Computing Gain Formula
Unadjusted basis is how much have I paid in this item. See 26 USC § 1012. This is not value. Value is defined as the fair market value, what is the item worth now. If the value increases, there is a gain. A decrease is a loss.
26 USC § 1001 describes how to calculate a gain or loss.
- Gain = Amount realized – Adjusted basis.
- Loss = Adjusted Basis – Amount realized.
Basically, we’re looking for a positive number. If the number is negative, plug it into the other formula.
Amount realized is defined in 1001(b) as the money received plus the fair market value of other property received.
Adjusted basis is provided in 1016. This includes:
- Expenditures to improve the property (enhancements, increases basis)
- Depreciation deductions when allowed (decreases basis)
Helvering v. Bruun
309 U.S. 461 (1940).
Facts
The taxpayer had a tenant with a 99 year lease allowing the tenant to make improvements to the property. 14 years into the lease, the tenant demolished the old building and replaced it with a new one. Four years later the tenant defaulted and the taxpayer repossessed the property.
Analysis
This is a gain to be taxed. To determine when the gain is realized there are four situations. A gain is realized if:
- There is a property exchange
- A relief of a legal obligation to a third party
- A relief of obligation to the person receiving the party
- and “other.”
Here, there was “other” profit from completing the transaction. That is, value was added to the property and the taxpayer received that when the property was repossessed. That is, the property is back in the control of the landlord.
Additional Notes
§§ 109 and 110 essentially overruled this case (although it is still good law) saying that it is not a realized gain unless there is a cash transaction.
Philadelphia Park Amusement Co. v. United States
126 F. Supp. 184 (Ct. Claims 1954).
Facts
Philadelphia Park exchanged wtih the city a broken down bridge (given) for a 10 year extension on the franchise (received). Here, the court is trying to figure out the basis of the franchise extension. Is it the value of the bridge as the original cost, the value of the bride at the time of the exchange, or is it the fair market value of the bridge?
Analysis
Ultimately, the court determines the fair market value of the bridge determines what the basis of the franchise is. This is because it is difficult to determine the basis of a franchise. So, the bridge, the item used in the exchange, becomes a good measurement for the basis of the franchise.
There are two main takeaways
- The taxpayer’s basis in property received is the same as the fair market value of the property given.
- If the value of the first property is difficult to ascertain, then the value of the second property can be used to determine the first’s value.
Special Basis Rules
Gift § 1015
The donee takes the donor’s adjusted basis in the property unless the donor basis exceeds the fair market value. That is, the donee takes the higher basis, either fair market value (in case of a loss) or donor’s adjusted basis (in case of a gain). The donor is also not taxed on giving the property.
Inheritance § 1014
The beneficiary’s basis in the property is the fair market value of the property when the decedent died.
Transfers in Satisfaction of an Obligation
United States v. Davis
370 U.S. 65 (1962).
Facts
Mr. and Mrs. Davis were seperating. As part of a seperation agreement, Mr. Davis gave Mrs. Davis 500 shares of stock (he spent 75,000 on the stock, basis; valued at 82,000 at the time of the seperation) in return for her agreement to relinguish her marital rights on other property.
So, the question is, is this a taxible event and what is the amount realized?
Analysis
The court says this is a taxible event because he received consideration (waiver of marital rights) in exchange for the stock. Thus, there was a realization moment. The next question is determine who has to pay the taxes on the gain.
Once the wife takes the stock, the court says her basis is 82,000 because that is the cost of the stock when she received it. The reason for this is because the waiver of marital rights is difficult to ascertain, so the basis is the same as the fair market value of the stock.
Additional Notes
Congress overruled this case when it comes to marital agreements (but not any other obligations). See § 1041. The section says there is no gain or loss when there is a marital transfer. Thus, the giving spouse does not need to pay taxes on the gain. Instead, the basis of the person receiving is the basis of the giver (same as a gift). For example, in Davis, the basis of the receiving wife would have been 75,000, the basis of the husband.
