Tax Accounting, Basis, and Timing
Tax Accounting, Basis, and Timing
This domain tests when items are recognized, how basis is computed and recovered, and how method choices create or defer deductions.
Core rules
- Cash-method taxpayers recognize income when actually or constructively received and deduct when paid; accrual taxpayers use the all-events test plus economic performance.
- Accounting methods must clearly reflect income; changes generally require Form 3115 and a §481(a) adjustment. Small business taxpayers may use cash and avoid §263A UNICAP if under the gross-receipts test.
- Basis: cost basis, adjusted basis (capital recoveries, depreciation), substituted basis (gifts carry over; inheritances get §1014 stepped-up basis). Realized gain = amount realized − adjusted basis; recognized gain is the lesser of realized gain or boot in a §1031 exchange.
- §1031 applies only to real property held for productive use or investment; boot is taxable. Depreciation recapture under §1245/§1250 converts gain to ordinary.
- Timing: installment method §453; OID accrues; constructive receipt; claim of right §1341.
Worked example
Taxpayer exchanges real property with FMV $500,000 and adjusted basis $200,000 for replacement real property worth $450,000 plus $50,000 cash boot. Realized gain = $500,000 − $200,000 = $300,000. Recognized gain = lesser of $50,000 boot or $300,000 = $50,000. New basis = old basis $200,000 + recognized gain $50,000 − boot received $50,000 = $200,000 (equivalently, replacement FMV $450,000 − deferred gain $250,000). The $250,000 deferred gain carries into the replacement property.
Traps
Applying §1031 to personal property or inventory; forgetting boot; using FMV as basis; missing depreciation recapture; deducting prepaid expenses without economic performance; ignoring the §179 taxable-income limit; changing method without Form 3115; treating a gift's basis as FMV.