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  1. 1. McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter 10Property Dispositions
  2. 2. 10-2Learning Objectives1. Calculate the amount of gain or loss recognized on thedisposition of assets used in a trade or business2. Describe the general character types of gain or lossrecognized on property dispositions3. Explain the rationale for and calculate depreciationrecapture4. Describe the tax treatment of unrecaptured §1250gains and determine the character of gains on propertysold to related parties5. Describe the tax treatment of §1231 gains or losses,including the §1231 netting process6. Explain common exceptions to the general rule thatrealized gains and losses are recognized currently
  3. 3. 10-3Dispositions Amount Realized Amount realized by a taxpayer from the sale orother disposition of an asset is everything of valuereceived from the buyer less any selling costs Taxpayers typically receive cash when they sellproperty, they may also accept marketablesecurities, notes receivable, similar assets, or anycombination of these items as payment
  4. 4. 10-4Dispositions Adjusted Basis Original basis reduced by depreciation or othertypes of cost recovery deductions taken againstthe property
  5. 5. 10-5Dispositions Realized Gain or Loss on Disposition The amount of gain or loss taxpayers realize on asale or other disposition of assets is simply theamount they realize minus their adjusted basis inthe disposed assets
  6. 6. 10-6Dispositions Recognized Gain or Loss on Disposition Gains (losses) that increase (decrease)taxpayers’ gross income Taxpayers must immediately recognize the vastmajority of realized gains and losses, they may beallowed to permanently exclude the gains fromtaxable income
  7. 7. 10-7Character of Gain or Loss Ordinary Assets Assets created or used in a taxpayer’s trade orbusiness Business assets held for less than a year Example – Inventory, Accounts Receivable,Machinery and Equipment If taxpayers sell ordinary assets at a gain, theyrecognize an ordinary gain that is taxed atordinary rates If taxpayers sell ordinary assets at a loss, theydeduct the loss against other ordinary income
  8. 8. 10-8Character of Gain or Loss Capital Assets Assets held for investment, for the production ofincome, or for personal use Qualification as capital asset depends on thepurpose for which taxpayers uses the assets Both individual and corporate taxpayers prefercapital gains to ordinary income
  9. 9. 10-9Character of Gain or Loss §1231 Assets Depreciable assets and land used in a trade orbusiness held for more than one year If the taxpayer recognizes a net §1231 gain, thenet gain is treated as a long-term capital gain If the taxpayer recognizes a net §1231 loss, thenet loss is treated as an ordinary loss §1231 gains on individual depreciable assets maybe recharacterized as ordinary income under thedepreciation recapture rules
  10. 10. 10-10Depreciation Recapture Potentially applies to gains (not losses) on the saleof depreciable or amortizable business property When applied, it recharacterizes the gain on thesale of a §1231 asset Does not affect §1231 losses Computation depends on the type of §1231 assetsthe taxpayer is selling (personal or real property) Changes only the character but not the amount ofgain that taxpayers recognize when they sell adepreciable asset
  11. 11. 10-11Depreciation Recapture §1245 Property Personal property and amortizable intangibleassets are §1245 assets The lesser of gain recognized or accumulated depreciation is recaptured(characterized) as ordinary income under §1245 Any remaining gain is §1231 gain There is no depreciation recapture on assets soldat a loss
  12. 12. 10-12Depreciation Recapture When taxpayers sell or dispose of §1245 property,they encounter one of the following three scenariosof gain or loss recognize a gain created solely through depreciationdeductions recognize a gain created through both depreciationdeductions and actual asset appreciation recognize a loss
  13. 13. 10-13Depreciation Recapture §1250 Depreciation Recapture for RealProperty Depreciable real property (an office building or awarehouse), sold at a gain is subject to recapturecalled §1250 depreciation recapture A modified version of the recapture rules called §291depreciation recapture applies to corporations but notto other types of taxpayers §291, corporations selling depreciable real propertyrecapture as ordinary income 20 percent of the lesser of therecognized gain or the accumulated depreciation
  14. 14. 10-14Other Provisions Affecting TheRate at which Gains are Taxed Unrecaptured §1250 Gain for Individuals Depreciable real property sold at a gain is §1250property, but is no longer subject to §1250recapture The gain that would be §1245 recapture if theasset were §1245 property is called unrecaptured§1250 gain Unrecaptured §1250 gain is §1231 gain that, ifultimately characterized as a long-term capitalgain, is taxed at a maximum rate of 25 percent
  15. 15. 10-15 Characterizing Gains on the Sale ofDepreciable Property to Related Parties All gain recognized from selling property i.e., adepreciable asset to a related-party buyer isordinary income Seller is required to recognize ordinary income fordepreciation deductions the buyer will receive in thefuture The tax laws are designed to provide symmetrybetween the character of deductions an assetgenerates and the character of income the assetgenerates when it is soldOther Provisions Affecting TheRate at which Gains are Taxed
  16. 16. 10-16 Includes family relationships including siblings,spouses, ancestors, and lineal descendants Also includes an individual and a corporation if theindividual owns more than 50 percent of the stock ofthe corporation, a partnership and any of itspartners, and an S corporation and any of itsshareholdersOther Provisions Affecting TheRate at which Gains are Taxed
  17. 17. 10-17Calculating Net §1231 Gains orLosses Taxpayer could benefit from this strategy inthree ways accelerating losses into year 1 deferring gains until year 2 characterizing the gains and losses due to the§1231 netting process §1231 Look-Back Rule A nondepreciation recapture rule Affects the character but not the amount of gainson which a taxpayer is taxed
  18. 18. 10-18Calculating Net §1231 Gains orLosses Gains and losses from individual assetdispositions are annually netted together Net §1231 gains may be recharacterized asordinary income under the §1231 look-back rule
  19. 19. 10-19Nonrecognition Transactions Like-Kind Exchanges For an exchange to qualify as a like-kindexchange for tax purposes, the transaction mustmeet the following three criteria The property is exchanged “solely for like-kind”property. Both the property given up and the property receivedin the exchange by the taxpayer are either “used in atrade or business” or are “held for investment,” by thetaxpayer The “exchange” must meet certain time restrictions
  20. 20. 10-20Nonrecognition Transactions Definition of Like-Kind Property Real Property Used in a trade or business or held for investment isconsidered “like- kind” with other real property used ina trade or business or held for investment Personal Property Considered “like-kind” if it has the same general useand is used in a business or held for investment
  21. 21. 10-21Nonrecognition Transactions Property Ineligible for Like-Kind Treatment Includes inventory, most financial instruments,partnerships interests, domestic property exchangedfor property used in a foreign country and all propertyused in a foreign country Property Use Timing Requirements for a Like-Kind Exchange Like-kind property exchanges may involveintermediaries Taxpayers must identify replacement “like-kind”property within 45 days of giving up their property
  22. 22. 10-22Nonrecognition Transactions Tax Consequences When Like-Kind PropertyIs Exchanged Solely for Like-Kind Property Tax Consequences of Transfers InvolvingLike-Kind and Non-Like-Kind Property (Boot) Non-like-kind property is known as boot When boot is given as part of a like-kindtransaction: The asset received is recorded in two parts: propertyreceived in exchange for like-kind property andproperty received in a sale (bought by the boot)
  23. 23. 10-23Nonrecognition Transactions When boot is received: Boot received usually creates recognized gain Gain recognized is lesser of gain realized or bootreceived The basis of boot received is the fair market valueof the boot
  24. 24. 10-24Nonrecognition TransactionsReporting Like-Kind Exchanges Involuntary Conversions Gain is deferred when appreciated property isinvoluntarily converted in an accident or naturaldisaster Basis of property directly converted is carried overfrom the old property to the new property In an indirect conversion, gain recognized is the lesserof: Gain realized, or Amount of reimbursement thetaxpayer does not reinvested in qualified property Qualified replacement property must be of a similar orrelated use to the original property
  25. 25. 10-25Nonrecognition Transactions Installment Sales Sale of property where the seller receives the saleproceeds in more than one period Must recognize a portion of gain on eachinstallment payment received Inventory, marketable securities, and depreciationrecapture cannot be accounted for underinstallment sale rules Does not apply to losses
  26. 26. 10-26Nonrecognition Transactions Gains Ineligible for Installment Reporting Other Nonrecognition Provisions Related-Party Loss Disallowance Rules Tax laws essentially treat related parties as thoughthey are the same taxpayer Related parties are defined in §267 and includecertain family members, related corporations, andother entities (partnerships) Losses on sales to related parties are not deductibleby the seller Related party may deduct the previously disallowedloss to the extent of the gain on the sale to theunrelated third party