.
However, she knows that her grandmother would not want
her to have to pay income taxes on the sale.

Alice inquires as to whether there is any way that she

could reduce the Federal income tax on the sale to $0.
You inform Alice of the exclusion provision under
121 of the Code.
She can qualify for this exclusion of realized gain provision
if she satisfies the at least two-out-of-five-years ownership
and use requirements.
This would necessitate her moving into the house for 2
years and occupying it as her principal residence.
95

Refocus On The Big Picture (slide 5 of 5)

What If?
From a tax planning perspective, what could Alice
have done so that none of the $50,000 of realized
gain in Example 54 from the involuntary conversion
was recognized?
To postpone all of the $50,000 realized gain, Alice would
have to reinvest all of the $100,000 of insurance proceeds
received in another building.
Under this circumstance, the basis of the replacement
building would be a carryover basis of $50,000 ($100,000
cost $50,000 deferred gain).
96

If you have any comments or suggestions concerning this

PowerPoint Presentation for South-Western Federal
Taxation, please contact:
Dr. Donald R. Trippeer, CPA
trippedr@oneonta.edu
SUNY Oneonta

2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

97