R2: Basis & Holding Period of Assets

3 ways to acquire property

1. Purchase

2. Gift

3. Inherit

basis of purchased tangible property

Basis is the cost of the property.

• Sales price - basis = gain or loss

• Holding period begins on purchase date

real property

land and all items permanently affixed to the land (buildings, paving, etc.)

personal property

all property not classified as real property

holding period for purchased property

begins on the date the property is acquired (purchase date)

basis spreading adjustments (stock dividends & stock splits)

same amount of basis spread over more shares, so basis per share will be lower after split

basis of gifted property

General rule: gifted property’s basis is the NBV at the time of the gift UNLESS FMV of gift < donor’s NBV

• when exception to the rule occurs, it depends on the sale price

Gifted property FMV < donor’s NBV

Scenario 1: sales price > NBV

gain = sales price - NBV

Gifted property FMV < donor’s NBV

Scenario 2: sales price < NBV

loss = sales price - FMV

Gifted property FMV < donor’s NBV

Scenario 3: sales price is between NBV & FMV

no gain or loss recognized

holding period for gifted property

gift recipient usually assumed the donor’s holding period

*if Scenario 2, holding period starts as of the date of the gift

basis of inherited property

General rule: basis is FMV at date of death

alternate valuation date (inherited property only)

• if executor elects to use alternate valuation date, the basis of the asset is the FMV at the earlier of:

  • distribution date of asset (maximum of 6 months)

  • 6 months after death

holding period for inherited property

inherited property is automatically considered to be LT property regardless of how long it has actually been held

general rule for capitalization

if the benefit provided lasts longer than 1 year, generally the asset will be capitalized

de minimis safe harbor

• a taxpayer with AFS (applicable financial statement) can deduct the amount paid for items up to $5,000 as an expense

• taxpayer without AFS is limited to $2,500 per item

• if cost of the item is more than allowance, entire cost must be capitalized

tax basis of property converted from personal to business use

tax basis is the lesser of:

• the original cost basis

• FMV of property on date of conversion

adjusted basis

original cost basis - depreciation

tax basis of property converted from personal to business use sold at a gain

• tax basis = adjusted basis of the property @ sale date

sales price - adjusted basis = gain

tax basis of property converted from personal to business use sold at a loss

1. Take lesser of:

• adjusted cost basis @ time of conversion

• FMV of property @ time of conversion

2. Reduce amount from step 1 by depreciation after the conversion to business use.

Sales price - (step 1 - depreciation) = loss

intangible property basis

• initial basis is usually the cost/purchase price

• adjusted basis = initial basis adjusted downward by amortization

Section 197 purchased intangibles

intangible assets acquired in connection with the purchase of an existing business

R&D for intangible assets

must be capitalized and amortized

patents & copyrights

• initial basis = purchase price

• if self-created → basis is cost to create (development, legal, fees)

organizational costs

• applies to the formation & organization of a partnership, LLC, or corporation

• qualifying costs:

  • legal/accounting fees

  • filing fees

  • cost of organizational meetings

start-up costs

• applies to the start-up of a business organized as a sole proprietorship, partnership, or corporation

• costs to investigate & create the business that are incurred before the business begins operations

expensing business organizational costs & start-up costs

• taxpayers may immediately expense the first $5,000 of organizational costs & the first $5,000 of business start-up costs

• $5,000 allowance is reduced dollar-for-dollar when total costs exceed $50,000 for each item