Property transaction

9.1 Cost Basis

General Rule: Initial basis is the cost of the property.

• Cost Includes: Purchase price, sales tax, freight, installation, legal fees, title insurance, recording fees, and major improvements.

• Cost Excludes: Repairs, maintenance, insurance, and other expenses not capitalized.

Lump-Sum Purchase: When multiple assets are bought for one price, allocate the total cost based on the relative Fair Market Value (FMV) of each asset.

Basis of Property Received for Services: The FMV of the property received is included in gross income. This FMV becomes the recipient's cost basis.

9.2 Property Received by Gift

General Rule: The donee's basis is generally the donor's adjusted basis (carryover basis).

• Gift Tax Paid: The basis is increased by the gift tax paid attributable to the property's appreciation.

Dual Basis Rule (If FMV at gift < Donor's Basis):

• For Determining a GAIN: Use the donor's basis.

• For Determining a LOSS: Use the FMV at the date of the gift.

• If Sold for a price between FMV and Donor's Basis: No gain or loss is recognized.

9.4 Inherited Property

General Rule: Basis is the FMV on the date of the decedent's death ("step-up" or "step-down" in basis).

• Alternate Valuation Date: The executor can elect to use the FMV 6 months after death, but only if it decreases both the gross estate value and the estate tax.

• Holding Period: The heir's holding period is automatically long-term.

9.5 Stock Dividends and Splits

Non-Taxable Stock Dividend/Split:

• Basis: The basis of the original shares is reallocated to the old and new shares based on their relative FMVs.

• Holding Period: Includes the holding period of the original shares.

Taxable Stock Dividend:

• Basis: The basis in the new shares is their FMV on the date of distribution.

• Holding Period: Begins on the day after the distribution.

Stock Rights:

• Basis is allocated if the FMV of the rights is 15% or more of the FMV of the underlying stock; otherwise, basis is zero unless an election is made.

9.6 Adjustments to Asset Basis

Basis is INCREASED by:

• Capital improvements, legal fees to defend title, zoning costs.

• Shareholder Contributions: A shareholder's contribution of property to a corporation increases their stock basis by the basis of the contributed property.

Basis is DECREASED by:

• Depreciation: The larger of the depreciation allowed or allowable.

• Casualty/Theft Losses: By the amount of the deductible loss.

• Tax Credits: Certain credits (like energy credits) reduce basis.

• Return of Capital Distributions: Nontaxable distributions that reduce stock basis. Once basis is zero, subsequent distributions are capital gains.

9.7 Holding Period

• General Rule: Begins the day after acquisition.

• Property Held > 1 Year: Long-Term.

• Property Held ≤ 1 Year: Short-Term.

• Tacking of Holding Period: The holding period of the previous owner is added ("tacked on") in the case of:

  • Gifts (for gain calculation)

  • Inherited Property (always LT)

  • Like-Kind Exchanges (Sec. 1031)

  • Nontaxable stock dividends and splits

9.8 Capital Gains and Losses

Capital Assets: Defined as all property except:

1. Inventory

2. Accounts/notes receivable from business

3. Depreciable property used in a trade or business (Sec. 1231 assets)

4. Copyrights held by the creator

5. Certain government publications

Calculation of Gain/Loss:

• Amount Realized = Cash + FMV of Property Received + Liabilities Relieved of – Selling Expenses

• Realized Gain/(Loss) = Amount Realized – Adjusted Basis

Capital Gains Tax Rates for Individuals (2024):

• Short-Term Gains: Taxed at ordinary income rates.

• Long-Term Gains: Taxed at preferential rates: 0%, 15%, or 20%, based on taxable income.

• Special 25% Rate: For unrecaptured Section 1250 gain (depreciation on real property).

• Special 28% Rate: For gains on collectibles and Section 1202 small business stock.

Netting Process:

1. Net all short-term gains and losses to get Net STCG or Net STCL.

2. Net all long-term gains and losses to get Net LTCG or Net LTCL.

3. If both are gains, they are taxed separately.

4. If one is a gain and the other is a loss, they are netted together.

Capital Loss Limits:

• Individuals: Can deduct up to $3,000 ($1,500 if MFS) of net capital loss against ordinary income each year. Excess losses carry forward indefinitely.

• Corporations: Cannot deduct net capital losses against ordinary income. Losses can be carried back 3 years and forward 5 years as short-term.

9.9 & 9.10 Special Stock Rules

Section 1202 Stock (Qualified Small Business Stock):

• Exclusion: 50%, 75%, or 100% of the gain is excluded from income, depending on when the stock was acquired.

• Holding Period: Must be held for more than 5 years.

• Limit: The exclusion is limited to the greater of $10 million or 10x the stock's adjusted basis.

Section 1244 Stock (Small Business Stock):

• Benefit: Losses are treated as ordinary losses (not capital losses).

• Limit: Maximum ordinary loss deduction is $50,000 per year ($100,000 on a joint return).

Wash Sales: Losses are disallowed on the sale of stock or securities if substantially identical stock is purchased 30 days before or after the sale. The disallowed loss is added to the basis of the newly acquired stock.

Worthless Securities: Treated as a sale on the last day of the tax year, resulting in a capital loss.