Basis
The Purpose of Basis is to determine taxability
Terms Associated with Basis
Cost Basis: is the sum of capitalized acquisition costs.
Substituted basis : is computed by reference to basis in other property.
Transferred basis: is computed by reference to basis in the same property in the hands of another
Exchanged basis: is computed by reference to basis in other property previously held by the person.
Converted basis : is when personal-use property is converted to business use, the basis of the property is the lower of its basis or the FMV on the date of conversion.
Additions to Basis
1, Cost basis constitutes capitalized costs and cannot be deducted. They are capitalized and if business use, they can be depreciated.
2. Major improvements add to the basis of the property. Those items that add life to the cost of longer than one year.
a Cost for construction of real or tangible personal property.
b. Construction period including interest and taxes most be capitalized as part of a building cost.
c. The cost basis includes the fair market value of property given up.
d. Payment for an asset may be made by cash, cash equivalent, property with liability or services
e. Increased for note to the seller.
f. If the property is subject to a liability which is assumed by the buyer, the basis is increased.
g. Property received in exchange for services is income to the recipient and the fair market value of the property is the cost basis.
Acquisition of More than One Property for a Lump Sum
Basis is as follows:
FMV of Asset X Lump Sum Price
FMV of all Assets
Example:
Facts: Two buildings on a lot were sold for $220,000. The FMV of the first building is $80,000 and the second building is $120,000. Total FMV is $80,000 +120,000= $200,000.
Therefore Building 1 80,000 = 40%
200,000
40% X 220,000 = $88,000 basis for Building 1
Building 2 120,000 = 60%
200,000
60% X 220,000 = $132,000 basis for Building 2
Residual Method
If the IRS determines that the prior method is improper or there is no agreement as to the cost of any particular asset sold to determine basis then the residual method is used. This method is relevant for goodwill.
Each of the assets is applied in a certain order according to FMV.
The order is as follows:
1. Cash and cash equivalents
2. Near cash items such as CD or Government
Securities
3. Accounts Receivable
4. Property held for sale to customers
5. All other assets except 197 intangibles.
6. Section 197 intangibles.
7. Goodwill
How do we acquire assets?
1. Purchase
2. Gift
3. Inheritance
4. Property acquired for Services
Property Acquired by Gift
The donee's basis in the property acquired by gift is the donor's basis increased for any appreciation of gift tax paid. The annual exclusion for 2016 gift tax is $14,000.
Let's Review the computation of gift tax attributable to appreciation as follows:
Example:
Facts: ___________ received a gift from a relative. FMV $200,000, Adj. basis $60,000. The gift tax paid by the relative was $20,000. What is the basis to the donee?
Formula:
(FMV) 200,000 - (adj. basis) 60,000 = 140,000 = .752%
(FMV) 200,000-(Annual exclus.) 14,000 186,000
.752 X $20,000 (gift tax paid) = $15,040 gift tax attributable to depreciation
The new basis in the property is the donor's adj. basis: 60,000
Gift tax attributable to appreciation: +15,040
Donee's basis: 75,040
Basis of Gift for Depreciation
A. If the gift is immediately used for business, the basis is the donor's adjusted basis.
B. If the gift is converted from personal to business, the basis is the lower of:
a. adjusted basis
or
b. FMV
FMV LESS THAN DONOR'S ADJUSTED BASIS AT DATE OF GIFT
AND LATER TRANSFERRED (SOLD) FOR:
1. Gain: Basis is donor's adjusted basis
plus or minus any required adjustment to basis.
2. Loss: Fair Market Value
l plus or minus and required adjustment to basis
3. No gain/loss if transferred for more than FMV at date of gift but less than the donor's basis at date of gift.
Examples of FMV less than Donor's adjusted Basis at Date of Gift
1. Sold at a Gain:
Gift of rare bird given to _______with FMV $3,000 and donor's basis of $5,000. Later sold for $10,000.
What is the basis?
Answer: Basis is $5,000. Result using basis creates less of a gain.
2. Sold at a Loss:
Gift of rare gem to __________ with FMV $8,000 and basis $16,000. Later sold for $5,000
What is the basis:
Answer: Basis is $8,000 Result using FMV creates less of a loss.
'
3. No Gain or Loss
Gift of jewelry given to_____ with a basis of $9,000 and FMV of $3,500 at date of gift. Later sold for $7,000.
The sales price is more than FMV but less than basis. Therefore no gain or loss on the transaction.
Property Received for Services
Compensation is ordinary income. If property is received for services, basis is the FMV of the property minus any cash or other property given. The basis is also includible in income of the recipient.
Inherited Property
General Rule: Basis is the FMV on the date of death.
Alternative Valuation Date: If chosen, then basis is the fair market value 6 months after the decedent's death.
If an asset is distributed within the alternative valuation date, then the basis is the FMV on the date or distribution date.
LET'S TALK ABOUT BASIS OF STOCK
There are two method to determine basis upon sale of stock:
A. Specific identification of stock sold which is the first method.
B. If the specific identification method cannot be used then the first in, first out (FIFO) is used
Stock dividends
1. Stock dividends are not to be confused with cash dividends. The stock company issues stock.
2. The holding period of stock dividends includes that of the old stock.
3. The earnings and profits are not altered for a tax free stock dividend.
4. Stock dividends to shareholders generally are not taxable. However basis of new stock is determined by the following ratio:
FMV of new stock X original basis
Total FMV of stock
Example: __________ bought 10 shares of common stock for $1,000 and later received 10 shares of preferred for every 5 shares of common stock. This means that preferred is 2X10= 20 shares of preferred stock. At the time of the transaction, the FMV of common stock is $30 per share and the FMV of preferred stock is $10 per share.
Computation; Common stock is 30 FMV X 10 shares =$300
Preferred stock is 10 FMV X 20 shares = $200
Total FMV 500
Formula: Common 300 X Cost $1,000 = $600 Basis
500
Preferred 200 X Cost $1,000 = $400 Basis
500
Stock Rights
Stock rights are rights to purchase stock at a certain price. This price is called the exercise price.
Basis if exercised is any basis allocated to the right plus the exercise price. One can receive the right to buy stock and when they actually purchase the stock, they exercise the right.
Taxable Stock Distribution
They are subject to tax in the amount of FMV. If an option is given between stock distribution, cash or other property, the amount of distribution is the greater of:
a. FMV of stock
b. Cash
c. FMV of other property
Stock Split
A stock split is not a taxable distribution. Basis is allocated between the old and new stock based on relative FMV. Holding period of new stock includes that of the old stock.
The End
THE END