Investment Loss

[Beersheba]

Taxpayer invests $50,000 in domestic stocks during 2022, and keeps them.

At the end of 2022 the FMV of these stock is $43,000.

Which of the following be true?

1. GAAP requires a loss of $7000 be recorded.
2. Tax basis of the investment is still $50,000.
3. A book-to-tax difference is created in 2022.
4. The book-to-tax difference is not reported in 2022 but when stocks are sold.
5. Taxable income recognizes the $7000 loss, and no book-to-tax difference exists.

[RWG1950]

I reckon # 2 be true.

[Beersheba]

Thanks RWG - the list is awkward (as most of my posts are), and the elements on the list are not mutually exclusive. Example: If the first (GAAP) is not true, then 2,3, and 4 become irrelevant but not #5.

[Rapid Robert]

"Which of the following be true?"

That question needs to be qualified by date. In other words, it should be phrased, "Which of the following is true at the end of 2022?" (*) What is true on that date may not be true before or after. For example, suppose #1 is true (I have no idea, is it?) The question is when does GAAP require an adjustment to be recorded (if it does)? After all, the investment FMV probably changed every trading day since it was acquired. For my own personal balance sheet, I mark-to-market stock investments once per calendar quarter, my residential property once per year, and a 529 plan once per year. It really has more to do with how long you expect to own the asset, doesn't it?

(*) note this is for discussion purposes, to bring the time period into it, not a criticism of the wording of the OP

[Lion]

Taxpayer invests $50,000 in domestic stocks during 2022, and keeps them.

At the end of 2022 the FMV of these stock is $43,000.

If I'm the tax preparer for this individual taxpayer investing in domestic stocks that he still holds, then I don't care about anything on your list!!

If he had a large capital gain already in 2022, such as the sale of his second house, I would suggest he speak to his investment advisor about harvesting some losses.

2. on your list is true, but wouldn't matter to me until he sells.

Even when he sells, I would not be working with GAAP or book-to-tax differences of 1., 3., 4., and 5.

If he sold at the end of 2022 under your scenario, he would have a $7,000 loss for that investment on Form 8949, but that's not what you asked. (You said he keeps them.)

If we're doing tax planning for 2022 his investments would be only one item in his whole financial life that I'd discuss with this taxpayer. Even then, if multiple stocks make up his $50,000 investment, then maybe one stock is a $10,000 gain but another is a $17,000 loss, so details would matter if tax planning or harvesting losses.

I don't know what you're really asking. Are you putting together a net worth statement for an individual, a personal financial statement?

You're asking about held assets, but held assets seldom appear on a tax return until they become part of a transaction.

[Rapid Robert]

"Are you putting together a net worth statement for an individual, a personal financial statement?"

... or a question for a tax quiz, or just to spark conversation here, or? Any of which are fine reasons.

Now here is a follow up: does it matter to the answer if taxpayer is using accrual or cash method of accounting?

[Beersheba]

Thanks to RR and Lion for the responses.

So that we won't have to scroll hither and thither, the choices are presented again:

1. GAAP requires a loss of $7000 be recorded.
2. Tax basis of the investment is still $50,000.
3. A book-to-tax difference is created in 2022.
4. The book-to-tax difference is not reported in 2022 but when stocks are sold.
5. Taxable income recognizes the $7000 loss, and no book-to-tax difference exists.

When any question is brought to the forum, there is always the possibility that basic information is lacking before any answer can be contemplated. Sometimes the qualifiers should be reasonably assumed, sometimes the conditions are so sparsely stated that the picture needs to be fully painted. I intended all the choices should apply to 2022, and thought this could be assumed, but without so stating, should have been clearer.

Lion's response puts the finger on a more basic oversight. This clearly should have been assigned to either a personal return or some other entity. As she pointed out, if this is for a personal return, some of the questions are not even relevant. For purposes of going forward, please assume that the situation applies to an entity where a balance sheet and M-2 are required. For example, an 1120-S.

If you care to go forward, I still don't know the answer and not sure I can understand code/regs or even know where to find them. I would appreciate any response, given the new criteria stated above.

Thanks to this group for your patience. I'm often awkward and often not the most popular kid on the block.

[Rapid Robert]

I used to prepare a return for an investment partnership (securities investments through a regular brokerage). I always showed balance sheet per books at FMV, and an adjustment on Schedule M-2 Line 4 as follows. (The market was always increasing during the years I prepared the return, so I only had gains to deal with).

Line 4 statement:
marketable securities incr per stmt <---- net increase in account balance including unrealized gains/losses from brokerage stmt
marketable securities spent/dist <----- amounts withdrawn during the year (partially offset by Line 6)
less gain included in income <----- recognized gains already included in income, no need to adjust (Line 3)

[Maribeth]

I don't do financial statements anymore so I have not kept up with GAAP so I'm not aware if GAAP requires investments marked-to-market at year end. If I were to mark-to-market at year end, I would do the entry on the books the same way as officer life insurance is handled: Setting up the asset Unrealized gain on investment on the balance sheet. And then the offsetting income account on the income statement. When preparing the return, I'd have a M-1 adjustment for the income reported on books but not on return.

So my answers to your questions would be:

1. GAAP requires a loss of $7000 be recorded. ???? not sure if that is a requirement now. It did not use to be.
2. Tax basis of the investment is still $50,000. Yes
3. A book-to-tax difference is created in 2022. Yes, if the books are mark-to-market
4. The book-to-tax difference is not reported in 2022 but when stocks are sold. Yes & No, depending on how books are kept
5. Taxable income recognizes the $7000 loss, and no book-to-tax difference exists. NO

jm2cw,
Maribeth

[Beersheba]

Thanks to all for responding.

Looks like the only thing uncertain is the GAAP question. EAs are not engrained in the science of GAAP as are CPAs.

The problem is, EAs are still confronted with the requirement to complete balance sheets on "book" basis, and many choose to report on accrual basis. Even though there are thresholds specified, I believe the preparer has a responsibility to the client to fully report Sch L and Sch M-1 and M-2.

[kathyc2]

Thanks to all for responding.

Looks like the only thing uncertain is the GAAP question. EAs are not engrained in the science of GAAP as are CPAs.

The problem is, EAs are still confronted with the requirement to complete balance sheets on "book" basis, and many choose to report on accrual basis. Even though there are thresholds specified, I believe the preparer has a responsibility to the client to fully report Sch L and Sch M-1 and M-2.

Publicly held companies are required to report financials on GAAP basis. Unless required by outside investors or a bank, most small business financials are OCBOA. If the company gave you a set of financial statements where they report the current market value (rather than cost) of a readily marketable security, then you have a book to tax difference. If you are assisting client to prepare financial statements on anything other than tax basis, you are needlessly exposing yourself to liability.

[Uncle Sam]

Please note that due to changes made in SSARS No. 21, the term OCBOA (Other Comprehensive Basis of Accounting) is replaced with the term "Special Purpose Framework"

[Rapid Robert]

"If you are assisting client to prepare financial statements on anything other than tax basis, you are needlessly exposing yourself to liability."

I can't dispute that. However, there are some entity clients I've prepared returns for who don't really keep any other books besides their tax returns (or simple Quickbooks files that I make journal entries to when I prepare the return, which is almost the same thing). So yes, I have prepared balance sheets on other than a tax basis (as part of the tax return), and I hope my fee was high enough (ha-ha).. Is preparing Schedule L really the same thing as preparing "financial statements" for liability purposes? I get the EOY numbers directly from the client's brokerage statements, doesn't this fall under "good faith reliance on information provided by the taxpayer as long as it does not appear incomplete or inaccurate"?

[Beersheba]

RR I feel very much the same way. CPAs do not endorse non-CPAs doing CPA work. Quite simple and fair enough. Obviously, I don't do audits, reviews, or anything resembling an attest function. Sometimes a client will get their banker to call me and ask about the viability of a taxpayer, and I wont touch that either. Won't even give "negative assurance."

But I can't back off the preparation of Schedule Ls because some in the CPA community don't want me doing it. I work with a few local CPAs for collaborative efforts and have a good working relationship with them. In 2019 I was in the hospital for 148 days with pancreatitis, and three of my CPA friends rushed in to serve my clientele.

In particular, this thread concerned itself with treatment of securities, but in real practice there is a much larger issue in comparison. Since 2018, more and more taxpayers are being allowed to pay taxes using the cash method, regardless of how their books are kept. I believe the best course for most taxpayers is to embrace the accrual method for their books, because accrual method brings the most accurate measurement of an entity's financial health. Schedule M-1 reconciliation may result in a few hundred dollars because of investments, but could result in many thousand dollars because of cash basis election.

[kathyc2]

"If you are assisting client to prepare financial statements on anything other than tax basis, you are needlessly exposing yourself to liability."

I can't dispute that. However, there are some entity clients I've prepared returns for who don't really keep any other books besides their tax returns (or simple Quickbooks files that I make journal entries to when I prepare the return, which is almost the same thing). So yes, I have prepared balance sheets on other than a tax basis (as part of the tax return), and I hope my fee was high enough (ha-ha).. Is preparing Schedule L really the same thing as preparing "financial statements" for liability purposes? I get the EOY numbers directly from the client's brokerage statements, doesn't this fall under "good faith reliance on information provided by the taxpayer as long as it does not appear incomplete or inaccurate"?

I didn't say don't help with accounting. I said if you do, have the financial statements on tax basis, rather than GAAP. Mostly, the purpose of GAAP is to make sure income is not overstated so as not to mislead investors or lenders. Do you want to take on keeping depreciation records for both book and tax? Calculate allowance for doubtful accounts, accrued warranty, etc?