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MODULE 19
Computing Gain or Loss on
Disposition
of Assets
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1. Computing gains and losses
2. Basis considerations
3. Installment sales
Computing Gains and
Losses
Key Learning Objectives
The gains and (losses) formula
 Applicable law
 Amount realized
 Adjusted basis

The Gains and (Losses) Formula
Sales price
-Selling expenses
Amount realized
-Adjusted basis
Realized gain (loss)
-Deferred gain (loss)
Recognized gain (loss)
Applicable Law

The gain or loss from the sale of property
 Determined
by the law in force at the
date of sale

Depreciation adjustments reduce basis
 Determined
by the law in force at the
time the property is acquired
Amount Realized

Sum of
Any money received
 Plus FMV of property received
 Less any selling expenses

Adjusted Basis
Uncovered Cost of the Asset
Original cost basis
 Minus cost recoveries
 Plus improvements

Basis Considerations
Key Learning Objectives
 Recovery of capital doctrine
 Determining cost basis
 Cost basis factors
 Gift basis
 Property acquired from decedent
 Property converted from personal use
Adjusted Basis Determined by

How acquired



Purchase
Gift
Inherited
Basis Determined by Purchase

Purchase



Cash/FMV of property received
Debt assumption
Non-deductible improvements
Basis Determined by Gift

Note: D= doner; D'e = donee; Date of gift = DOG

General rule if FMV > basis at DOG
 Use
D's basis and
 Adjust for gift taxes

If FMV < basis at DOG see special rules
Basis Determined by Gift
Adjustment for Gift Taxes Paid
D = doner; D'e = donee; DOG = date of gift
 Gift taxes are paid by D
 Gift taxes are based on FMV at DOG
 Adjustment to D’e basis only if

 FMV

> basis at DOG
D’e gets gift taxes relating to appreciation
[FMV- basis]
FMV
In Class Exercise:
Adding Gift Taxes to Basis
D = doner; D'e = donee; DOG = date of gift
 At DOG
FMV
= $17,000

D’s basis = 13,500

Gift tax
= 2,000
 Calculate D’e basis

Solution--In Class Exercise:
Adding Gift Taxes to Basis
Property is appreciated at DOG
 So start with adjusted basis of $13,500
 Add % of gift taxes relating to appreciation

 $412
Gift taxes x (FMV - AB) ÷ FMV
 $2,000 x ($17,000 - $13,500) ÷ $17,000
 Total basis to D'e = $13,912 ($13,500+$412)

Basis Determined by Gift
FMV < Basis at DOG

D = doner; D'e = donee; DOG = date of gift
 No
adjustment for gift taxes
 Basis (AB) determined when D’e sells
 If used by D’e and subject to
depreciation, use FMV at DOG
Basis Determined by Gift
FMV < Basis at DOG
D= doner; D'e = donee; DOG = date of gift
 Sold for

>
D's basis then AB = D's basis
 < FMV at DOG then AB = FMV at DOG
 < D’s basis BUT > FMV at DOG
 AB = Amount realized
 No gain/loss recognized to D’e
In Class Exercise: Gift Basis
FMV < Basis at DOG
D = doner; D'e = donee; DOG = date of gift
 At DOG: AB = $12,000 FMV = $10,000
 D’e sells at a later date for:
Case
A
B
C
AR = $13,000 $11,000 $9,000
 What is adjusted basis in each case?
 What is total gain realized?

In Class Exercise: Gift Basis
FMV < Basis at DOG
At DOG: AB = $12,000 FMV = $10,000
Case
A
B
C
AR = $13,000 $11,000 $ 9,000
AB = 12,000 11,000 10,000
GL = $ 1,000
0
(1,000)
 Note that you would plug any basis for AR
between $10,000 and $12,000

Conversion From Personal Use

Follow rules similar to gift rules
 If
FMV > A/B use A/B
 If FMV < A/B use FMV
In Class Exercise: Conversion
from Personal Use
John has an automobile used 100% for
personal purposes for two years
 He converts it to 100% business use when
 A/B = $16,000
FMV = $8,500
 What is John’s basis for business purposes?

Solutions: In Class Exercise:
Conversion from Personal Use
He converts it to 100% business use when
 A/B = $16,000
FMV = $8,500
 John uses $8,500 since FMV is lower than
A/B when the property is converted
 The $7,500 decline in value is considered to
be a non-deductible personal expenditure

Basis Determined by Inheritance
Use value reported on estate’s tax return
 Generally FMV at date of death (DOD)
 Estate may choose to use alternative
valuation date

 FMV
6 months after DOD
Installment Sales
Key Learning Objectives
Eligible sales
 Ineligible sales
 Mandatory reporting
 Gain reported
 Problem areas

Installment Sale

At least one payment is received after the
close of the tax year in which the
disposition of the asset occurs
Ineligible Sales
Dealer disposition of property held for sale
to customers
 Gains relating of the recapture provisions
of §1245 and §1250
 Stock or securities traded on an established
securities market
 Property of any kind regularly traded on an
established market

Mandatory Reporting
Unless Election Out
Any sale that is covered by the definition of
an “installment sale”
 Must elect out of the installment method to
avoid
 Election out attached to a timely tax return
 Entire gain included in income for the
taxable year

Consequences of Electing Out of
Installment Method
 Cash
basis amount realized
Money
 Accrual
and FMV of property
basis amount realized
Money
and FMV of property
Face value of any obligation received
Installment Method
Gain Reported As Cash Collected
Gross profit = A/R - A/B
 Gross profit percentage =
Gross profit ÷ total contract price
 Gain recognized =
Gross profit percentage x am’t received
 Ratio applied to payments received in the
current period

In Class Exercise: Gain Reported
on Installment Sale
 Mary
agrees to sell for $500,000
 Land for which she paid $300,000
 She will receive $100,000 a year for
5 years
 Interest will be paid at the required rate
 How much gain will she recognize
each year?
Solution: In Class Exercise: Gain
Reported on Installment Sale
Gross profit = A/R
- A/B
 $200,000
= $500,000 - 300,000
 Gross profit percentage =
gross profit ÷ total contract price
 40% =
$200,000 ÷
$500,000

Solution: In Class Exercise: Gain
Reported On Installment Sale
Gross profit percentage = 40%
 Amount received each year = $100,000
 Gain recognized each year = $40,000
Gross profit percentage x am’t received
40% x $100,000
 Total gain recognized is $200,000

 $40,000
x 5
In Class Exercise: Gain Reported
on Installment Sale & §1250
Gains associated with depreciation cannot
be deferred through an installment sale
 How would Mary’s gain recognition change
if the property she sold was a building AND
 $50,000 of the gain is §1250 recapture?

Solution: In Class Exercise: Gain
Reported on Installment & §1250
Gross profit = A/R
- A/B
 $200,000
= $500,000 - $300,000
 BUT $50,000 is recognized immediately so
gross profit is reduced to $150,000
 Gross profit percentage =
Gross profit ÷ total contract price
 30% =
$150,000 ÷
$500,000

Solution: In Class Exercise: Gain
Reported On Installment & §1250
Gross profit percentage = 30%
 Amount received each year = 100,000
 Gain recognized each year = 30,000
Gross profit percentage x am’t received
30%
x $100,000
 Total gain recognized is $200,000

 $30,000
x 5 + $50,000
Installment Method Problem
Area: Imputed Interest
If the contract does not specify an interest
rate equal to the applicable federal rate
 Then interest will be imputed at that rate

Problem Area-Related Party Sales



Sale between related parties
 Spouses, children, grandchildren, and parents
 Controlled corporation, partnership, trust, estate
Normal rules apply, unless
 Property is depreciable or
 Purchaser resells the property before payment
of the original sales price
Rules can be avoided if the taxpayer can establish
(to the Secretary’s satisfaction) that tax avoidance
was not the motive for the transaction
Transferring an Installment
Obligation
Sale, gift, or other transfer of the installment
obligation
 Unreported gain may be reported at the time
of transfer
 Difference between

 Basis
in the obligation and
 Amount realized

Fair market value of the obligation
Basis in Obligation

Excess of the face value of the obligation
over an amount equal to the income which
would be returnable were the obligation
satisfied in full
Interest on Deferred Taxes
Require the taxpayer to pay interest
 Only required if the sales price of the
property exceeds $150,000
 Obligations from all such sales that arise
during and are outstanding at the end of the
tax year exceed $5,000,000
 Gains associated in excess of $5,000,000
