CHAPTER 7
PROPERTY TRANSACTIONS:
BASIS, GAIN AND LOSS,
AND NONTAXABLE EXCHANGES
SOLUTIONS TO PROBLEM MATERIALS
Question/
Problem
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Topic
Amount realized and basis determination
Basis and cost recovery
Personal use asset sale and exchange
Recognition and condemnation
Issue recognition
Basis and cost identification
Allocation of purchase price to goodwill
Gift basis
Ethics problem
Gift basis
Gift basis and effect of gift tax
Issue recognition
Gift basis
Alternate valuation date for inherited property
Alternate valuation date for inherited property
Related party loss disallowance
Wash sales
Property converted from personal use
Property converted from personal use
Like-kind exchange: recognition and basis
Like-kind exchange: related party
Like-kind exchange: like-kind property
Like-kind exchange: boot received
Issue recognition
Like-kind exchange: basis
Like-kind exchange: like-kind property
Form of the transaction
Like-kind exchange: boot given that has
declined in value
7-1
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in Prior
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2003 Entities Volume/Solutions Manual
Question/
Problem
29
30
31
32
Topic
Like-kind exchange and mortgage assumed
Like-kind exchange: recognition, boot, and basis
Like-kind exchange and mortgage assumed
Involuntary conversion: qualifying replacement
property
Ethics problem
Involuntary conversion: recognition and basis
Involuntary conversion: recognition and basis
Involuntary conversion: recognition and basis
Sale of residence: calculation and maximum
§ 121 exclusion
Transfer of property between spouses or incident
to divorce
33
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35
36
37
38
Status:
Present
Edition
Q/P
in Prior
Edition
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Modified
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30
31
32
Modified
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37
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Depreciation
Depreciation
Like-kind exchanges
Unchanged
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Modified
1
2
3
Stock sale identification
§ 1045 transactions
Deferred like-kind exchange
Internet activity
Internet activity
Unchanged
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New
Unchanged
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2
Bridge Discipline
Problem
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Research
Problem
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5
PROBLEM MATERIAL
1.
a.
b.
Original basis of land
Original basis of house
Less: Depreciation
Adjusted basis of house and land
$ 10,000
70,000
( 32,200)
$ 47,800
Original basis of tennis court
Less: Depreciation
Adjusted basis of tennis court
$
Amount realized
Less: Adjusted basis ($47,800 + $3,700)
Realized gain
$ 125,000
( 51,500)
$ 73,500
Amount realized [$125,000 (cash) + $20,000 (mortgage)]
Less: Adjusted basis
Realized gain
$ 145,000
( 51,500)
$ 93,500
5,000
( 1,300)
$ 3,700
Property Transactions: Basis, Gain and Loss, and Nontaxable Exchanges
c.
Same answer as in part (b.) above.
pp. 7-3 to 7-5 and Concept Summary 7-1
2.
a.
Black must report on her income tax return the greater of the depreciation allowed
of $20,000 ($24,000 X 10/12) or allowable of $24,000. The depreciation allowed is
the amount actually deducted, whereas the depreciation allowable is the amount
that should have been deducted under the depreciation convention. Black should
amend her 2002 income tax return and deduct the correct amount of depreciation
($24,000).
b.
Adjusted basis on January 1, 2002
Less: Depreciation allowable
Adjusted basis on December 31, 2002
$375,000
( 24,000)
$351,000
pp. 7-4 and 7-5
3.
a.
Amount realized
Less:
Adjusted basis
Realized loss
Recognized loss
$34,500
(38,000)
($ 3,500)
$ -0-
Realized losses on personal use assets are not deductible.
b.
Same result as in part (a) above.
p. 7-7
4.
a.
Amount realized
Less: Adjusted basis
Realized loss
Recognized loss
$270,000
(290,000)
($ 20,000)
$
-0-
A realized loss on the condemnation of a personal use asset is not recognized.
b.
Amount realized
Less: Adjusted basis
Realized gain
Recognized gain
$300,000
(290,000)
$ 10,000
$ 10,000
A realized gain on the condemnation of a personal use asset is recognized if similar
property is not acquired. However, as discussed in Chapter 15 under “Sale of a
Residence – § 121,” the recognized gain of $10,000 can be avoided if the
§ 121
requirements are satisfied.
c.
If the house were income-producing property, the realized loss of $20,000 would be
recognized.
pp. 7-6 and 7-7
7-3
7-4
2003 Entities Volume/Solutions Manual
5.
Marmot & Squirrel should defer the realized gain on the disposition of the warehouse.
Therefore, the partnership should structure the transaction to qualify as an involuntary
conversion. Thus, the associated issues are whether the form of the disposition qualifies
and whether the replacement qualifies. The acquisition by the condemning authority would
qualify. Since the city is condemning the property, the sale to the real estate broker also
would qualify. Replacing the warehouse with the office building will qualify since the
form of the involuntary conversion is the condemnation of real property used in a trade or
business. Unless the firm via the negotiation process can get more from the city than the
real estate broker, it should sell the land to the real estate broker and replace it with the
office building within the qualified replacement period (i.e., three years from the end of the
tax year in which a proceeds inflow is received that is large enough to produce a gain). pp.
7-27 to 7-30
6.
a.
Finch, Inc.’s adjusted basis for Bluebird Corporation stock on December 31, 2002 is
$210,000 ($150,000 + $60,000).
b.
Amount realized
Less:
Adjusted basis (60 shares X $1,500 per share)
Realized loss
Recognized loss
c.
If Finch cannot adequately identify the shares sold, a FIFO presumption is made.
Thus, the 60 shares sold are presumed to come from the 100 shares purchased on
June 3, 2002 for $150,000 (i.e., $1,500 per share). Therefore, Finch has a recognized
loss of $39,000 as calculated in (b) above.
$51,000
(90,000)
($39,000)
($39,000)
p. 7-8
7.
a.
Marco’s recognized gain on the sale of his business is calculated as follows:
Amount realized ($650,000 - $30,000)
Less: Adjusted basis
Realized gain
Recognized gain
b.
$620,000
(427,000)
$193,000
$193,000
The $25,000 excess of the purchase price of $650,000 over the fair market value of
the listed assets of $625,000 is assigned to goodwill. Thus, the adjusted basis for
each of the assets for Stella is as follows:
Production equipment
Packaging equipment
Distribution equipment
Building and land
Goodwill
c.
Hoffman, Smith, and Willis, CPAs
5191 Natorp Boulevard
Mason, OH 45040
June 3, 2002
Ms. Stella Simson
300 Woodland Drive
Cincinnati, OH 45207
$ 93,750
156,250
187,500
125,000
87,500
$650,000
Property Transactions: Basis, Gain and Loss, and Nontaxable Exchanges
Dear Ms. Simson:
I am responding to your inquiry regarding your proposal to purchase the assets of
Marco’s sole proprietorship. Your $650,000 purchase price is allocated among the
assets to produce the following adjusted basis for each asset:
Production equipment
Packaging equipment
Distribution equipment
Building and land
Goodwill
$ 93,750
156,250
187,500
125,000
87,500
$650,000
The goodwill of $87,500 represents the difference between the $650,000 purchase
price and the total fair market value of each of the other assets.
Since the building is depreciable and the land is not, the $125,000 adjusted basis for
the building and land needs to be allocated between these two assets. If you have
not already done so, I suggest that an appraisal be obtained for this purpose.
If I can be of further assistance, please let me know.
Steve Wills, CPA
Tax Partner
pp. 7-8, 7-9, and Example 13
8.
a.
Basis for loss = $62,000; $58,000 (amount realized) - $62,000 (adjusted basis) =
$4,000 (recognized loss).
b.
$0. The proceeds of $59,000 are between the gain basis of $65,000 and the loss basis
of $50,000. Therefore, neither gain nor loss is recognized.
pp. 7-11 to 7-13
9.
The issue is whether Holly will have a carryover basis of $2,500 for the stock inherited
from Alice or a stepped-up basis (FMV at date of Alice's death) for the inherited stock.
Section 1014(a) provides the general rule that the basis for inherited property is the fair
market value of the property on the date of the decedent's death. However, § 1014(e)
provides an exception to this FMV basis (the so-called deathbed gift rule). Under this
provision, if appreciated property is inherited by a taxpayer (or the taxpayer's spouse) and
the property was acquired by the decedent by gift from that taxpayer, a carryover basis may
be required. Such a carryover basis is required if the time period between the date of the
gift and the date of the donee's death is not greater than one year.
If Alice lives for over one year after she receives the gift of the stock from Holly, they will
be able to achieve their objective to "beat the tax system." Under this assumption, Holly's
basis for the inherited stock will be the FMV on the date of Alice's death. Conversely, if
Alice does not live for over a year, then Holly's basis for the stock will be a carryover basis
of $2,500.
7-5
7-6
2003 Entities Volume/Solutions Manual
There are risks involved for Holly in attempting to step-up the basis of the stock free of
Federal income tax. First, Alice could decide not to will the stock to Holly. Second, Alice's
medical costs or other aspects of her life style could result in the consumption of the stock.
In both of these situations, Holly will receive nothing.
If the stock were a painting, the tax consequences and the risks would be the same.
pp. 7-14 to 7-16
10.
a.
$5,000 ($27,000 cost - $22,000 accumulated depreciation).
b.
$2,500 ($5,000 basis/2 years).
c.
Gain basis = $5,000 (Barbara’s original basis) - $2,500 (depreciation allowed) =
$2,500; $20,000 (selling price) - $2,500 (adjusted basis) = $17,500 (realized gain).
d.
Gain basis = $5,000 (Barbara’s original basis) - $2,500 (depreciation for one year) =
$2,500. $24,000 (selling price) - $2,500 (adjusted basis) = $21,500 (realized gain).
pp. 7-11 to 7-13
11.
a.
Jessica’s gain basis for the stock is increased as a result of Kirk’s payment of gift
tax. This eliminates some of the taxation that Jessica would face upon the disposal
of the appreciated property. Jessica’s gain basis for the stock is $10,563 [$10,000 +
(($6,000/$16,000) X $1,500)].
b.
If the transaction were completed in 1976, the full amount of the gift tax paid by
Kirk would be added to the carryover basis to determine the donee’s gain basis.
Thus, Jessica’s gain basis would be $11,500 ($10,000 + $1,500).
pp. 7-12 and 7-13
12.
Either Simon or Fred should receive the benefit of deducting the realized loss on the sale of
the stock. On the surface, it appears that Simon should give the stock to Fred and let Fred
sell it, since Fred is in the higher tax bracket (i.e., 27% versus Simon’s 15%). However, a
taxpayer cannot deduct another taxpayer’s loss. For gift property, this is achieved by the
loss basis to the donee being the lower of (1) the donor’s adjusted basis, or (2) the fair
market value on the date of the gift. Therefore, since the stock has declined in value (i.e.,
adjusted basis is greater than the fair market value at the date of the gift), Simon should sell
the stock, deduct the realized loss, and give the sales proceeds to Fred). pp. 7-11 and 7-12
13.
Liz has generated zero recognized gain or loss, since the amount realized ($54,000) falls
between the basis for gain ($70,000) and the basis for loss ($50,000). In this case, the gift
tax paid does not affect basis. Example 18 and pp. 7-11 and 7-12
Property Transactions: Basis, Gain and Loss, and Nontaxable Exchanges
14.
a.
b.
No, the executor cannot elect the alternate valuation date. In order to be permitted to
do so, the following requirements must be satisfied:

The election results in the reduction of the value of the gross estate.

The election results in the reduction of the estate tax liability.
Denise's basis for the property is the fair market value on the date of Martha's death
(primary valuation date) of $825,000.
pp. 7-14 and 7-15
15.
a.
If the primary valuation date and amount apply, Robert's basis for the assets would be
the fair market value at the date of Earl's death.
Cash
Stock
Apartment building
Land
b.
$ 10,000
125,000
300,000
100,000
$535,000
The election of the alternate valuation date by the executor would produce the
following basis for each asset distributed to Robert.
Cash
Stock
Apartment building
Land
$ 10,000
85,000
325,000
110,000
$530,000
Since the stock was distributed prior to the alternate valuation date, Robert's basis for
it would be the fair market value on the date of its distribution to him.
pp. 7-14 and 7-15
16.
a.
Sale by Susan
Amount realized
Adjusted basis
Realized gain
Recognized gain
$ 140,000
( 125,000)
$ 15,000
$ 15,000
Sale by Jerry
Amount realized
Adjusted basis
Realized gain
Recognized gain
$ 143,000
( 140,000)
$ 3,000
$ 3,000
Jerry’s gain basis of $140,000 is the same as Ellen’s adjusted basis.
7-7
7-8
2003 Entities Volume/Solutions Manual
b.
Sale by Susan
Amount realized
Adjusted basis
Realized loss
Recognized loss
$140,000
( 150,000)
($ 10,000)
$
-0-
Since Susan and Ellen are related parties, the realized loss of $10,000 is disallowed by §
267.
Sale by Jerry
Amount realized
Adjusted basis
Realized gain
Recognized gain
$ 143,000
( 140,000)
$ 3,000
$ 3,000
Jerry is not eligible to use any of Susan’s disallowed loss of $10,000 under the right of
offset since he is not the original transferee (i.e., Ellen is the original transferee).
p. 7-16
17.
a.
Amount realized
Less: Adjusted basis
Realized loss
Recognized loss
$3,600
(4,000)
($ 400)
($ 100)
The sale of 300 of the 400 shares is a wash sale, as the purchase of 300 shares of
Amber stock on January 19th is within 30 days of the sale of Amber stock on
December 28th. Consequently, $300 of the realized loss of $400 is disallowed
[$400 X (300 shares/400 shares)].
b.
Purchase price
Plus: Disallowed loss on wash sale
Adjusted basis
$2,850
300
$3,150
The disallowed loss of $300 on the wash sale is added to the purchase price of
$2,850.
c.
The wash sale provision will prevent Redwood Company from recognizing $300 of
the realized loss of $400 ($3,600 amount realized - $4,000 adjusted basis).
Redwood Company can avoid the wash sale provision by not acquiring
substantially identical stock within 30 days before or after the date of the sale.
Therefore, they should not purchase shares of stock in Amber within this time
period. Redwood could purchase Amber stock outside this 60-day window or
purchase the stock of another corporation.
pp. 7-17 and 7-18
Property Transactions: Basis, Gain and Loss, and Nontaxable Exchanges
18.
a.
Amount realized
Less: Adjusted basis (date of sale)
Realized gain (loss)
Recognized gain (loss)
Personal Use
$33,000
(42,000)
($ 9,000)
$
7-9
Office
$ 11,000
(11,370)*
($ 370)
-0-
($
370)
The realized loss on the personal use portion is not recognized.
b.
Amount realized
Less: Adjusted basis (date of sale)
Realized gain
Recognized gain
Personal Use
$52,500
(42,000)
$10,500
$
Office
$ 17,500
(11,370)*
$ 6,130
-0-
$ 6,130
*$11,370 = 14,000 basis at conversion - $2,630 cost recovery.
The $10,500 personal use residence gain may be excluded under sec. 121.
pp. 7-17 and 7-33
19.
a.
Surendra's basis for loss is $150,000, the lower of the adjusted basis of $180,000 or
the fair market value at the date of the conversion of $150,000.
b.
Surendra's basis for depreciation is $150,000, the same as the basis for loss.
c.
Surendra's basis for gain is the adjusted basis of $180,000.
p. 7-17
20.
a.
Amount realized
Adjusted basis
Realized gain
$ 260,000
(190,000)
$ 70,000
Recognized gain
$
-0-
The exchange qualifies for § 1031 postponement treatment.
21.
b.
Because of the postponed gain, the basis in the land is $190,000 ($260,000 $70,000). p. 7-19
a.
October 7, 2002
Amount realized
Adjusted basis
Realized gain
Recognized gain
$250,000
(175,000)
$ 75,000
$
-0-
The transaction qualifies as a like-kind exchange. Tex's basis for the land received is
$175,000 ($250,000 - $75,000).
7-10
2003 Entities Volume/Solutions Manual
February 15, 2003
Amount realized
Adjusted basis
Realized gain
Recognized gain
$300,000
(175,000)
$125,000
$125,000
The sale of the land by Tex results in the realized gain of $75,000 previously
postponed being recognized plus an additional $50,000 of appreciation.
b.
October 7, 2002
Amount realized
Adjusted basis
Realized gain
$250,000
(175,000)
$ 75,000
Recognized gain
$
-0-
The transaction qualifies as a like-kind exchange. Tex's basis for the land received is
$175,000 ($250,000 - $75,000).
February 15, 2003
Only Paige is involved in the sales transaction on February 15, 2003. However, since
Tex and Paige are related parties, neither party must dispose of the like-kind property
received for two years. Since Paige sold her land prior to the expiration of the
two-year period, Tex's postponed gain of $75,000 on the October 7, 2002 exchange is
recognized on February 15, 2003. As a result of this, Tex's adjusted basis for his land
is increased to $250,000 ($175,000 adjusted basis + $75,000 recognized gain).
c.
Smith, Raabe, and Maloney, CPAs
5191 Natorp Boulevard
Mason, OH 45040
November 1, 2002
Mr. Tex Wall
The Corral
El Paso, TX 79968
Dear Mr. Wall:
You have asked me to provide you with the tax consequences of the October 7, 2002
land exchange with your daughter, Paige. Based on the data you provided, the tax
consequences to you are as follows:
Amount realized
Less: Adjusted basis
Realized gain
Recognized gain
$250,000
(175,000)
$ 75,000
$
-0-
Since the transaction qualifies for nontaxable exchange treatment as the exchange of
like-kind property, your potential gain of $75,000 is postponed. The adjusted basis
for the land you received is $175,000 ($250,000 fair market value - $75,000
postponed gain).
Property Transactions: Basis, Gain and Loss, and Nontaxable Exchanges
7-11
Section 1031 of the Internal Revenue Code provides for the aforementioned
treatment. However, since the exchange was with a related party (i.e., Paige), the
Code provides that neither you nor Paige should dispose of the land you received in
the exchange prior to two years after the date of the exchange (i.e., October 8, 2004).
Such a disposition by either of you would make the exchange transaction on October
7, 2002 taxable for both Paige and you as of the date of the disposition. I suggest that
you communicate this information to Paige.
If I can be of further assistance, please let me know.
Sincerely,
Margaret Ryan, CPA
Tax Partner
pp. 7-23 and 7-24
22.
a.
Amount realized
Adjusted basis ($3,000 + $5,000)
Realized gain
$ 14,000
( 8,000)
$ 6,000
Recognized gain
$
-0-
The personal computer and the laser printer are depreciable tangible personal
property which are in the same general business asset class. Therefore, the exchange
qualifies as the exchange of like-kind property. pp. 7-22 to 7-24
b.
23.
Because the realized gain of $6,000 is postponed, Starling's basis for the printer is
$8,000 ($14,000 fair market value - $6 ,000 postponed gain). pp. 7-25 and 7-26
a.
Amount realized ($175,000 + $100,000)
Adjusted basis
Realized gain
$275,000
(125,000)
$150,000
b.
Recognized gain
$100,000
The exchange qualifies for like-kind exchange treatment. However, since boot
(i.e., the stock) is received, the realized gain is recognized to the extent of the boot
received. As the boot received of $100,000 is less than the realized gain of
$150,000, only $100,000 of the $150,000 realized gain is recognized.
c.
The basis of the land is $125,000 (fair market value of $175,000 minus postponed
gain of $50,000). The basis of the stock is the fair market value of $100,000.
pp. 7-22 to 7-26
24.
The critical question is whether the transactions qualify for § 1031 deferral treatment.
Tulip, Inc.’s preference probably is to have the gain on the land deferred and the loss on the
stock recognized. Therefore, the key is to be aware of whether the land and the stock to be
received qualify as like-kind property. Since only the land qualifies, Tulip can exchange
the land (i.e., defer the realized gain) and either sell or exchange the stock (i.e., recognize
the realized loss). However, Tulip may want to sell the land in order to avoid § 1031
7-12
2003 Entities Volume/Solutions Manual
treatment and recognize the gain. This could be the case if Tulip has no other recognized
gains and current year deductibility of the stock loss would otherwise be limited to $0. pp.
7-21 to 7-23
25.
a.
Because the postponed gain is $50,000, the basis equals $150,000 ($200,000 $50,000).
b.
Because the postponed gain is $320,000, the basis equals $30,000 ($350,000 $320,000).
c.
The transaction does not qualify as a like-kind exchange. Therefore, the basis of the
newly acquired asset (the bulldozer) is equal to its fair market value, or $42,000.
d.
The transaction does not qualify as a like-kind exchange. Therefore, the basis of the
newly acquired asset (ExxonMobil common stock) is equal to its fair market value,
or $18,000.
e.
The transaction does not qualify as a like-kind exchange. Therefore, the basis of the
personal use mountain cabin is equal to its fair market value, or $115,000.
pp. 7-21 to 7-23
26.
Smith, Raabe, and Maloney, CPAs
5191 Natorp Boulevard
Mason, OH 45040
November 21, 2002
Hyacinth Realty Co.
2501 Longview Lane
Des Moines, IA 50311
Dear President of Hyacinth Realty Co.:
You have asked us about the tax consequences of an all-cash sale vs. an exchange for land
located overseas. Nonrecognition treatment is not available for the land swap, because §
1031(h) states foreign land and U.S. land are not like-kind property despite their similarity.
Thus, an exchange of land in Iowa for land in Italy would be taxable in full, just like an
all-cash sale.
Should you need additional information, please do not hesitate to contact me.
Sincerely yours,
Marilyn Pierce, CPA
Partner
pp. 7-22 and 7-23
Property Transactions: Basis, Gain and Loss, and Nontaxable Exchanges
27.
a.
Amount realized
Adjusted basis
Realized gain
$15,000
(12,000)
$ 3,000
Recognized gain
$ 3,000
7-13
b.
The basis for Machine B is its cost of $15,000.
c.
Such an exchange would have resulted in the realized gain being postponed under §
1031. However, this would cause Redbud’s basis in the machine received to be
$12,000 ($12,000 adjusted basis + $0 gain recognized + $0 boot given or $15,000
fair market value - $3,000 postponed gain). Because the sale transaction is fully
taxable, the recognition of gain permits Redbud to have a higher basis for the new
machine. In addition, Redbud may have some losses with which they can offset the
$3,000 recognized gain.
d.
Amount realized
Adjusted basis
Realized loss
$12,000
(15,000)
$ 3,000
Recognized loss
$ 3,000
The basis for Machine B is its cost of $12,000. Avoiding § 1031 treatment enables
Redbud to recognize the $3,000 realized loss.
pp. 7-23 to 7-26
28.
a.
Realized gain = $50,000 [$60,000 (gain on like-kind property) - $10,000 (loss on
property given up that is not like-kind)].
b.
Recognized loss = $10,000 (on property given up that is not like-kind).
c.
New basis = $50,000 [$110,000 (fair market value of new real estate) - $60,000
(postponed gain on the like-kind property)].
Example 38 and pp. 7-24 and 7-25
29.
a.
The exchange qualifies as a like-kind exchange.
Amount realized ($410,000 + $90,000)
Adjusted basis
Realized gain
$500,000
(420,000)
$ 80,000
Recognized gain
$ 80,000
The mortgage assumed by Indigo, Inc. is treated as boot received by Avocet
Management Co. Therefore, Avocet’s recognized gain is $80,000, the lower of the
boot received of $90,000 or the realized gain of $80,000.
b.
Fair market value of office building and land
Less: Postponed gain
Adjusted basis
c.
The alternative would produce the following tax consequences:
$410,000
-0$410,000
7-14
2003 Entities Volume/Solutions Manual
Amount realized ($410,000 + $90,000)
Adjusted basis
Realized gain
$500,000
(420,000)
$ 80,000
Recognized gain
$ 80,000
Since the cash is treated as boot, the recognized gain of $80,000 would be the same as
in (a). Avocet’s adjusted basis for the office building and land of $410,000 would be
the same as in (a). Therefore, the tax consequences to Avocet under the alternative
proposal are the same as under the original proposal.
pp. 7-21 to 7-27
30.
a.
Realized gain = $9,000 [($12,000 fair market value of new asset + $4,000 boot
received) - $7,000 adjusted basis of old asset].
Recognized gain = $4,000.
Postponed gain = $5,000.
New basis = $7,000 ($12,000 fair market value of new asset - $5,000 postponed
gain).
b.
Realized loss = $1,000.
Recognized loss = $-0-.
Postponed loss = $1,000.
New basis = $16,000 ($15,000 fair market value of new asset + $1,000 postponed
loss).
c.
Realized loss = $1,500.
Recognized loss = $-0-.
Postponed loss = $1,500.
New basis = $9,500 ($8,000 fair market value of new asset + $1,500 postponed loss).
d.
Realized gain = $10,000.
Recognized gain = $-0-.
Postponed gain = $10,000.
New basis = $22,000 ($32,000 fair market value of new asset - $10,000 postponed
gain).
e.
Realized gain = $2,000.
Recognized gain = $1,000.
Postponed gain = $1,000.
New basis = $10,000 ($11,000 fair market value of new asset - $1,000 postponed
gain).
f.
Realized loss = $2,000.
Recognized loss = $-0-.
Postponed loss = $2,000
New basis = $10,000 ($8,000 fair market value of new asset + $2,000 postponed
loss).
Example 41 and pp. 7-21 to 7-26
Property Transactions: Basis, Gain and Loss, and Nontaxable Exchanges
31.
a.
Amount realized [$150,000 (cash) + $975,000 (office building)
+ $240,000 (mortgage)]
Adjusted basis of apartment house given up
Realized gain
7-15
$1,365,000
( 950,000)
$ 415,000
b.
Recognized gain = $390,000 [$150,000 (cash) + $240,000 (mortgage assumed by
Dove is treated as boot received); lower of boot received of $390,000 or realized gain
of $415,000].
Postponed gain = $25,000.
c.
New basis = $950,000 [$975,000 (fair market value of office building received) $25,000 (postponed gain)].
Example 41 and pp. 7-23 to 7-26
32.
a.
Since the taxpayer is an owner-investor, the taxpayer use test applies. Replacing
the warehouse that is rented to various tenants with a shopping mall that is rented to
various tenants in a different location qualifies as replacement property.
b.
Since the taxpayer is an owner-user, the functional use test applies. Replacing the
warehouse used in his business with another warehouse in a different state which is
to be used in his business qualifies as replacement property under the functional use
test.
c.
Since Swallow was an owner-user of the building, the functional use test applies.
Thus, Swallow's use of the replacement property and of the involuntarily converted
property must be the same. Since Swallow’s use of the four-unit apartment
building is different from the use of the building in her retail business, the
apartment building does not qualify as replacement property.
d.
Since Susan and Rick are owner-users, the functional use test applies. The rental
duplex does not qualify as replacement property under this test.
pp. 7-27 to 7-29
33.
There are two issues that need to be addressed. The first is whether both Steve and Ross
can qualify for deferral treatment under § 1033. The second is the manner in which Ross
behaved in acquiring the property.
The resolution of the first issue for Ross is straightforward. As he is aware that the property
is going to be condemned, he could qualify for deferral under § 1033(a)(2) even if he sold
the property to someone other than the condemning authority. Since his intent is to sell to
the condemning authority, he obviously qualifies. For Steve, the earliest date he can sell
his property to Ross and qualify for deferral treatment is the date of the threat or imminence
of requisition or condemnation of the property. Even though he does not appear to be
aware of such a threat or imminence at the time of the sale to Ross, unless Ross informs
him, it is unlikely the IRS would question his qualification for § 1033. However, he does
not need to use § 1033. He can qualify for exclusion under § 121 since the house is his
principal residence.
The manner in which Ross conducted his affairs initially raises serious questions. At the
least, Ross has been less than truthful. While the property is being purchased by a
7-16
2003 Entities Volume/Solutions Manual
corporation, Ross failed to disclose that he and his spouse own the corporation. In addition,
Ross failed to disclose that the property is going to be subject to condemnation
proceedings. Finally, Ross may be violating realtors' ethical standards which could result
in sanctions.
Making another proposal based on his “second thoughts” would put Ross in a much better
ethical position. In all likelihood, Steve will sell the property to him anyway.
pp. 7-27 to 7-31
34.
a.
Amount realized
Adjusted basis
Realized gain
$390,000
(210,000)
$180,000
Recognized gain
$
-0-
The transactions qualify for § 1033 involuntary conversion treatment. Thus, since
Lark Corporation reinvested the $390,000 of insurance proceeds received in
qualifying property, all of the $180,000 realized gain is postponed.
Lark’s basis for the replacement office building is $210,000 [$390,000 (cost) $180,000 (postponed gain)].
b.
Amount realized
Adjusted basis
Realized gain
$390,000
(210,000)
$180,000
Recognized gain
$180,000
The transactions do not qualify for § 1033 involuntary conversion treatment. Lark
did not reinvest any of the insurance proceeds received in qualifying property (i.e., an
office building and a warehouse are not similar property under the functional use
test).
Lark’s basis for the replacement office building is $350,000.
c.
Amount realized
Adjusted basis
Realized gain
$390,000
(210,000)
$180,000
Recognized gain
$180,000
None of the realized gain is postponed because Lark did not acquire qualifying
replacement property.
pp. 7-27 to 7-31
Property Transactions: Basis, Gain and Loss, and Nontaxable Exchanges
35.
a.
7-17
Magenta’s realized gain is calculated as follows:
Amount realized
Adjusted basis
Realized gain
$450,000
(300,000)
$150,000
Since the form of the involuntary conversion is a direct conversion (i.e., a
warehouse for a warehouse), § 1033 nonrecognition is mandatory. Thus, none of
the realized gain of $150,000 is recognized. Magenta 's basis for the replacement
warehouse is $300,000 ($450,000 fair market value - $150,000 postponed gain).
b.
As indicated in part (a), since the form of the involuntary conversion is a direct
conversion, § 1033 nonrecognition is mandatory. What Magenta should have done
was not have accepted the surplus warehouse, but instead to have negotiated for
cash. Then, they could have achieved their objective of recognizing gain by not
electing § 1033 treatment.
pp. 7-27 to 7-30
36.
a.
Postponed gain = $-0-. The $40,000 realized gain is recognized because the amount
that the taxpayer reinvested is only $100,000. Basis = $100,000 - $0 = $100,000.
b.
Postponed loss = $-0-. The casualty loss is recognized. Basis = $200,000 - $0 =
$200,000.
c.
Postponed gain = $50,000. Basis = $350,000 - $50,000 = $300,000.
d.
Postponed loss = $-0-. The $2,000 casualty loss is recognized, less the $100 floor =
$1,900. The $1,900 must be reduced further by 10% of adjusted gross income. This
10% floor is applied to the total of casualty losses that are deductible for the taxable
year rather than to each casualty. Basis = $17,000 - $0 = $17,000.
e.
Postponed gain = $80,000. Basis = $240,000 - $80,000 = $160,000.
f.
Postponed gain = $1,000. Basis = $19,000 - $1,000 = $18,000. Note that better tax
consequences could be obtained if the § 121 exclusion requirements are satisfied.
g.
Loss is nondeductible. Basis = $26,000 - $0 = $26,000.
h.
Postponed gain = $50,000. Basis = $200,000 - $50,000 = $150,000.
pp. 7-27 to 7-30
37.
a.
Milton’s amount realized is calculated as follows:
Selling price
Less selling expenses:
Realtor’s commission
Appraisal fee
Exterminator’s certificate
Recording fees
Amount realized
$245,000
$14,000
500
300
400
( 15,200)
$229,800
7-18
2003 Entities Volume/Solutions Manual
Amount realized
Adjusted basis
Realized gain
§ 121 exclusion
Recognized gain
$229,800
(150,000)
$ 79,800
( 79,800)
$
-0-
Milton qualifies for the § 121 exclusion.
b.
Milton’s basis for his new residence is its cost of $210,000.
c.
Amount realized ($735,000 - $15,200)
Adjusted basis
Realized gain
§ 121 exclusion
Recognized gain
$719,800
(150,000)
$569,800
(250,000)
$319,800
Since Milton is single, his maximum § 121 exclusion is $250,000. Milton’s basis for
his new residence is its cost of $210,000.
p. 7-33
38.
a.
Amount realized
Adjusted basis
Realized gain
Recognized gain
$80,000
(35,000)
$45,000
$
0
Realized gains or realized losses on property transactions between spouses are not
recognized.
b.
Sal’s adjusted basis for the Peach stock is a carryover basis of $35,000 (i.e., for basis
purposes, the transaction is treated as a gift).
c.
The tax consequences would be the same as in (a) and (b) if Ruth had made a gift of
the stock to Sal. Since the sale form and the gift form produce the same tax
consequences, the key is whether Sal wants to transfer the $80,000 to Ruth.
p. 7-33
BRIDGE DISCIPLINE PROBLEMS
1.
a.
Book depreciation [($100,000 - $12,000)  8 X ½]
$ 5,500
The straight-line method is used for book purposes because the asset is expected to
benefit Blue evenly throughout its 8-year life.
Tax depreciation ($100,000 X .20) – see Table 4-1
b.
$20,000
The book-tax difference in the year of acquisition is $14,500 ($20,000 - $5,500).
That is, depreciation for tax purposes is $14,500 higher than depreciation expense
for book purposes.
Property Transactions: Basis, Gain and Loss, and Nontaxable Exchanges
2.
Book depreciation
Year 1 [($100,000 - $12,000)  8 X ½]
Year 2 [($100,000 - $12,000)  8]
Year 3 [($100,000 - $12,000)  8]
Year 4 [($100,000 - $12,000)  8]
Year 5 [($100,000 - $12,000)  8]
Year 6 [($100,000 - $12,000)  8]
Year 7 [($100,000 - $12,000)  8 X ½]
Total accumulated depreciation
$ 5,500
11,000
11,000
11,000
11,000
11,000
5,500
$ 66,000
Amount realized
Adjusted basis for book purposes ($100,000 - $66,000)
Gain for book purposes
$ 40,000
( 34,000)
$ 6,000
Tax depreciation - See Table 4-1
Year 1 ($100,000 X .20)
Year 2 ($100,000 X .32)
Year 3 ($100,000 X .1920)
Year 4 ($100,000 X .1152)
Year 5 ($100,000 X .1152)
Year 6 ($100,000 X .0576)
Total accumulated depreciation
$ 20,000
32,000
19,200
11,520
11,520
5,760
$100,000
Amount realized
Adjusted basis for tax purposes ($100,000 - $100,000)
Gain for tax purposes
$ 40,000
(
0)
$ 40,000
7-19
Therefore, because the gain for book purposes is $6,000 and the gain for tax purposes is
$40,000, the book-tax difference is $34,000.
3.
a.
Yes.
b.
No. Inventory does not qualify as productive use or investment property.
c.
No. An exchange of investment realty for a personal residence does not qualify.
d.
No. Securities do not qualify as productive use or investment property.
e.
Yes.
f.
No. Although the truck and the computer both are business personalty, they are not
in the same general business asset class.
g.
Yes.
h.
No. Stock in different corporations does not qualify as like-kind property under
§ 1031.
i.
Yes. The office furniture and office equipment both are personalty and they are in the
same general business asset class.
j.
No. Real property located in the United States exchanged for foreign real property
(and vice versa) does not qualify as like-kind property.
7-20
2003 Entities Volume/Solutions Manual
pp. 7-22 and 7-23
RESEARCH PROBLEMS
1.
Beverly’s recognized gain on the sale of the 6,000 shares of Color, Inc. is $90,000. She
may use the specific identification method to identify the shares sold.
Concord Instruments Corporation, 67 TCM 3036, T.C. Memo. 1994-248, in a similar fact
pattern, concluded that the oral instructions to the broker to sell the stock with the highest
cost basis constituted adequate identification of the shares.
Reg. § 1.107-1(c)(3) provides that stock is adequately identified if (1) the taxpayer
specifies the particular stock to be sold at the time of the sale, and (2) the broker confirms in
writing the taxpayer's instructions within a reasonable period of time. The IRS position, in
Concord, was that the broker did not provide a written confirmation of the taxpayer's
instructions as required by this regulation. Therefore, in determining the amount of the
recognized gain, the FIFO basis must be used to determine the cost basis of the shares sold.
The taxpayer's response was to admit the regulation requirement was not satisfied, but to
take the position that alternatives exist to the method prescribed in the regulations for
identifying shares of stock sold. The taxpayer's position was based on alternatives
provided in case law which preceded Reg. § 1.107-1(c)(3).
The Tax Court accepted the taxpayer's argument. It concluded that the current regulations
do not state that they provide the exclusive means for identifying the shares of stock sold.
Instead, the regulations merely provide a safe harbor. Adequate identification can occur in
other ways. Therefore, the Tax Court permitted the taxpayer to use the specific
identification method.
2.
Amos’ realized gain is calculated as follows:
Amount realized
– Basis
= Realized gain
$100,000
(10,000)
$ 90,000
Since the stock that Amos sold is qualified small business stock and since he held the stock
for over six months, Amos is eligible to elect § 1045 deferral treatment. To comply under §
1045, he must reinvest the $100,000 net proceeds in qualified small business stock within
60 days of the sale.
Rev. Proc. 98-48, 1998-2 C.B. 367, contains the mechanics for making the election. Amos
must make the election by his tax return due date (including extensions) for the year in
which the qualified small business stock is sold. The election is made by:

Reporting the entire gain from the sale of the qualified small business stock
on Schedule D.
Property Transactions: Basis, Gain and Loss, and Nontaxable Exchanges
7-21

Writing “Section 1045 rollover” directly below the line on which the gain is
reported.

Entering the amount of the gain deferred under § 1045 on the same line on
which “section 1045 rollover” appears as a loss in accordance with the
instructions for Schedule D.
If Amos should decide not to make the § 1045 deferral election, his recognized gain would
be $90,000 and the basis for his new stock would be its § 1012 cost of $100,000. If Amos
does make the election, his recognized gain is $0 (i.e., he has no reinvestment deficiency
since he reinvested the $100,000 amount realized from the sale of the qualified small
business stock). His basis for the new stock would be $10,000 ($100,000 amount realized
- $90,000 deferred gain).
3.
Section 1031 provides that a deferred exchange of like-kind property is eligible for
postponement of gain if the following requirements are satisfied:

The property to be received is identified within 45 days of the date the taxpayer
transfers his or her property to the other party to the exchange.

The identified property is received by the taxpayer by the earlier of the following:

180 days of the date the taxpayer transfers his or her property to the other party to the
exchange.

The due date for the tax return (without extensions).
In a case (David A. Knight, 75 TCM 1992, T.C. Memo. 1998-107) with facts similar to
those for Fran and Bob, the Tax Court applied a strict interpretation to the statutory
language for deferred exchanges under § 1031. Thus, Fran and Bob will have recognized
gain calculated as follows:
Amount realized
Adjusted basis
Realized gain
Recognized gain
$75,000
(20,000)
$55,000
$55,000
Their basis for the Houston parcel will be its fair market value of $75,000.
7-22
4.
2003 Entities Volume/Solutions Manual
The Internet Activity research problems require that the student access various sites on the
Internet. Thus, each student’s solution likely will vary from that of the others.
You should determine the skill and experience levels of the students before making the
assignment, coaching them where necessary so as to broaden the scope of the exercise to
the entire available electronic world.
Make certain that you encourage students to explore all parts of the World Wide Web in
this process, including the key tax sites, but also information found through the web sites of
newspapers, magazines, businesses, tax professionals, government agencies, political
outlets, and so on. They should work with Internet resources other than the Web as well,
including newsgroups and other interest-oriented lists.
Build interaction into the exercise wherever possible, asking the student to send and receive
e-mail in a professional and responsible manner.
5.
See the Internet Activity comment above.