 Hello and welcome to the session in which we would look at the disposition of personal use property. Now we have to understand what do we mean by personal use property. It's a property that you use as the name suggests, as the wording suggests for personal use. It doesn't mean for business use. It doesn't mean for income producing. Simply put the car, the vehicle that you drive for entertainment, for going shopping, for going to work. I'm assuming you're an employee for taking vacation, so on and so forth. So this is the vehicle. This is a personal use asset. Now this personal use asset could be also a business use asset. Simply put, you could have this Mercedes Benz SUV and you can use it for business purposes. So what we are assuming here is this is for personal use. So first thing we want to understand is the personal use property. You could have a computer for personal use, your desk, so on and so forth, your furniture. Those are all personal use. Like think about your refrigerator at the house. It doesn't get any more explicit than that. That's a personal use asset. Now what happened with personal use asset? Well, when you dispose of them, you have to figure out the amount realized, how much you received, compare it to the basis and if you have a gain, the gain is taxable. Now you have to look at the amount realized minus the adjusted basis. If you have a loss, the loss is disallowed. It means too bad you cannot take the loss. So this topic, the disposition of personal property, it falls under the umbrella of the third and non-taxable gains and losses, but specifically it's going to be disallowed losses, losses that you cannot deduct. Why? Because it's a personal use property. Use it for personal use to go on vacation, to go to the movie theater, so on and so forth. I'm not really sure who still goes to the movie theater, but nevertheless, just to kind of make the point. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation, as well as your accounting courses. My CPA material is aligned with your CPA review course, such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today, no obligation, no credit card required. Now let's get into the details of things. So if you dispose of a personal use property and you hold it for more than one year, it's classified as capital asset. Don't worry, we'll worry about how how capital asset is taxed in a separate session, but we classified as capital asset and subject to the capital gains, if it's held more than one year. Now if it's held less than one year and you have a gain, well, it's considered ordinary income. A taxpayer who sells a capital asset at a gain must report the difference between the sale price and adjusted basis as capital gain. Again, it's considered the capital asset. We'll talk about about capital gain later. So don't worry, just know for now, it's capital gain if you hold it for more than a year. If you held it less than a year, then it's ordinary income. In contrast, the IRS rules does not allow you to deduct losses on the sale of personal use property. So if you incur a loss, guess what? You cannot take the loss. You cannot deduct the loss. If you really think about it for a moment, old personal asset, if you want to sell them, if you want to sell your furniture back to your refrigerator, your personal car, your desk, your computer, I'm looking at my desk and looking at stuff at my calculator, at my picture frames, anything I want to sell on the chair that on the chair that I'm sitting on now, believe it or not, every time you want to sell those assets, if you use them, you are going to get a loss. So think about this. If the IRS allows you to sell those and generate losses, people will be buying stuff using them, then selling them and get a tax deduction. So you guys see the point where it's not feasible or it's not reasonable. It's really a good idea for us citizens, but that's not allowed, but you can see why. So hopefully you remember why you cannot deduct those losses. It's worth noting that taxpayers may claim itemized deduction for personal casualty loss only if such losses are attributable to the federally declared disaster area. For example, most likely because of the hurricane EN, that's federally declared disaster area, any losses will be deducted as itemized deduction. And we'll talk about itemized deduction later on. And this law will change 2025. I'm doing this recording in 2022. So it should last few more years until we're back to 2025. Now, what happened is some people, what they try to do, they will try to convert their personal property, personal use property, not personal property, personal use property into a business use. Can you do that? Of course you can. For example, I have my computer and I want to or my car and I want to convert my car from a personal use car to a business use. Can you take the loss when you do that? And the answer is no, you cannot take the loss because otherwise everyone will do this. So the conversion of a property from personal to business use may not be used by the taxpayer as a tool for the deduction of this allowed losses. And I explain to you why they will not allow you this allowed losses. A personal use asset loss may never be converted into a business use deductible loss. So it's not possible. So what happened when you convert what happened, what basis do you use? This is what we need to know about when the fair market value of the property on the conversion date is less than the adjusted basis. And believe it or not, as I just told you, most personal use asset when you convert them, most likely, most likely, the fair, the fair value should be less than the adjusted basis. Again, why? Because you use those, you use the property and as you use personal property, they lose value. So how do we know what is the basis for that asset when we later sell it? Well, we're going to go back to the gift property rules, which is the dual basis for the gift property rules. So let me review real quick, otherwise go to the gift property rules. If you want more in details, let's assume you have an asset, you purchased a personal use asset with an adjusted basis of 10,000. This is your adjusted basis. When you converted this asset to business use, the fair market value happens to be 8,000. Now, what is your basis when you sell this asset? Well, it all depends on the future selling price. If you sell this asset for 7,000, later on, you're going to consider your basis as 8. If you sold it for 7, which is, you even sold it less than the fair market value. So this is 8,000, the fair market value when you convert, then you will compare the 7 to the 8. Let's assume you sold your asset for 12,000. If you sold it for 12,000, your basis for the gain will be the 10,000. Therefore, you make a profit of 2,000. Here you have a loss of 1,000. Now, if you sold it in between, if you remember, there's no gain and no loss, the basis will be the same as the selling price. So if you sold it between 10 and 8. So remember, you have loss basis, the loss basis is 7, the gain basis, I'm sorry, the loss basis is 8, the gain basis is 10. This is if you sell it. Now, obviously, when you convert an asset, you also have to depreciate this asset. What basis do you use? Well, the original loss basis. So for the depreciation, you will take the lower of the basis or the asset fair market value. It's going to be the asset fair market value, assuming it's lower. It's the loss basis at the time of the conversion. So the basis is, this basis is also used for the depreciation. So for the depreciation, if we go back to this example, adjusted basis of 10k, and when you converted it to us 8k, so this is, if you incurred a loss later, this is the basis for the loss. The basis for the loss is your depreciation, which is the same thing as the lower of adjusted basis or fair market value, fair market value is lower. Now, the best way to illustrate this concept is to run through some numbers. Emily's personal residence was converted to a rental property. At the time of the conversion, the property has an adjusted basis of 170, fair value of 155. Can she take any losses? No, the $15,000 decline in value is not allowed as a deduction. Let's take a look at another example. Sandra converted her personal residence to a rental property after living there for six years. At the time of the conversion, the property has an adjusted basis of 270, fair value of 235. Again, what are we looking at here? We're looking where the fair value is lower. So this is the adjusted basis, which is 270, and when she converted, the fair market value is 235. So we have where we're going to have to be dealing with the dual basis. Determine the loss or the gain basis for the, determine the loss and the gain basis for the rental property. Well, it depending whether you sell it at a gain or a loss, the gain basis will be 270. So if you sell it at a gain, simply put, if you sell this, this asset at a gain, it means more than the adjusted basis, your basis will be the 270. So if you sold it later on for 290, the basis will be 270. If you sold it at a loss, if you sold this asset, eventually sold it for 210. If you sold it, if you sold it for 210, and this is a good review for the gift basis, for the gift basis, if you sold it for 210, your basis, your loss basis is the 235, the fair market value. So the loss basis is 235, the gain basis is 270. Determine the depreciation basis. The depreciation basis will be the loss basis. The depreciation basis is the lesser of the adjusted basis or the fair market value, which is in this case, the 235, the loss basis. Would Sandra have, have had a better tax position if instead of converting, sold it for 235 and acquire a new home for the same value? And the answer is no, it's a personal use property, definitely not. Losses on sale of personal use properties are this allowed, they are this allowed. You can do that. So this is what you need to know about personal use property, and this is a good review for the gift tax because we're using the dual basis. So to summarize, the personal use property, if you dispose of them at a loss, you cannot, the loss is this allowed. How about the gain? Oh no, the gain is taxable, whether it's longer than a year capital gain or shorter ordinary income. What should you do now? Go to Farhat Lectures, look at MCQs, whether you are a CPA, EA candidate or accounting students, you really want to learn this. How would you learn this? Look at additional resources, multiple choice, true, false, good luck, study hard, and of course, stay safe.