1. [LO 1] Compare and contrast different ways in which a taxpayer triggers a realization event by disposing of an asset.
A realization event for tax purposes is created in many ways. Virtually any disposal will result in a sale or other disposition. These include a sale, trade, gift to charity, disposal to the landfill, or destruction in a natural disaster. In a sale or trade (exchange), the taxpayer receives something of value in return for the asset. In contrast, a charitable contribution, disposal, or destruction from a natural disaster generally results in a loss of any remaining basis in the asset without compensation (unless reimbursed by insurance).
2. [LO 1] Potomac Corporation wants to sell a warehouse that it has used in its business for 10 years. Potomac is asking $450,000 for the property. The warehouse is subject to a mortgage of $125,000. If Potomac accepts Wyden Inc.’s offer to give Potomac $325,000 in cash and assume full responsibility for the mortgage on the property, what amount does Potomac realize on the sale?
When the property disposed of is subject to a liability and the buyer assumes the liability, the relief of debt increases the amount realized. Thus, Potomac’s amount realized consists of $450,000, which is cash of $325,000 plus $125,000 relief of debt. This assumes that the buyer hypothetically transfers cash to the seller in order to pay off the mortgage.
3. [LO 1] Montana Max sells a 2,500-acre ranch for $1,000,000 in cash, a note receivable of $1,000,000, and debt relief of $2,400,000. He also pays selling commissions of $60,000. In addition, Max agrees to build a new barn on the property (cost $250,000) and spend $100,000 upgrading the fence on the property before the sale. What is Max’s amount realized on the sale?
Anything received by the seller during a sale or exchange is included in the amount realized. Most dispositions result in cash to the seller. However, amount realized includes, but is not limited to, cash, the fair market value of any other property received (e.g. marketable securities or a similar asset), or relief of debt. In addition, selling expenses reduce the amount realized. Therefore, Max’s amount realized includes the $1,000,000 of cash, $1,000,000 note receivable, relief of debt of $2,400,000, and is reduced by selling commissions of $60,000 (selling expenses reduce the amount realized, S.C. Chapin, CA-8, 50-1 USTC ¶9171). Anything the seller gives up in the transaction is added to the basis of the property given up and is not considered part of the amount realized. Therefore, the barn and fence improvements are not considered part of Max’s amount realized. Note, however, that making these improvements decreases his realized gain by increasing Montana Max’s adjusted basis in the property due to the improvements.
4. [LO 1] Hawkeye sold farming equipment for $55,000. It bought the equipment four years ago for $75,000, and it has since claimed a total of $42,000 in depreciation deductions against the asset. Explain how to calculate Hawkeye’s adjusted basis in the farming equipment.
Hawkeye will calculate its adjusted basis in the farming equipment by reducing the historical cost by any cost recovery deductions taken—namely, depreciation. Therefore, Hawkeye’s adjusted basis is $33,000 ($75,000 less $42,000). The tax adjusted basis is usually different than the book adjusted basis. This is because most assets use a different recovery period, cost recovery method (e.g. double declining balance), and convention (e.g. half-year) for tax than for book purposes. See Chapter 9 for how these differences arise. Due to the difference in cost recovery deductions, the adjusted basis is likely different unless the asset is fully depreciated for both book and tax purposes.
5. [LO 1] When a taxpayer sells an asset, what is the difference between realized...
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