Property Transactions and Basis Rules
Property transactions are one of the most complex and frequently tested areas on the REG section of the CPA exam. Understanding how to calculate basis, determine gain/loss character, and apply nonrecognition rules is critical.
Basis of Property: How Acquired
| Acquisition Method | Basis Rule | Key Details |
|---|---|---|
| Purchase | Cost basis | Purchase price + Sales tax + Freight + Installation + Testing costs |
| Gift | Dual basis rule | Gain basis: Donor's adjusted basis + gift tax attributable to appreciation. Loss basis: Lower of donor's AB or FMV at date of gift. If selling price is between the two, no gain or loss. |
| Inheritance | Fair market value at date of death | FMV on date of death OR alternate valuation date (6 months later if elected). Holding period is always long-term. |
| Conversion from personal to business | Lower of AB or FMV at conversion date | For depreciation, use lower of AB or FMV. For gain, use AB. |
Gain/Loss Character: Section 1231, 1245, 1250
| Section | Applies To | Gain Treatment | Loss Treatment |
|---|---|---|---|
| §1231 | Depreciable business property and real property held >1 year | Long-term capital gain (after netting) | Ordinary loss |
| §1245 | Depreciable personal property (machinery, equipment, vehicles) | Ordinary income to extent of accumulated depreciation; excess is §1231 gain | Ordinary loss |
| §1250 | Depreciable real property (buildings) | Ordinary income only to extent of excess depreciation over straight-line (rare under current law); 25% rate on unrecaptured §1250 gain | Ordinary loss |
Key rule: §1245 recapture is applied BEFORE §1231 netting. All accumulated depreciation on personal property is recaptured as ordinary income.
Like-Kind Exchange (§1031)
| Requirement | Detail |
|---|---|
| Qualifying property | Real property held for business or investment use (NOT inventory, stocks, bonds, or personal-use property) |
| Like-kind | Real property for real property (domestic for domestic only; no foreign-to-domestic exchanges) |
| Identification period | 45 days after transfer of relinquished property |
| Exchange period | 180 days after transfer (or due date of tax return, if earlier) |
| Boot | Non-like-kind property received (cash, relief of liabilities, personal property). Boot received triggers recognition of gain (but not loss). |
Section 1031 Basis and Gain Formulas
- Realized gain = FMV of property received + Boot received − Adjusted basis of property given up
- Recognized gain = Lesser of: (1) Realized gain, or (2) Boot received
- Basis of new property = FMV of new property − Deferred gain (or + Deferred loss)
- Alternative: Basis of new property = AB of old property + Gain recognized − Boot received + Boot paid
Installment Sales (§453)
| Component | Formula |
|---|---|
| Gross Profit % | Gross Profit / Contract Price |
| Gross Profit | Selling Price − Adjusted Basis − Selling Expenses |
| Contract Price | Selling Price − Assumed Mortgage (to extent it does not exceed basis) |
| Gain recognized per year | Cash collected in year × Gross Profit % |
Exclusions from installment method: Losses; inventory sales; dealer dispositions; depreciation recapture (§1245/1250 recapture is recognized entirely in year of sale).
Wash Sale Rule (§1091)
Loss on sale of securities is disallowed if substantially identical securities are purchased within 30 days before or after the sale. The disallowed loss is added to the basis of the replacement securities.
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