Income Tax Fundamentals  2010 Gerald E. Whittenburg & Martha Altus-Buller 2010 Cengage Learning
A capital asset is any asset  other  than  inventory, receivables, copyrights, certain U.S. Government publications and de...
<ul><li>Sale/exchange of capital asset results in a capital gain or loss </li></ul><ul><ul><li>Although not defined precis...
<ul><li>Determining holding period is the first step in determining tax treatment </li></ul><ul><li>The holding period for...
Realized Gains/Losses vs.  Recognized Gains/Losses Amount realized* less: Adjusted basis of property *  Realized gain (los...
<ul><li>Amount Realized = Gross sales price -  Selling expenses </li></ul><ul><ul><li>Gross sales price  is the amount rec...
<ul><ul><li>Example </li></ul></ul><ul><ul><li>On 8/4/09, Juliana sold 326 shares of stock in Wind Farms Inc. that she had...
<ul><li>Example </li></ul><ul><ul><li>On 8/4/09, Juliana sold 326 shares of stock in Wind Farms Inc. that she had purchase...
Adjusted Basis   Original cost plus:   Capital improvements* less:  Accumulated depreciation Adjusted basis *Items that si...
<ul><li>Oftentimes difficult for taxpayers to track adjusted basis of stock </li></ul><ul><ul><li>Depends upon whether sto...
<ul><li>There are complex capital gain rules based on type of capital gain </li></ul><ul><li>Study the table “Capital Gain...
<ul><li>Net long-term capital gain (LTCG) rates depends upon regular tax bracket </li></ul><ul><ul><li>Taxed at 0% for tax...
<ul><li>Net short-term capital gain (STCG) is taxed as ordinary income  </li></ul><ul><li>Short term capital gains result ...
Long-term gains netted against Long-term losses Net Long-term Gain or Loss Short-term gains netted against Short-term loss...
If net short-term &  long-term are opposite signs: Net Short-term Gain or Loss against Net Long-term Gain or Loss Net Capi...
<ul><li>Note that net capital losses (short-term and long-term) limited to $3,000/year with an indefinite carry forward   ...
<ul><li>When taxpayer has net capital loss position, must offset capital gains using ordering rules </li></ul><ul><ul><ul>...
<ul><li>Example </li></ul><ul><li>Shavril has the following capital gains and losses in the current year: </li></ul><ul><u...
<ul><ul><li>Short-term (Step 1 – net short-term activities) </li></ul></ul><ul><ul><li>Short-term capital gains $  0 </li>...
<ul><li>Example </li></ul><ul><li>Thurber has several capital transactions in the current year as follows: </li></ul><ul><...
<ul><li>Example </li></ul><ul><li>Thurber has several capital transactions in the current year as follows: </li></ul><ul><...
Amount realized from disposition less: Adjusted basis of property  Realized gain (loss) less: Deferred gain allowed   Reco...
<ul><li>§1231 assets are not capital assets, but they are given special tax treatment </li></ul><ul><li>Asset must be held...
<ul><li>Net all  § 1231 gains against losses </li></ul><ul><li>Net  § 1231 gain is classified as long-term capital gain </...
Lookback Provision For  Net  § 1231 Gain <ul><li>There would be an advantage to having all §1231 losses (ordinary losses) ...
Lookback Provision Example <ul><li>Taxpayer had the following  § 1231 gains and losses: </li></ul><ul><ul><li>2007 $ 4,000...
<ul><li>Prevents taxpayers from receiving the dual benefits of a depreciation deduction  and  capital gain treatment upon ...
<ul><li>§  1245 applies to property such as </li></ul><ul><ul><ul><li>Depreciable personal property  </li></ul></ul></ul><...
<ul><li>Example </li></ul><ul><li>Francesca sells depreciable personal property used in her business on 4/1/09 for the pri...
<ul><li>Example </li></ul><ul><li>Francesca sells depreciable personal property used in her business on 4/1/09 for the pri...
<ul><li>§ 1250 applies to depreciable real property  </li></ul><ul><ul><li>Other than that identified as  §1245 </li></ul>...
<ul><li>Requires that portion of the gain attributable to depreciation that is not §1250 or  §1245  recapture to be taxed ...
<ul><li>Example </li></ul><ul><li>Ella purchases an apartment complex for $7,000,000 on 1/1/88. The property is depreciate...
<ul><li>Example </li></ul><ul><li>Ella purchases an apartment complex for $7,000,000 on 1/1/88. The property is depreciate...
<ul><li>Casualty loss is the lesser of  </li></ul><ul><ul><li>Property’s adjusted basis or </li></ul></ul><ul><ul><li>Decl...
<ul><li>Business casualty and theft losses result from damage caused by a sudden, unexpected and/or unusual event </li></u...
<ul><li>Treatment of gains and losses depends on holding period </li></ul><ul><ul><li>Property held one year or less </li>...
<ul><ul><li>Example </li></ul></ul><ul><ul><li>Sherry incurred the following casualty gains/losses and insurance reimburse...
<ul><ul><li>Example </li></ul></ul><ul><ul><li>Sherry incurred the following casualty gains/losses and insurance reimburse...
<ul><li>An installment sale occurs when </li></ul><ul><ul><li>Real or personal property or business/rental property is sol...
<ul><li>Taxable Gain   =  Realized Gain*  x  Cash Received </li></ul><ul><li>  Contract Price** </li></ul><ul><li>*Realize...
<ul><li>No gain/loss recognized when an exchange of like-kind property occurs (deferred gain/loss) </li></ul><ul><ul><li>L...
<ul><li>Realized Gain  = FMV of property received  – adjusted basis of property given up  </li></ul><ul><li>Recognized Gai...
<ul><li>Example </li></ul><ul><li>Barry exchanges his marina for Adolph’s land.  The marina has a fair market value of $25...
<ul><li>Example </li></ul><ul><li>Barry exchanges his marina for Adolph’s land.  The marina has a FMV of $250,000 and an a...
<ul><li>Gain recognition may be deferred if involuntary disposal of property  </li></ul><ul><ul><li>Due to an act of God, ...
<ul><li>Exclusion on gain of personal home allowed on sale of home  </li></ul><ul><ul><li>For sales 5/6/97 or later </li><...
<ul><li>Sales before 5/7/97 were treated very differently </li></ul><ul><li>Taxpayers didn’t have to recognize gain on sal...
 
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Chapter 8

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  • Section 8.1 Capital Assets Tax law defines a capital asset as any property, whether or not used in a trade of business, other than: Stock in trade, inventory, or property held primarily for sale to customers in the ordinary course of a trade or business Depreciable property or real property used in a trade or business Copyrights, literary, musical or artistic compositions, letters or memorandums, or similar property if the property is created by the taxpayer Accounts or notes receivable and Certain U.S. Government publications
  • Section 8.2 Holding Period Gains and losses from the sale of capital assets are called capital gains and losses and are classified as either short-term (held up to a year) or long-term (held longer than a year).
  • Section 8.3 Calculation of Gain or Loss The gain or loss realized is the difference between the amounts received from the sale of the property (including cash and the fair market value of any other property) and any costs paid to transfer the property. The adjusted basis of property is the original basis adjusted by adding capital (major) improvements and deducting depreciation allowed or allowable. The original basis is usually the cost of the property, including costs incidental to the purchase. Capital improvements are expenditures for permanent improvements to or restoration of the property. These expenditures help increase the useful life or the value of the property. Property received as an inheritance has a basis equal to the fair market value at the decedent’s date of death.
  • Section 8.4 Net Capital Gains To calculate a taxpayer’s net capital gain or capital loss, the following procedures must be followed: Capital gains and losses are classified as short-term or long-term Long-term capital gains are offset by long-term capital losses, resulting in either a net long-term capital gain or net long-term capital loss Short-term capital gains are offset by short-term capital losses, resulting in either a net short-term capital gain or net short-term capital loss If Step 2 results in a net long-term capital gain, it may be offset by any net short-term capital loss. If Step 2 results in a net long-term capital loss, it may offset net short-term capital gain.
  • Section 1231 and the Sears Tower . Recently, the Sears Tower in Chicago was sold. The property had been owned for more than 12 months by a partnership that held the building as a rental property and depreciated it. Consequently, the building was a § 1231 asset. The partnership sold the building at a loss of approximately $20 million. The loss was a § 1231 loss.
  • Section 8.6 Section 1231 Gains and Losses Section 1231 assets include: Depreciable or real property used in a trade or business, Timber, coal or domestic iron ore Livestock (not including poultry) held for draft, breeding, dairy or sporting purposes Unharvested crops on land used in a trade or business. To calculate Section 1231 gains and losses, net all Section 1231 gains and losses. If the gains exceed the losses, the excess is a long-term capital gain. When the losses exceed the gains, all gains are treated as ordinary income and all losses are fully deductible as ordinary losses.
  • Section 1231 Lookback . a. Net § 1231 gain is offset by the nonrecaptured net § 1231 losses incurred in the previous five taxable years. b. The amount of current year net § 1231 gains offset by the nonrecaptured net § 1231 losses are treated as ordinary income instead of receiving long-term capital gain treatment. c. The current year net § 1231 gain which survives the lookback is treated as long-term capital gain .
  • Section 8.7 Depreciation Recapture Three main depreciation recapture rules exists for Section 1245 property, Section 1250 property and unrecaptured depreciation on real estate taxed at the 25 percent rate. Section 1245 property includes the following: Depreciable personal property Livestock Amortizable personal property such as patents, copyrights, leaseholds and professional sports contracts Elevators and escalators Pollution control facilities Nonresidential real property Any gain recognized from the disposition of Section 1245 property will be classified as ordinary income up to an amount equal to the depreciation claimed after 1961. Any amount over the ordinary income amount is considered Section 1231 gain. Section 1250 applies to real property other than Section 1245 property. If the property was depreciated using the straight-line method, no recapture is necessary. A special 25 percent tax rate was implemented for real property gains attributable to depreciation previously taken and not already recaptured under the Section 1250 rules. The result of the rule is that the gains on the sale of real estate may be taxed at three different rates: ordinary income rates to the extent of Section 1250 recapture, 25 percent (or 10 percent if in the 10 percent tax bracket) on unrecaptured depreciation left after Section 1250 recapture and 20 percent (or 10 percent or 8 percent, if in the 15 percent ordinary tax bracket) on any remaining long-term gain.
  • Section 8.8 Capital Gains and Casualty Gains and Losses Casualty gains are the result of receiving an insurance reimbursement in an amount in excess of the basis of the property. Casualty gains and losses must be netted for tax purposes. If the losses exceed gains, the excess loss is treated as an itemized deduction. When casualty gains exceed casualty losses for the year, none of the casualty losses are subject to the 10 percent of adjusted gross income limitation. Casualty gains and losses from property used in a business or for investment must be classified as a capital asset, trade or business property subject to an allowance for deprecation, or ordinary income property. Clearly, the issue becomes very complex, depending on classification of the asset. Form 4686 and Form 4797 assists taxpayers with the instructions for treatment of the gains and losses.
  • Section 8.9 Installment Sales When taxpayers sell property but do not receive the entire payment, an installment sale is created. The taxpayer may spread the gain from the sale over the tax periods in which the payments will be received, or elect to report all the gain in the year of sale.
  • Section 8.10 Like-Kind Exchanges Recognition of gains or losses may be deferred for tax purposes, even if the gain or loss has been realized. To qualify as a nontaxable exchange, the property exchanged must be held for productive use in a trade or business or for investment. When an exchange only involves qualified like-kind property, no gain or loss is recognized. If the exchange included cash or other property (boot), the tax consequences can be limited. Gain is recognized in an amount equal to the lesser of the gain realized or the boot received. Relief from liability is the same as receiving cash and is treated as boot. A like-kind exchange must involve real property for real property or personal property for personal property. Also, property classifications must be identical. Office equipment must be exchanged for office equipment, not computers, to be a like-kind exchange
  • Section 8.11 Involuntary Conversions Taxpayers are sometimes forced to dispose of property as a result of circumstances beyond their control, such as natural disasters. Gains on these conversions may be deferred. Replacement property must be similar in use and service. A realized gain on the involuntary conversion occurs when a taxpayer receives an insurance settlement or other payment for the property in excess of the adjusted basis in the property. The involuntary conversion provision applies only to gains, not losses
  • Chapter 8

    1. 1. Income Tax Fundamentals 2010 Gerald E. Whittenburg & Martha Altus-Buller 2010 Cengage Learning
    2. 2. A capital asset is any asset other than inventory, receivables, copyrights, certain U.S. Government publications and depreciable or real property used in a trade or business. Capital assets are defined by exception
    3. 3. <ul><li>Sale/exchange of capital asset results in a capital gain or loss </li></ul><ul><ul><li>Although not defined precisely - ‘sale’ is receipt of cash or release of debt and ‘exchange’ requires transfer of ownership </li></ul></ul><ul><ul><li>Capital gains and losses receive special tax treatment </li></ul></ul><ul><ul><li>Tax treatment based on length of time property has been owned </li></ul></ul>
    4. 4. <ul><li>Determining holding period is the first step in determining tax treatment </li></ul><ul><li>The holding period for capital assets is how long the taxpayer owned the asset </li></ul><ul><ul><li>Long-term assets are held for > 12 months </li></ul></ul><ul><ul><li>Short-term assets are held for < 12 months </li></ul></ul>
    5. 5. Realized Gains/Losses vs. Recognized Gains/Losses Amount realized* less: Adjusted basis of property * Realized gain (loss) less: Allowed gain deferral* Recognized gain (loss ) * Models for these items are found on the next screens Realization of gain or loss requires the “ sale or exchange” of an asset.
    6. 6. <ul><li>Amount Realized = Gross sales price - Selling expenses </li></ul><ul><ul><li>Gross sales price is the amount received by the seller from the buyer </li></ul></ul><ul><ul><ul><li>Cash and fair market value (FMV) of property received </li></ul></ul></ul><ul><ul><ul><li>plus </li></ul></ul></ul><ul><ul><ul><li>Seller’s liability assumed by or paid for by the buyer </li></ul></ul></ul><ul><ul><ul><li>Less selling expenses (costs paid to transfer property) </li></ul></ul></ul>
    7. 7. <ul><ul><li>Example </li></ul></ul><ul><ul><li>On 8/4/09, Juliana sold 326 shares of stock in Wind Farms Inc. that she had purchased 6/18/99. Her cost basis = $10,000; she sold the shares for $19,000 with a commission of $1,300. Calculate amount realized and realized gain. </li></ul></ul>
    8. 8. <ul><li>Example </li></ul><ul><ul><li>On 8/4/09, Juliana sold 326 shares of stock in Wind Farms Inc. that she had purchased 6/18/99. Her cost basis = $10,000; she sold it for $19,000 with a commission of $1,300. Calculate amount realized and realized gain. </li></ul></ul><ul><li>Solution </li></ul><ul><li>Amount realized = $17,700 ($19,000 – 1,300) </li></ul><ul><li>Realized gain = $7,700 ($17,700 - 10,000) </li></ul>
    9. 9. Adjusted Basis Original cost plus: Capital improvements* less: Accumulated depreciation Adjusted basis *Items that significantly result in increase to property value or increase useful life
    10. 10. <ul><li>Oftentimes difficult for taxpayers to track adjusted basis of stock </li></ul><ul><ul><li>Depends upon whether stock was purchased, inherited or received as a gift </li></ul></ul><ul><li>Basis depends upon how acquired </li></ul><ul><ul><ul><li>If inherited, heir’s basis is fair market value at time of death </li></ul></ul></ul><ul><ul><ul><li>If acquired as gift, depends upon whether it is sold at a gain or loss </li></ul></ul></ul>
    11. 11. <ul><li>There are complex capital gain rules based on type of capital gain </li></ul><ul><li>Study the table “Capital Gains & Applicable Tax Rates” in Section 8.4 and note the following: </li></ul><ul><ul><li>Short-term capital gains are taxed at ordinary income rates </li></ul></ul><ul><ul><li>Long-term capital gains are taxed at preferred rates, (see next slide) depending on which bracket a taxpayer is normally in </li></ul></ul><ul><ul><li>Unrecaptured § 1250 gain has differing rates, depending on which bracket a taxpayer is normally in </li></ul></ul>
    12. 12. <ul><li>Net long-term capital gain (LTCG) rates depends upon regular tax bracket </li></ul><ul><ul><li>Taxed at 0% for taxpayers in 10% or 15% brackets </li></ul></ul><ul><ul><li>Taxed at 15% for taxpayers in all other brackets </li></ul></ul><ul><li>Collectibles held more than 12 months are taxed at a maximum rate of 28% </li></ul><ul><li>Unrecaptured depreciation on real estate is taxed at a maximum rate of 25% </li></ul>
    13. 13. <ul><li>Net short-term capital gain (STCG) is taxed as ordinary income </li></ul><ul><li>Short term capital gains result from selling capital assets held less than or equal to one year </li></ul>
    14. 14. Long-term gains netted against Long-term losses Net Long-term Gain or Loss Short-term gains netted against Short-term losses Net Short-term Gain or Loss = = Step 1: Classify each item as short-term or long-term and net by groups
    15. 15. If net short-term & long-term are opposite signs: Net Short-term Gain or Loss against Net Long-term Gain or Loss Net Capital Gain or Loss = <ul><ul><ul><li>Step 2: If short-term & long-term net results are same sign: </li></ul></ul></ul><ul><ul><ul><li>do not net ! You will have both a STC and LTC gain or loss. </li></ul></ul></ul>
    16. 16. <ul><li>Note that net capital losses (short-term and long-term) limited to $3,000/year with an indefinite carry forward </li></ul><ul><li>Must maintain ‘nature’ of capital loss (i.e. – short-term or long-term) when carrying it forward </li></ul><ul><ul><li>In subsequent years, must deduct STCL first </li></ul></ul><ul><li>Note: Must comply with ordering rules </li></ul>
    17. 17. <ul><li>When taxpayer has net capital loss position, must offset capital gains using ordering rules </li></ul><ul><ul><ul><li>Net STCL first reduce 28% gains </li></ul></ul></ul><ul><ul><ul><ul><li>Then reduce 25% gains </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Then reduce regular LTCG </li></ul></ul></ul></ul><ul><ul><ul><li>Net LTCL first reduce 28% gains </li></ul></ul></ul><ul><ul><ul><ul><li>Then reduce 25% gains </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Then reduce regular STCG </li></ul></ul></ul></ul>
    18. 18. <ul><li>Example </li></ul><ul><li>Shavril has the following capital gains and losses in the current year: </li></ul><ul><ul><li>Short-term capital loss ($ 2,000) </li></ul></ul><ul><ul><li>Long-term capital gain 12,000 </li></ul></ul><ul><ul><li>Long-term capital loss carryover (7,000)* </li></ul></ul><ul><ul><li>*Brought forward from prior year </li></ul></ul><ul><ul><li>What is Shavril’s net capital position? In 2009, what are the tax implications for Shavril’s capital activities, if he’s in the 15% bracket? </li></ul></ul>
    19. 19. <ul><ul><li>Short-term (Step 1 – net short-term activities) </li></ul></ul><ul><ul><li>Short-term capital gains $ 0 </li></ul></ul><ul><ul><li>Short-term capital loss (2,000) </li></ul></ul><ul><ul><li>Net ST position $(2,000) </li></ul></ul><ul><ul><li>Long-term (Step 2 – net long-term activities) </li></ul></ul><ul><ul><li>Long-term capital gain $ 12,000 </li></ul></ul><ul><ul><li>Long-term capital loss carryover ( 7,000) </li></ul></ul><ul><ul><li>Net LT position $ 5,000 </li></ul></ul><ul><ul><li>(Step 3 –first two steps go in different directions, </li></ul></ul><ul><ul><li>so net) </li></ul></ul><ul><ul><li>Net long-term capital gain [(2,000) + 5,000] $ 3,000 </li></ul></ul><ul><ul><li>His $3,000 LTCG will be taxed at 0% because he is in the 15% ordinary income tax bracket. </li></ul></ul>
    20. 20. <ul><li>Example </li></ul><ul><li>Thurber has several capital transactions in the current year as follows: </li></ul><ul><li>Description Date Acquired Date Sold Selling Price Cost Basis </li></ul><ul><li>Jet Blue Bond 5/5/01 6/1/09 41,400 39,000 </li></ul><ul><li>Micron Stock 8/3/08 6/1/09 11,000 12,300 </li></ul><ul><li>AP Health 9/2/99 6/1/09 19,000 24,000 </li></ul><ul><li>What is Thurber’s net capital position? If he has a carry forward, how much and what kind is it? </li></ul>
    21. 21. <ul><li>Example </li></ul><ul><li>Thurber has several capital transactions in the current year as follows: </li></ul><ul><li>Description Date Acquired Date Sold Selling Price Cost Basis </li></ul><ul><li>Jet Blue Bond 5/5/01 6/1/09 41,400 39,000 </li></ul><ul><li>Micron Stock 8/3/08 6/1/09 11,000 12,300 </li></ul><ul><li>AP Health 2/2/99 6/1/09 19,000 24,000 </li></ul><ul><li>What is Thurber’s net capital position? If he has a carry forward, how much and what kind is it? </li></ul><ul><li>Solution </li></ul><ul><li>Jet Blue LTCG = $2,400; Micron STCL = $1,300; AP Health LTCL = $5,000 . Net long-term capital loss = $2,600. Since have both net short-term and long-term losses, deduct net short-term loss and $1,700 of net long-term loss. Will carry forward a net long-term capital loss of $900 to 2010. </li></ul>
    22. 22. Amount realized from disposition less: Adjusted basis of property Realized gain (loss) less: Deferred gain allowed Recognized gain (loss) Ordinary §1231 (Form 4797) Capital (Schedule D) Personal Use Character of gain (loss)
    23. 23. <ul><li>§1231 assets are not capital assets, but they are given special tax treatment </li></ul><ul><li>Asset must be held > 12 months and used in a trade or business </li></ul><ul><ul><li>Depreciable real or personal property used in trade or business </li></ul></ul><ul><ul><li>Timber, coal, or domestic iron ore </li></ul></ul><ul><ul><li>Livestock (not poultry) held for certain purposes </li></ul></ul><ul><ul><li>Unharvested crops on land used in trade </li></ul></ul>
    24. 24. <ul><li>Net all § 1231 gains against losses </li></ul><ul><li>Net § 1231 gain is classified as long-term capital gain </li></ul><ul><li>Net § 1231 loss is classified as ordinary loss </li></ul><ul><li>This is the best of both worlds! </li></ul><ul><ul><li>Lower tax rates on gains </li></ul></ul><ul><ul><li>No limit on losses </li></ul></ul>
    25. 25. Lookback Provision For Net § 1231 Gain <ul><li>There would be an advantage to having all §1231 losses (ordinary losses) in a different year from gains (long-term capital gains) </li></ul><ul><li>To control manipulation, net §1231 gains are treated as ordinary income to the extent that the taxpayer has nonrecaptured net § 1231 losses in the prior 5 year period </li></ul>
    26. 26. Lookback Provision Example <ul><li>Taxpayer had the following § 1231 gains and losses: </li></ul><ul><ul><li>2007 $ 4,000 loss </li></ul></ul><ul><ul><li>2008 10,000 loss </li></ul></ul><ul><ul><li>2009 16,000 gain </li></ul></ul><ul><ul><li>In 2009, taxpayer’s net § 1231 gain of $16,000 will be treated as $14,000 of ordinary income and $2,000 of long-term capital gain </li></ul></ul>
    27. 27. <ul><li>Prevents taxpayers from receiving the dual benefits of a depreciation deduction and capital gain treatment upon sale of the asset </li></ul><ul><ul><li>Requires gains to be treated as ordinary to the extent of prior depreciation deductions </li></ul></ul><ul><ul><ul><li>§1245 recapture </li></ul></ul></ul><ul><ul><ul><li>§1250 recapture </li></ul></ul></ul><ul><ul><ul><li>“ Unrecaptured depreciation” previously taken on real estate taxed at 25% </li></ul></ul></ul>
    28. 28. <ul><li>§ 1245 applies to property such as </li></ul><ul><ul><ul><li>Depreciable personal property </li></ul></ul></ul><ul><ul><ul><li>Nonresidential real estate placed in service between 1981-1986 with accelerated depreciation </li></ul></ul></ul><ul><li>Gains are treated as ordinary income to the extent of any depreciation taken </li></ul><ul><ul><li>Any gain in excess of depreciation is netted with §1231 gains/losses and given beneficial tax treatment </li></ul></ul>
    29. 29. <ul><li>Example </li></ul><ul><li>Francesca sells depreciable personal property used in her business on 4/1/09 for the price of $50,000. It was purchased for $60,000 four years ago and she has claimed depreciation on the property of $25,000. What is her §1245 recapture? </li></ul>
    30. 30. <ul><li>Example </li></ul><ul><li>Francesca sells depreciable personal property used in her business on 4/1/09 for the price of $50,000. It was purchased for $60,000 four years ago and she has claimed depreciation on the property of $25,000. What is her §1245 recapture? </li></ul><ul><li>Solution </li></ul><ul><li>§1245 recapture potential $25,000 </li></ul><ul><li>Adjusted basis ($60,000 – 25,000) 35,000 </li></ul><ul><li>Recomputed basis ($35,000 + 25,000) 60,000 </li></ul><ul><li>Gain realized ($50,000 – 35,000) 15,000 </li></ul><ul><li>Ordinary income is lesser of (1) $60,000 recomputed basis – 35,000 adjusted basis or (2) $50,000 amount realized - 35,000 adjusted basis. The entire gain of $15,000 is ordinary income instead of §1231 gain. </li></ul>
    31. 31. <ul><li>§ 1250 applies to depreciable real property </li></ul><ul><ul><li>Other than that identified as §1245 </li></ul></ul><ul><ul><li>Requires partial recapture of depreciation </li></ul></ul><ul><ul><li>Gains are treated as ordinary income to the extent of accelerated depreciation taken over straight-line amount </li></ul></ul><ul><ul><li>Rarely occurs </li></ul></ul>
    32. 32. <ul><li>Requires that portion of the gain attributable to depreciation that is not §1250 or §1245 recapture to be taxed at a rate of 25% </li></ul><ul><ul><li>Or 10% if taxpayer in 10% bracket </li></ul></ul><ul><ul><li>Or 15% if taxpayer in 15% bracket </li></ul></ul><ul><li>Widely seen in practice as many rentals are depreciated and then sold at gain </li></ul><ul><ul><li>Any gain not attributable to depreciation (in excess of original cost) is a §1231 gain </li></ul></ul>To the extent of the remaining amount in that bracket, then 25%
    33. 33. <ul><li>Example </li></ul><ul><li>Ella purchases an apartment complex for $7,000,000 on 1/1/88. The property is depreciated straight-line and her accumulated depreciation is $6,100,000. She sells the property on 9/3/09 for $8,500,000. She is in the 33% bracket. </li></ul><ul><li>What is Ella’s (a) realized gain and </li></ul><ul><li> (b) how is it split between §1231 gain and 25% rate for unrecaptured depreciation? </li></ul>
    34. 34. <ul><li>Example </li></ul><ul><li>Ella purchases an apartment complex for $7,000,000 on 1/1/88. The property is depreciated straight-line and her accumulated depreciation is $6,100,000. She sells the property on 9/3/09 for $8,500,000. She is in the 33% bracket. </li></ul><ul><li>What is Ella’s (a) realized gain and </li></ul><ul><li> (b) how is it split between LTCG and 25% rate for unrecaptured depreciation? </li></ul><ul><li>Solution </li></ul><ul><li>Realized gain = $8,500,000 - (7,000,000 – 6,100,000) = $7,600,000 </li></ul><ul><li>There was $6,100,000 of depreciation taken, which will be taxed at 25%. The remainder of the gain = 7,600,000 </li></ul><ul><li> - 6,100,000 </li></ul><ul><li> Taxed as LTCG $1,500,000 </li></ul>
    35. 35. <ul><li>Casualty loss is the lesser of </li></ul><ul><ul><li>Property’s adjusted basis or </li></ul></ul><ul><ul><li>Decline in the value of the property (repair cost) </li></ul></ul><ul><ul><li>Deductible loss is reduced by </li></ul></ul><ul><ul><ul><li>Insurance proceeds received </li></ul></ul></ul><ul><ul><ul><li>$500 per event </li></ul></ul></ul><ul><ul><ul><li>10% of AGI per year </li></ul></ul></ul><ul><ul><li>Itemized deduction on Schedule A </li></ul></ul><ul><li>Casualty gain occurs when insurance reimbursement > adjusted basis of property </li></ul>
    36. 36. <ul><li>Business casualty and theft losses result from damage caused by a sudden, unexpected and/or unusual event </li></ul><ul><ul><li>For property fully destroyed, deduct adjusted basis </li></ul></ul><ul><ul><li>For property partially destroyed, deduct the lesser of the property’s adjusted basis or the decline in the value </li></ul></ul><ul><ul><ul><li>Any insurance reimbursement reduces loss </li></ul></ul></ul><ul><ul><ul><li>May cause gain </li></ul></ul></ul>
    37. 37. <ul><li>Treatment of gains and losses depends on holding period </li></ul><ul><ul><li>Property held one year or less </li></ul></ul><ul><ul><ul><li>Net gains and losses are treated as ordinary </li></ul></ul></ul><ul><ul><ul><li>Losses from investment property separately calculated </li></ul></ul></ul><ul><ul><li>Property held more than one year </li></ul></ul><ul><ul><ul><li>Net gains is treated like §1231 </li></ul></ul></ul><ul><ul><ul><li>Net losses must have components analyzed separately </li></ul></ul></ul><ul><ul><ul><li>Interaction of §1231 and casualty gains/losses from business or investment property is complex – beyond full scope of text </li></ul></ul></ul>
    38. 38. <ul><ul><li>Example </li></ul></ul><ul><ul><li>Sherry incurred the following casualty gains/losses and insurance reimbursements in one year, all of the assets are personal property. The fences were destroyed by a hurricane & the boat and trailer by a windstorm . </li></ul></ul>
    39. 39. <ul><ul><li>Example </li></ul></ul><ul><ul><li>Sherry incurred the following casualty gains/losses and insurance reimbursements in one year, all personal. The fences were destroyed by a hurricane & the boat and trailer by a windstorm . </li></ul></ul>Solution Hurricane results in a casualty gain = $8,000 - $15,000 = $7,000. Windstorm results in a casualty loss = ($44,000 - $10,000) + ($8,000 - $0) = $42,000 - $500 floor = $41,500. Net casualty loss = $34,500. The total net casualty loss of $34,500 is further reduced by 10% of AGI.
    40. 40. <ul><li>An installment sale occurs when </li></ul><ul><ul><li>Real or personal property or business/rental property is sold and </li></ul></ul><ul><ul><li>Note is signed and payments are collected over time </li></ul></ul><ul><li>Congress allows taxable gain to be reported as cash received, not when sale completed </li></ul><ul><ul><li>However, can elect to report all the gain in the year of sale </li></ul></ul><ul><li>Otherwise, use Form 6252, Installment Sale Income </li></ul><ul><ul><li>Must recapture any §1245 or §1250 first </li></ul></ul><ul><ul><li>Then calculate gross profit percentage </li></ul></ul><ul><ul><li>Then multiply percentage by cash received each year </li></ul></ul>
    41. 41. <ul><li>Taxable Gain = Realized Gain* x Cash Received </li></ul><ul><li> Contract Price** </li></ul><ul><li>*Realized Gain = Sales Price </li></ul><ul><li> - Selling Expense </li></ul><ul><li> - §1245 or §1250 Recapture </li></ul><ul><li> - Adjusted Basis </li></ul><ul><li>**Contract Price = Sales Price – Assumed Liabilities </li></ul>
    42. 42. <ul><li>No gain/loss recognized when an exchange of like-kind property occurs (deferred gain/loss) </li></ul><ul><ul><li>Like-kind property transactions occur when </li></ul></ul><ul><ul><ul><li>Exchanging real property for real property </li></ul></ul></ul><ul><ul><ul><li>or </li></ul></ul></ul><ul><ul><ul><li>Exchanging personal property for personal property of the same asset class </li></ul></ul></ul><ul><ul><li>Rules only apply to business or investment property </li></ul></ul><ul><li>May have some recognized gain if “boot” is received </li></ul><ul><ul><li>Boot is defined as cas h received in an exchange or any property (inventory, stocks, bonds, or other securities) that is not like-kind </li></ul></ul>
    43. 43. <ul><li>Realized Gain = FMV of property received – adjusted basis of property given up </li></ul><ul><li>Recognized Gain = Lesser of realized gain or boot received </li></ul><ul><li>Basis of New Property = Adjusted basis of property given up + boot paid – boot received + gain recognized </li></ul>
    44. 44. <ul><li>Example </li></ul><ul><li>Barry exchanges his marina for Adolph’s land. The marina has a fair market value of $250,000 and an adjusted basis of $175,000. The land has a FMV of $305,000. Barry also gives Adolph $25,000 cash. </li></ul><ul><li>What is Barry’s realized gain, recognized gain, and new basis in the land? </li></ul>
    45. 45. <ul><li>Example </li></ul><ul><li>Barry exchanges his marina for Adolph’s land. The marina has a FMV of $250,000 and an adjusted basis of $175,000. The land has a FMV of $305,000. Barry also gives Adolph $25,000 cash. What is Barry’s realized gain, recognized gain, and new basis in the land? </li></ul><ul><li>Solution </li></ul><ul><li>Realized gain = $105,000 $305,000 – ($175,000 + $25,000) </li></ul><ul><li>Recognized gain =$0 since no boot was received </li></ul><ul><li>Basis of land $175,000 + 25,000 + 0 + 0 = $200,000 </li></ul>Adjusted basis of property given up + boot paid – boot received + gain recognized
    46. 46. <ul><li>Gain recognition may be deferred if involuntary disposal of property </li></ul><ul><ul><li>Due to an act of God, theft, condemnation, etc. </li></ul></ul><ul><ul><li> and </li></ul></ul><ul><ul><li>Insurance proceeds are reinvested in qualified replacement property within 2 years after close of tax year in which conversion occurred </li></ul></ul><ul><li>Must recognize gain if insurance proceeds exceed adjusted basis of property </li></ul><ul><li>Losses are not deferred </li></ul>
    47. 47. <ul><li>Exclusion on gain of personal home allowed on sale of home </li></ul><ul><ul><li>For sales 5/6/97 or later </li></ul></ul><ul><ul><li>If owned and used as principal residence for two of the last five years </li></ul></ul><ul><li>Gain exclusion is up to $500,000 (MFJ) or $250,000 (S) </li></ul>
    48. 48. <ul><li>Sales before 5/7/97 were treated very differently </li></ul><ul><li>Taxpayers didn’t have to recognize gain on sale of house if ‘bought up’ for new residence </li></ul><ul><ul><li>Therefore, many taxpayers who had sold one or more principal residences over a period of years have a principal residence with a basis that is far lower than the cost of that residence </li></ul></ul><ul><ul><li>These taxpayers get ‘fresh basis’ equal to purchase price of newly purchased residence </li></ul></ul>

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