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REG Practice Questions: Calculating the Basis of Assets Converted to Business Use
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May 3, 2024
In this video, we walk through 5 REG CPA exam practice questions on calculating the basis for assets converted from personal use to business use. Important Links Link to the free study training webinar mentioned in the video: https://www.superfastcpa.com/strategic-study See the full post for this video: https://www.superfastcpa.com/reg-practice-questions-explained-calculate-the-basis-of-assets-converted-to-business-use/ See the other REG walkthrough videos here: https://www.superfastcpa.com/free-reg-cpa-practice-question-walkthroughs/ 00:00 Intro 00:38 Question 1: Calculate the Tax Basis of a Personal Asset to Business Use 02:51 Question 2: Tax Basis of Converting Personal Computer to Business Use 05:53 Question 3: Calculating the Tax Basis for Gain or Loss of a Converted Business Asset 08:51 Question 4: Calculating the Tax Basis of a Property to Rental Property, Including Federally-Declared Disaster Losses 11:49 Question 5: Calculating the Tax Basis of a Business Property Including Building Improvements 15:39 Pillar Topics
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Hi, I'm Logan with Super Fast CPA
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In today's video, we're going to be covering how to calculate the tax basis of an asset converted
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from personal to business use. If this is the first thing you're seeing from us, our whole study approach focuses on using
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the multiple choice questions as your main learning tool. If you want a detailed overview of our study strategies, be sure to go to the free webinar
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we have on SuperfastCPA.com. The link will be in the description, or you could even go right now if you want
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One more thing about this video, I'll only be going over five questions in this free video, but if you become a member of Super Fast CPA, you'll have access to the full video
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which covers 10 questions on this topic. Alright, let's go into some of the questions
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All right, so again, we're using this as our main learning material. So we're going to use this question and the following questions to learn what we're supposed
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to learn according to the AI CPA blueprint on how to calculate the tax basis of property
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that was originally for personal use to business use. All right, let's go ahead and read through it
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Carlos Jacobs is starting a mobile coffee cart business and is conversational. converting his personal use espresso machine to business use
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The espresso machine cost $3,200 when he purchased it three years ago, and now has a fair
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market value of $2,000. What is Carlos' tax basis for depreciation for the espresso machine
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All right. Now before we look at the answers and kind of learn what we're supposed to learn from this question
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pause the video, make sure you understand what this question is asking, and then restart the
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video and we'll jump into the answers. All right. So let's look at the answer. The answer is $2,000. All right. The tax basis of the espresso
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machine for depreciation is the fair market value at the date of conversion of $2,000. Okay, so why is it $2,000
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The depreciable basis of property converted from personal use to business use is the lesser of either
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the original cost basis as adjusted for any improvements to the property or the fair market value
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of the property on the date of the conversion. Okay. So right there, just in that one explanation
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understand something really important. So when something is converted from personal use to business
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use, on the date of conversion, the tax basis for depreciation is either the original cost
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you know, with any improvements, or the fair market value on that date. So really straightforward
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explanation there. So that does make sense why it would be $2,000, because, you know
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the original cost was $3,200 and now the fair market, and the fair market value
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was $2,000 on the date of the conversion. So the lesser of those two is $2,000. So now that it's
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for business use, from here on out, the tax basis for depreciation will be $2,000. And then let's just
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kind of read through these. It's always smart to read through the other explanations just to see if
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there's anything else you could learn. Yep, that's basically what that explained up there
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All right. I think that makes sense. That makes sense to me. Let's go ahead and go on to the next
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question. All right. David Mills recently transitioned his personal computer into his
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new web development business. The computer originally cost $3,000, and at the time of conversion
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to business use, it had a fair market value of $1,800. After claiming $600 in depreciation
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deductions, David sold the computer for $1,200. What is David's tax basis in the computer
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for purposes of calculating the gain or a loss? Okay, again, pause the video. Think about that
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Just make sure you understand what it's asking, and then we'll go into the explanation in a second
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here. Okay, so let's see here. So the answer is $1,200. Okay, so let's understand why that is
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The tax basis for determining a gain or loss on the sale of property converted from personal
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to business use is the lesser of the $3,000 original cost basis or the $1,800 fair market
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value at the date of the conversion, then reduced by the $600 in depreciation deduction
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reduced by the $600 of depreciation deductions taken after the conversion. So the $1,800 for market
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value at conversion less than $600 of accumulated depreciation equals a $1,200 tax basis for calculating
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the gain or loss on the sale of the computer. Okay, so this one kind of builds on what we learned
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in the above question, where first we have to understand what the tax basis is on the date of the
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conversion, and that gives us the basis to use for taking the depreciation from, and then that
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gives us what the tax basis was when it was sold so that we could then calculate the gain
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of the loss. So, you know, we have to do what it was, what we did in the first question
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So first we have to decide what was the tax basis on the date of the conversion So it was either the or the fair market value of since you know and it the lesser of the two
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We learned that in the first question. So we start with $1,800. And after claiming $600 of deductions, he sold it for $1,200
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But the whole thing that it's asking in this question is what was the basis when he sold it
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And the basis would have been the adjusted basis of $1,800, less the $600, being $1,200
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So this question isn't asking us what the gain or loss was
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It's what was the tax basis that we would use to calculate the gain of the loss
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So we now know it was $1,800 less $600, equaling the $1,200 tax basis for calculating that gain
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which if we think about it would have been no gain or loss because he sold it for $1,200
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It had a tax basis of $1,200, so it had no gain or loss
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But that's not what the question was asking. And that's something that's really important to pay attention to when you're going through
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questions, pay attention to what it's actually asking you. So let's see here. Let's just learn a little
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bit more. Yep. So you do have to apply the depreciation to whatever the tax basis was at the date of the
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conversion. Tax basis for calculating the loss starts with the lesser of the 1800, not the higher of the
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original cost. Does that make sense? Okay, that makes sense. So we built on what we learned in the
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previous question. So I think we can move on to the next question. All right, next question. Michael
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Thompson converted his personal use snowblower to business use when he established his snow removal
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service. The snowblower originally cost $2,500 and had a fair market value of $1,800 at the date of the
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conversion. After claiming $1,200 in depreciation deductions, Michael sold the snowblower for $1,000
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What is Michael's tax bases in the snowblower for purposes of calculating a gain or loss
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So this is very similar to what we saw before. In fact, I think this is trying to teach us the same
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concept. Okay. So again, pause the video. Make sure you understand what's going on and then we'll dive
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into the answers. Okay. So let's look at the answer. I mean, just based off on what we learned
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before we even look at this, we could probably understand it because we're just building on our
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knowledge. So the original cost was 2,500. Fair market value at the date of conversion was 1,800. So we
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already know that at the date of the conversion, the tax basis would have been $1,800 from the fair
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market value because that's the lower of the two. And then after he claimed $1,200, that would mean that
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his basis when he sold it was $600.800 less $1,200 is $600. So he had a basis of $600, and that's what
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this is asking us. It's not asking us what the gain was, which we could calculate the gain, because
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he sold it for $1,000. The adjusted basis was $600. So that means that he had a gain of $400
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But again, that's not what it's asking. It's just asking what was the tax basis at the date of the sale
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the tax basis was $600. So let's read this. The tax basis for determining a gain or loss on the
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sale of a converted asset is determined by taking the lesser of the fair market value or the original
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cost. We've learned this. Then subtracting the accumulated depreciation. In this case, the fair market value
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is lower than the original cost. So the adjusted basis at the date of the sale is $1,200 less $1,200
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totaling $600. Yep, that's exactly what we said. The $1,000 sales price is greater than the $600
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adjusted basis at the date of the sale so the property is sold at a gain. All right. So where it looks
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like the above one was, you know, it could have, it was basically, it was, they didn't gain anything
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from it, but this one, it was a gain. So, you know, a little bit of a different question, but it was asking the same question, what was the tax basis on the date of the sale? So let's, let's take
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a look here. Tax basis, of course is not zero. You know, that wouldn't make sense because it does
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have to have a basis unless, I mean, I guess if it had $1,800 of depreciation, then, yes
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the basis would have been zero at the date of the sale. Okay. Yep. It has to be reduced by the
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depreciation. Okay. So, yeah, these ones are wrong because it's not taking the depreciation into
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account. All right. So, yeah, we're still learning things. So far we've learned how to calculate the
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tax basis at the date of the conversion. And then now that we know what the date of the conversion is
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we've also learned how to calculate what the tax basis was on the date of a sale of a converted asset
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So learning some good stuff here. Let's go on to the next question. Okay, next question
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Eight years ago, Julia purchased a vacant lot for $25,000. She later constructed a residence on the
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lot at a cost of Recently Julia decided to convert the residence into a rental property Prior to the conversion she made significant upgrades to the property totaling Additionally due to an extreme weather event in her area which was declared
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a federal disaster, Julia claimed a $5,000 deduction for the damage to the property. At the time
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she converted the residence to a rental, the property was appraised at $260,000, with the land valued
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at $40,000, and the building at $220,000. So we need to calculate Julia's depreciable basis for the
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rental property. Okay, again, it's asking us, what is the depreciable basis for the rental property
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And since it's saying rental property, we know that it's asking what is the depreciable basis
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once this was converted from personal to business use. So this is asking it in a whole new way
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Is the damage going to affect the basis? You know, what goes into the basis? So let's go ahead and learn
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from the question. Go ahead and pause if you need to make sure you understand the question. And if you're good, we're going to go into the question. All right. So we, we're, we're
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We know the general idea of what we've learned. You know, it's the lesser of the original cost or the fair market value, but let's see what goes into the original cost
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When a personal residence is converted to a rental property, the basis for depreciation is the lower of the property's fair market value at the time of conversion or its adjusted basis
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So we know that. We've learned that. Julia's adjusted basis in the residence at the time of conversion is $215,000, which is calculated by adding the original cost of construction, so $190,000, and the capital improvements of $30,000
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Okay, so $220,000, then subtracting the casualty loss deduction. So a casualty loss deduction, if that's taken, that does affect the basis
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Okay, so since the fair market value of the building at the time of the conversion is $220,000
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and the adjusted basis is $215,000. And again, this was the basis of the building at the date of the conversion
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Then it's the lesser of those two. So it would be $215,000. Okay
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So what did we learn from this? So, again, this is something, I mean, this is something that
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you probably should know from your basic accounting classes. Land is not a depreciable asset
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It doesn't depreciate. So we don't include the $25,000 in the total
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So we're only looking at the residence, $190,000. You add the upgrades that it does increase the basis, so $220,000
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And then she was able to take the deduction of the property, like the casualty loss
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and that reduces the basis to $215,000. All right. So, and obviously it's the lesser of the two. So it's the $215,000. Okay, we learned that land is not included when you are looking at converting a residence to a rental as far as the tax basis for the building. Okay, I think we've got some good information there, so let's go ahead and move on. Okay, five years ago, Marco purchased a historic bungalow for $120,000 and spent an additional $80,000 on renovations. Two years after the purchase, he installed
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a solar panel system for $25,000, which qualifies for a green energy tax credit
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This year, Marco decided to convert the bungalow into a bed-and-breakfast business
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Before the conversion, he had to repair some damages caused by a severe storm, which cost him $10,000
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and he was able to claim a $3,000 insurance reimbursement for those repairs
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On the day he started his bed and breakfast, the property was valued at $250,000
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with the land worth $50,000 and the building itself at $200,000. What is Marco's depreciable basis for the building when he converts it to business use
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Okay, so similar idea. The question is asking us a similar thing here, but slightly different
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You know, the question is, does a solar panel system count as an upgrade
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I would say yes. So that probably increases the basis. And then I doubt that the tax credit will affect it
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And this is different. So last time it was a, she had a deduction for the loss
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but this time it was, it's asking for an insurance reimbursement. So is that going to affect the basis
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All right. So just a quick guess, you know, we've learned a whole bunch from this video so far
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from these questions so far. Let's quickly see if we could figure it out with everything we've learned so far
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$120,000. That was how much he purchased it for. $80,000 on renovation
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So right there, our basis, his basis was $200,000. He installed a solar panel system
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I'm guessing that also counts as like an improvement to the property. So we're at $225,000
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Don't think the tax credit will affect it. Now this is where you know is an insurance reimbursement going to affect the basis of the property I don think so honestly because first of all it doesn say anything about it being a federally declared disaster
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So this looks like it might be more a personal expense. You know, we'll see
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So right now, $225,000 was the adjusted basis at the date of the conversion
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And then the fair market value was $200,000. So just based off what we've learned so far, we can probably guess that it's
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$200,000. Now, before we jump in, see if you can make a guess or see if you've calculated it
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correctly. And now we're going to look at the answer. Okay, we're right. $200,000. So, again
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his initial basis, $120,000 plus the renovations is $200,000. Yep, the solar panels do increase
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the basis because it's an improvement, $225,000 basis at that point. So since the insurance reimbursement
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for repairs simply covers the cost of repairs, it does not affect the basis for depreciation purposes
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because it neither improves nor enhances the value of the property beyond its original state
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So it's just trying to, you know, he's just using that to repair
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That was just like a personal expense, this $10,000. Whereas previously above, I believe the difference there was because of the federally declared disaster
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and the damage that happened, the house value actually decreased by $5,000
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I believe that's what it was trying to say up there. At the time of conversion to business use, the fair market value of the building is $200,000
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thousand dollars since the land is not depreciable its value is not included yep we knew that for property
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converted to business use the basis for depreciation is the lesser of the fair marker value of the
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property at the conversion or the adjusted basis at conversion marco's adjusted basis is $225,000
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and then the fair market value is $200,000 so yep it's the lesser of the two since the repairs are not
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considered improvements that increase the basis marco's depreciable basis for the building remains $200,000
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at the time of conversion to business use okay so we learned a lot from all these five questions
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All right. Before we move on, let's go ahead and do one part of the super fast CPA strategy
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which is called doing or finding pillar topics. So the idea behind pillar topics is these are the few things
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you know, the two or three things that we learned just from doing these questions that are obviously what we were supposed to learn using these multiple choice questions
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as our base. So the first pillar topic, I would say, is for a..
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converted or let's see here. Converted assets basis at date of conversion
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is the lesser of the original cost basis plus improvements or the FMV
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Okay, so that's one thing we learned right there. We learned that was like the main thing
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This was like the whole crux of it was that converted assets
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so converted from personal to business use, At the date of the conversion, the tax basis is, oh, I didn't even put that in here
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Oh, no, yeah. Basis at the date of the conversion is the lesser of the original cost, plus any improvements, as we saw here with, you know, the solar panels and everything
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or the fair market value. So, and then you then use this tax basis going forward for any gains or losses at the sale of the property
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So once we know this tax basis, we can use that tax basis to depreciate, and then we can use that basis and it's accumulated depreciation to calculate any gains or losses when we sell that property
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And then, you know, we learned a little bit, maybe this isn't a pillar topic, but we, you know, we learned that the repairs from just a severe storm and the insurance reimbursement weren't something that necessarily decreased the basis
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But if it was a federally declared disaster, we saw that that did, that was able to be taken as a loss, and that did decrease the basis
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We learned a lot from this video and these questions so far. All right. We're going to stop right there
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If you liked this video, be sure to go sign up for the free webinar training at superfast CPA.com
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We go over the six key ingredients to passing the CPA exam, not only this part of the process, but every other strategy to help you pass
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And again, as a reminder, if you are a member of Superfive CPA, you'll be able to access the full video of 10 questions instead of 5
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Thanks for watching. I hope this helped, and we'll see you in the next video
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