Murphy Flunks "Federal Taxation 101"

[SteveSy]

How did he realize anything? He had a card worth 10k and traded it for another card worth 10k, he gained nothing.

Ok, but this is a like kind exchange, so I would argue there has been no realization yet, (if 1031 has been met). But let's look at this separate from taxes.

If you found a $10,000 baseball card, aren't you a $10,000 baseball better off? Isn't this an accession to wealth?

If you agree here, then why shouldn't the gov't tax it, if its income as an accession to wealth?

At least that would make sense. Claiming there is a gain on a trade of equal value property is silly IMO. It defies common sense.

Now you can claim the tax is being deferred until the exchange but that's not how the IRS is trying to argue it. They're claiming a gain happens at the point of exchange which is nonsensical. Left alone and not challenged that could set horrible precedence.
Here’s another problem. Let’s say you pay the tax on that exchange what is your basis in the new item? It's still nothing, thus in the next exchange you could be taxed again and so on and so forth. Of course they aren’t doing that today but what about tomorrow after the basis nonsense is totally unchallengeable?

[Cpt Banjo]

Here’s another problem. Let’s say you pay the tax on that exchange what is your basis in the new item? It's still nothing, thus in the next exchange you could be taxed again and so on and so forth. Of course they aren’t doing that today but what about tomorrow after the basis nonsense is totally unchallengeable?

To quote from an earlier Stevie post:

I know, I know I’m an idiot. I don’t know tax law and I’m not a CPA or tax attorney…..

For once Stevie is right. He doesn't know tax law. Following the taxability of the original exchange, his basis in the property received is the zero basis of the property given up plus the gain recognized in the first exchange. So if he recognizes $10K in gain on the exchange, that's his new basis and he can engage in as many $10K exchanges all he wants with no subsequent gain, assuming he never depreciates any of the property he receives.

[Quixote]

Now you can claim the tax is being deferred until the exchange but that's not how the IRS is trying to argue it. They're claiming a gain happens at the point of exchange which is nonsensical. Left alone and not challenged that could set horrible precedence.

When did the IRS get involved in your hypothetical example?

[SteveSy]

Here’s another problem. Let’s say you pay the tax on that exchange what is your basis in the new item? It's still nothing, thus in the next exchange you could be taxed again and so on and so forth. Of course they aren’t doing that today but what about tomorrow after the basis nonsense is totally unchallengeable?

To quote from an earlier Stevie post:

I know, I know I’m an idiot. I don’t know tax law and I’m not a CPA or tax attorney…..

For once Stevie is right. He doesn't know tax law. Following the taxability of the original exchange, his basis in the property received is the zero basis of the property given up plus the gain recognized in the first exchange. So if he recognizes $10K in gain on the exchange, that's his new basis and he can engage in as many $10K exchanges all he wants with no subsequent gain, assuming he never depreciates any of the property he receives.

So if I realize a gain that equates to basis? I thought basis was cost....at least that's what many of you kept on arguing about. It still cost me nothing because taxes don't go towards cost. At least I've never been able to deduct my business taxes from the previous year as a cost of doing business. Maybe you know a tax trick I don't.

It seems to me you’re doing a flip flop. On the one hand you’re claiming the item I found has no basis, because it cost me nothing. Then when I trade this item that cost me nothing for another item I all of a sudden have a cost which is equal to the value of the item I trade or received whatever the case may be. Which means cost equals value but only when the government has its tax in hand.


Heh..so if I'm compensated for an injury that's my basis in my body. If I'm injured again the basis counts right...

[Cpt Banjo]

It still cost me nothing because taxes don't go towards cost.At least I've never been able to deduct my business taxes from the previous year as a cost of doing business. Maybe you know a tax trick I don't.

I said the gain you recognized is your new cost basis, not merely the tax you paid on the gain. And you don't get to deduct this cost; you capitalize it by adding it to your basis in the property received in the taxable exchange.

It seems to me you’re doing a flip flop. On the one hand you’re claiming the item I found has no basis, because it cost me nothing. Then when I trade this item that cost me nothing for another item I all of a sudden have a cost which is equal to the value of the item I traded. Which means cost equals value but only when the government has its tax in hand.

Wrong analysis. Your cost is the value of the property received because that's the gain you recognized on the exchange. When you have a gain on a taxable exchange, the law treats you just as if you'd sold the relinquished property for cash and then taken that cash and bought the property received in the exchange. If you had no basis in the relinquished property, you'd have a gain equal to the hypothetical cash received, which would be the value of the property received; this would also be the hypothetical cost of the property received in the exchange.

Now all this assumes that the value of what you give up is equal to the value of what you receive. I don't want to get into the case where they aren't...(It could happen--people can pay more than market sometimes because they really want something, and they want it now.)

[SteveSy]

Wrong analysis. Your cost is the value of the property received because that's the gain you recognized on the exchange. When you have a gain on a taxable exchange, the law treats you just as if you'd sold the relinquished property for cash and then taken that cash and bought the property received in the exchange.

Wait a minute.....

"Treats" is not the same thing as if it happened. You didn't sell anything you exchanged it, no pretending something happened to make your point. We're talking about reality. If your're going to use some alternate reality constructed by tax law then it's useless discussing this.

If you had no basis in the relinquished property, you'd have a gain equal to the hypothetical cash received, which would be the value of the property received; this would also be the hypothetical cost of the property received in the exchange.

The reality of course is there was no sale and no purchase made by cash thus in reality cost means value when convenient for the government. The point of the Murphy case is to show the basis argument is invalid because it ignores reality. Don't use the alternate reality created by the tax law to prove the tax law is right. The point of this discussion is to show the basis argument is logical and reasonable or it’s a strawman created to tax what shouldn’t be taxed.

[Florida]

Actually you are only POTENTIALLY better off once you find the card.

Only when the card is sold or used as collateral for a loan does the potential become the actual.

Until you actually realize a benefit from the card, it only POTENTIALLY makes you better off.

\


I would disagree. You are actually better off when you have that card. If you don't use it to your advantage, that's your problem. But you were still better off at the point you gained ownership over that baseball card.

You seem to be thinking in terms of cash and realization. But realization doesn't mean that you weren't better off until you realized money. Realization is a tax principle designed to tax people as they have the ability to pay. But you can have a realization without actually receiving any money. Phantom gains can be a really big problem in flow through entities. So, in short, I cannot agree that cash received is the only means becoming "better off".

Or maybe there is a realization event, but not a "recognition" event, despite the fact that no money was received.

[Cpt Banjo]

The point of the Murphy case is to show the basis argument is invalid because it ignores reality.

And you're trying to apply the rule used to determine the basis of the replacement property to the determination of the basis of what was given up, which is hopelessly illogical.

Look, the basis of property relinquished in an exchange is whatever it happens to be immediately before the exchange; you never get to increase it beforehand by reference to what you're going to receive in the exchange. If you could, no exchange would ever result in taxable gain. Example: you buy an asset for $400, and when it has appreciated in value to $1,000, you trade it for other property worth $1,000. Unless your transaction qualifies for tax-free exchange treatment under the Code (e.g., Section 1031), you have a gain of $600 because the value of what you got is $600 greater than the basis of what you gave up, and that's how you measure gain under Section 1001. In this connection, please realize that tax-free exchanges are matters of legislative grace; if you don't meet one of the various requirements for tax-free status, you don't get to defer the gain.

But what's the basis of the property you get in the exchange? It depends on whether it's a tax-free exchange or not. If it is, you carry over the basis in the old asset to the new one. If it's a taxable exchange, then the basis of the new assets is its value, which will also equal the basis of your old asset plus the gain you recognized on the swap.

The bottom line is that basis increases aren't free unless you die, in which case your beneficiaries get a step-up (and this is true even if no estate tax is payable). All other basis step-ups come at a cost, which in this case is the gain you had to recognize.

The hypothetical sale was simply a device to try to illustrate that a taxable exchange isn't treated any differently under tax law than a taxable sale followed by a reinvestment in the replacement property. If it were otherwise, people would never sell assets for cash; they'd simply barter. But since you're in the same economic position afterwards whether you sell/reinvest or you barter, the tax treatment is the same.

Now if you can't understand this, you've flunked Federal Taxation 101, and don't let the door hit you in the ass on the way out of the classroom.

[SteveSy]

The point of the Murphy case is to show the basis argument is invalid because it ignores reality.

And you're trying to apply the rule used to determine the basis of the replacement property to the determination of the basis of what was given up, which is hopelessly illogical.

Look, the basis of property relinquished in an exchange is whatever it happens to be immediately before the exchange; you never get to increase it beforehand by reference to what you're going to receive in the exchange. If you could, no exchange would ever result in taxable gain. Example: you buy an asset for $400, and when it has appreciated in value to $1,000, you trade it for other property worth $1,000. Unless your transaction qualifies for tax-free exchange treatment under the Code (e.g., Section 1031), you have a gain of $600 because the value of what you got is $600 greater than the basis of what you gave up, and that's how you measure gain under Section 1001. In this connection, please realize that tax-free exchanges are matters of legislative grace; if you don't meet one of the various requirements for tax-free status, you don't get to defer the gain.

I realize that....thanks though. You're trying to explain the tax law and I'm asking you to think outside the box. Let's try common sense, it's a good place to start.

If I originally purchased property for $400 and it appreciates to $1000 and I trade for a property that is valued at $1000 I gained nothing. My wealth has not increased one iota. Gain is an increase in something, nothing has increased at the exchange. I don’t want to pretend something happened when it didn’t so I can accept the theory.

Let's put this to the common sense test. Would anyone consider it a gain if the above took place? I'll tell you what, do you have any property that's appreciated? If so tell me the value and I'll purchase a like property valued at the same and we'll trade. We'll split your gain....if not why not, are you not interested realizing gain? How many people do you think would be willing to do that deal? How about no one because it's ridiculous to claim it's a gain.

But what's the basis of the property you get in the exchange? It depends on whether it's a tax-free exchange or not. If it is, you carry over the basis in the old asset to the new one. If it's a taxable exchange, then the basis of the new assets is its value, which will also equal the basis of your old asset plus the gain you recognized on the swap.

Ok, but that latter part doesn't make sense. That may be the law but it's illogical. Either basis is value or it is not...Now if you told me the value is basis due to legislative grace I could accept that. If it is then my original statement about the possiblity of being taxed multiple times exchanging like items over and over is true.

Now if you can't understand this, you've flunked Federal Taxation 101, and don't let the door hit you in the ass on the way out of the classroom.

Maybe you misunderstood me....I already understood the basics in tax law. I understand the tax law spells out what is taxed and how its taxed just like what you've said. What I want to do is apply common sense and reality to it and see if it's logical and reasonable.

I can claim, and prove, that I can drive my ordinary car everyday at light speed if you’ll accept that I get to deny common sense, reality and assert whatever I please as fact.

[Florida]

The point of the Murphy case is to show the basis argument is invalid because it ignores reality.

And you're trying to apply the rule used to determine the basis of the replacement property to the determination of the basis of what was given up, which is hopelessly illogical.

Look, the basis of property relinquished in an exchange is whatever it happens to be immediately before the exchange; you never get to increase it beforehand by reference to what you're going to receive in the exchange. If you could, no exchange would ever result in taxable gain. Example: you buy an asset for $400, and when it has appreciated in value to $1,000, you trade it for other property worth $1,000. Unless your transaction qualifies for tax-free exchange treatment under the Code (e.g., Section 1031), you have a gain of $600 because the value of what you got is $600 greater than the basis of what you gave up, and that's how you measure gain under Section 1001. In this connection, please realize that tax-free exchanges are matters of legislative grace; if you don't meet one of the various requirements for tax-free status, you don't get to defer the gain.

I realize that....thanks though. You're trying to explain the tax law and I'm asking you to think outside the box. Let's try common sense, it's a good place to start.

If I originally purchased property for $400 and it appreciates to $1000 and I trade for a property that is valued at $1000 I gained nothing. My wealth has not increased one iota. Gain is an increase in something, nothing has increased at the exchange. I don’t want to pretend something happened when it didn’t so I can accept the theory.

Let's put this to the common sense test. Would anyone consider it a gain if the above took place? I'll tell you what, do you have any property that's appreciated? If so tell me the value and I'll purchase a like property valued at the same and we'll trade. We'll split your gain....if not why not, are you not interested realizing gain? How many people do you think would be willing to do that deal? How about no one because it's ridiculous to claim it's a gain.

But what's the basis of the property you get in the exchange? It depends on whether it's a tax-free exchange or not. If it is, you carry over the basis in the old asset to the new one. If it's a taxable exchange, then the basis of the new assets is its value, which will also equal the basis of your old asset plus the gain you recognized on the swap.

Ok, but that latter part doesn't make sense. That may be the law but it's illogical. Either basis is value or it is not...Now if you told me the value is basis due to legislative grace I could accept that. If it is then my original statement about the possiblity of being taxed multiple times exchanging like items over and over is true.

Now if you can't understand this, you've flunked Federal Taxation 101, and don't let the door hit you in the ass on the way out of the classroom.

Maybe you misunderstood me....I already understood the basics in tax law. I understand the tax law spells out what is taxed and how its taxed just like what you've said. What I want to do is apply common sense and reality to it and see if it's logical and reasonable.

I can claim, and prove, that I can drive my ordinary car everyday at light speed if you’ll accept that I get to deny common sense, reality and assert whatever I please as fact.

you spent 400 for something and then replaced with with something worth 1000. i'd say there is economic gain. you had spent 400 and received something worth 1000. you realized a gain. you don't recognize a gain, however, because no money was involved. this is a matter of legislative grace. arguments can be made in favor of this course of action - don't put impediments to the free exchange of property in our economy by virtue of a tax, considering no money was involved.

but if you exchanged that item you paid 400 for (but now worth 1000), for an item worth 900, and you received 100 in cash, what then steve?

you gained nothing, right?

[SteveSy]

you spent 400 for something and then replaced with with something worth 1000. i'd say there is economic gain.

Ahh true but you overlooked something, I gave something valued at $1000 and received something vlued at $1000. I didn't convert it to cash and walk away I haven't realized anything. My wealth is exactly the same. For all we know the previous owner also purchased his for $400, not that it matters. Income is an increase in wealth.

but if you exchanged that item you paid 400 for (but now worth 1000), for an item worth 900, and you received 100 in cash, what then steve?

you gained nothing, right?

No I would say you gained $100 because $100 of the increase was converted to cash. You realized a gain.

I see the problem, what happens when someone trades their house for a house that cost less and the difference is paid in gold. However unless it's converted to cash it's really not a realized increase in wealth, is it?

I'll admit it's questionable in some circumstances. However, I still think using basis as a blanket approach is not the answer to make the determination whether its income or not. Basis falls apart concerning issues like compensation for damages. You could get your property replaced and would be forced to claim you gained.

[Brian Rookard]

It seems absurd to me to claim you have a gain when in fact you gained nothing. I don’t understand why that needs explanation. If I handed you a hundred dollar bill and you gave me 20 5’s did I gain anything? If I traded one hundred dollar bill for 20 things that cost $5 did I gain anything? If I found a hundred dollar bill and traded it for another $100 bill did I gain anything? Why is it if I find an item worth a $100 and trade it for another item of the exact same type worth $100 I’ve gained a $100?

Actually, you're focusing on the wrong event. It's not the exchange of one baseball card for another that should be the focus, it's the acquiring of a $10,000 baseball card for nothing ... THAT'S where the income came from.

No less than finding a million dollars that fell out of the armored car. It's the finding of the money in the first place which was the initial accession to wealth ... not what you spent it on or traded it for afterwards. At the moment you pick up the bag of money, you can be said to have income (leaving aside for the sake of argument whether you actually are able to own something which is clearly not yours, and which somebody will surely come back and look for).

Likewise, when you picked up the baseball card, you now had something worth $10,000 which you did not have before, your wealth just shot up by 10k. This is when you're taxed, as pointed out, at the moment you have reduced it to possession.

When you traded it later for an equivalent baseball card, I might agree that there was no income (but that's because you would've been already taxed on the original picking up of the card which is when you actually had income.)

It's not the later exchange that's the focus ... it's the initial acquisition of the card.

[SteveSy]

It seems absurd to me to claim you have a gain when in fact you gained nothing. I don’t understand why that needs explanation. If I handed you a hundred dollar bill and you gave me 20 5’s did I gain anything? If I traded one hundred dollar bill for 20 things that cost $5 did I gain anything? If I found a hundred dollar bill and traded it for another $100 bill did I gain anything? Why is it if I find an item worth a $100 and trade it for another item of the exact same type worth $100 I’ve gained a $100?

Actually, you're focusing on the wrong event. It's not the exchange of one baseball card for another that should be the focus, it's the acquiring of a $10,000 baseball card for nothing ... THAT'S where the income came from.

I agree to that.

Likewise, when you picked up the baseball card, you now had something worth $10,000 which you did not have before, your wealth just shot up by 10k. This is when you're taxed, as pointed out, at the moment you have reduced it to possession.

I've never said different, that makes sense. It's not at exchange where the increase happens.

It's not the later exchange that's the focus ... it's the initial acquisition of the card.

Agreed