Transcript Chapter 1- Instructor PowerPoint Slides. Summer, 2008

Chapter 11
Property Dispositions
Howard Godfrey, Ph.D., CPA
UNC Charlotte
Copyright © 2013, Dr. Howard Godfrey
Edited October 27, 2013
T13F-Chp-11-1-Property-Dispositions-2013
11. Property Dispositions
Introduction
Section 1231
Realized Gain-Loss Sec. 1231 Prop.
Amount Realized
Debt Assumptions
Character-Gain-Loss
Capital Gains & Losses
Capital Asset Definition
Sec. 1231 Netting
Recapture
Sec. 1245 Recapture
Sec. 1250 Recapture
Netting gains & losses
Sec. 1245 Property
Sec. 1250 Property
Unrecap. 1250 Gain
Strategies
Summary
L.Term vs Short-Term
Introduction
Realized Gain-Loss
Amount Realized
Debt Assumptions
Sale to Related Party
• Losses on sales to related parties are
disallowed
– Related parties include brothers, sisters,
spouse, ancestors and lineal
descendents, as well as a more-than
50% owned corporation
• If related buyer later sells property at a
gain, this gain can be reduced (not
below zero) by the seller’s previously
disallowed loss
Loss on Sale to Relative - 1
In April 2013, Pam sold stock with a cost
basis of $17,000, to Lisa, her sister, for
$10,000.
In September 2013, Lisa sold the same
shares of stock to her neighbor, Niki, for
$20,000.
What is Lisa's gain for 2013?
a. $0 b. $3,000 c. $7,000 d. $10,000
Loss on Sale to Relative - 2
Price received by Pam
$10,000
Pam's basis in stock
17,000
Loss realized by Pam
Loss Disallowed
on sale by Pam
Loss recognized by Pam
Loss on Sale to Relative - 3
Price received by Pam
$10,000
Basis to Pam
17,000
Loss realized by Pam
(7,000)
Loss Disallowed
on sale by Pam
(7,000)
Loss recognized by Pam
$0
Loss on Sale to Relative - 4
Price received by Lisa
Basis to Lisa
Gain realized by Lisa
Less Loss Disallowed
on sale by Pam
Gain recognized by Lisa
Loss on Sale to Relative - 5
Price received by Lisa
$20,000
Basis to Lisa
10,000
Gain realized by Lisa
10,000
Less Loss Disallowed
on sale by Pam
(7,000)
Gain recognized by Lisa
$3,000
Property Disposition
Amount realized from disposition
less: Adjusted basis of property
Realized gain (loss)
less: Allowed deferral
Recognized gain (loss)
Amount Realized
Amount realized is gross sales price less
selling expenses.
– Gross sales price is the amount received
by the seller from the buyer and includes:
• Cash and FMV of property or services received
• Seller’s debt assumed by or paid by the buyer
– Gross sales price is decreased by amounts
given to the buyer by the seller:
• Buyer’s expenses paid by or assumed by seller
Effect of Debt Assumption
• Assumption of debt is treated as a
realization of income similar to paying
or receiving cash
–Assumption of the seller’s debt
increases sales price (as if buyer paid
cash)
–Assumption of debt by the seller
decreases the sales price (as if buyer
received cash)
Types of Dispositions
• Sale – seller receives cash or cash
equivalents in return for asset
• Exchange – taxpayer receives property
other than cash or cash equivalents in
return for property transferred to the
other party
• Involuntary conversion – complete or
partial destruction due to events not
under control of taxpayer
(condemnations, thefts, and casualties)
• Abandonment – property is permanently
withdrawn from use (loss = basis of asset)
Amount Realized
+ Cash Received
+ FMV of property received
+ Seller’s liabilities assumed by the buyer
- Buyer’s liabilities assumed by the seller
- Selling expenses
= Amount Realized
Recognized Gain or Loss
• Almost all realized gains are
recognized (taxable)
• Losses are usually only recognized
(deductible) if they are
– Incurred in a business
– Incurred in an investment activity
– Casualty or theft losses
Allan’s Gains and Losses-1
Allan received $5,000 cash and an auto
worth $15,000 in exchange for a lot that
was encumbered by a $13,000 liability
that the buyer assumed.
a. What is the amount realized
on this sale?
b. If Allan had a basis of $34,000 in
the land, what is his gain or
loss on the sale?
Allan’s Gains and Losses-2
c. If Allen has owned the land
for five years as an investment,
what is the character of the gain
or loss?
d. How would your answer to (c)
change if the land had been
used by Allan’s business as
a parking lot?
Allan’s Gains and Losses-13
a. $5,000 + $15,000 + $13,000 = $33,000
amount realized.
b. $33,000 - $34,000 = $1,000 loss
c. Long-term capital loss.
d. If the property had been used in a
business, it would be Section 1231
property and it would be a Section 1231
loss.
Allan's Transactions
Cash received
Other Prop. Received- Auto
Mortgage assumed by buyer
Total Consideration Received
Expenses of sale
Sales commission
Other selling expenses
Total expenses of sale
Amount Realized
Cost (basis) of property
Gain (Loss)
$ 5,000
15,000
13,000
33,000
33,000
(34,000)
$ (1,000)
Capital Gains & Losses
Capital Asset Definition
Long-Term vs Short-Term
Gain-and-Loss Netting
Planning Strategies
Concept Review
Under the capital recovery
concept, a property’s basis may
be recovered before any taxable
income is realized from disposal
of property.
No income or loss is recognized
for tax purposes until it has first
been realized.
Character of Gain or Loss
Amount realized from
disposition
less: Adjusted basis of property
Realized gain (loss)
less: Allowed deferral
Recognized gain (loss)
Character of gain (loss)
Ordinary
Section 1231
Capital
Personal Use
Gains
Loss not
deductible
Capital Gains and Losses
A capital asset is “any asset other than
inventory, receivables, copyrights,
assets created by the taxpayer, and
depreciable or real property used in a
trade or business.”
A collectible gain or loss results from
the sale or exchange of works of art,
gems, metals, antiques, rugs, stamps,
wine, etc. held more than 12 months.
Capital Gains and Losse Holding Period
The holding period for capital assets is
how long the taxpayer owned the asset.
–Long-term means the asset was held for
more than 12 months.
–Short-term means the asset was held for
< 12 months.
Determining holding period is the first
step in determining tax treatment.
Capital Gains and Losses Netting Procedures
The following are treated as longterm gains and losses for the netting
procedure
–Collectible gains and losses
–Gains on qualified small business stock
–Unrecaptured Section 1250 gain
Capital Gains and Losses
Netting Procedures
Long-term gains
netted against
Long-term losses
Short-term gains
netted against
Short-term losses
=
Net Long-term
Gain or Loss
=
Net Short-term
Gain or Loss
Capital Gains and Losses
Netting Procedures
If one is a loss and one is a gain, then:
Net Short-term Gain or Loss
netted against
Net Long-term Gain or Loss
=
Net Capital
Gain or Loss
If both are losses or both are gains,
no further netting is done.
Barb-1
Four
Buckets
Stock Trans.
Yr 1 STCG
Yr 1 STCL
Yr 1 LTCG
Yr 1 LTCL
Two
One
Buckets
Bucket
Net
Net
Net
Short-T. Long-T. Gain (Loss) Return
$4,000
($2,400)
$4,000
($3,500)
Net Gain
Gain taxed at ordinary rates
Gain taxed at capital gains rates
Barb-2
Four
Buckets
Stock Trans.
Yr 1
STCG
Yr 1
STCL ($2,400)
Yr 1
LTCG
Yr 1
LTCL ($3,500)
Two
One
Buckets
Bucket
Net
Net
Net
Short-T. Long-T. Gain (Loss) Return
$4,000
$1,600
$4,000
$500
$2,100
Net Gain
Gain taxed at ordinary rates
Gain taxed at capital gains rates
$2,100
$1,600
$500
Tax Treatment for Net Long-term Gain
Individual Taxpayers
•Net long-term gain (minus net
collectibles gain, gain on qualified
small business stock, and
unrecaptured Section 1250 gain) is
taxed at a maximum rate of 15%
•5% if marginal tax rate < 15%
Adjusted Net Capital Gains (ANCG)
Are taxed at the 15% or 5% rates.
ANCG = NLTG - [Net Collectible Gain +
Small Business Gain - NSTCL - LTL
carryovers]* - unrecaptured Sec. 1250
gain + Eligible Dividend Income
* called: “28% rate gain”
Tax Treatment for Net Long-term Gain
Individual Taxpayers
– Collectibles held more than 12 months
are taxed at a maximum rate of 28%.
– 50% of the gain on qualified small
business stock is excluded, the
remainder taxed at a maximum rate of
28%.
– Unrecaptured Section 1250 gain is
taxed at a maximum rate of 25%.
Juan has these capital gains
and losses in the current year:
Short-term capital loss ($2,000)
Long-term capital gain $12,000
Long-term capital
loss carryover
Collectibles gain
($5,000)
$10,000
Example
Short-term:
S.T. capital loss
Long-term:
Collectibles gain
L.T. capital gain
L.T. capital loss c/o
L.T. capital gain
Net L.T. capital gain
($2,000)
$10,000
$12,000
($5,000)
$17,000
$15,000
Example
Results:
“28% rate gain” = ($10,000 -$5,000 - $2,000)
= $3,000
ANCG = $15,000 - $3,000 = $12,000
NLTCG is added to taxable income
Net capital gain, taxed at 15% = $12,000
Collectibles gain, taxed at 28% = $3,000
Tax Treatment for Net Short-term Gain
Individual Taxpayers
• Net short-term capital gain
is taxed as ordinary income
(i.e., taxpayer’s marginal tax
rate).
Gain Treatment for Corporations
•Corporations do not
receive special
treatment for capital
gains.
Tax Treatment for Net Loss
• Net Capital Loss
– Individuals may use only $3,000 to offset
other income
• Excess loss is carried forward indefinitely
and retains its short term or long term class
for netting purposes
– Corporations cannot deduct a net capital loss
• Excess loss carried back 3 then forward 5
years to offset capital gains
Big Corp's taxable income before
capital gains & losses $100,000
Big had the following:
Long-term capital gain
$3,000
Short-term capital loss ($9,000)
Taxable income?
Big Corp's taxable income before
capital gains & losses $100,000
Big had the following:
Long-term capital gain
$3,000
Short-term capital loss ($9,000)
Taxable income?
$100,000
Corporate Capital Loss Carryover
O'Donnell Corp. had these capital gains & (losses):
2009
2010
2011
2012
2013
$30,000 ($20,000) $15,000 ($30,000) $60,000
($20,000) $20,000
$10,000
Corporate Capital Loss Carryover
2009
2010
2011
2012
2013
$30,000 ($20,000) $15,000 ($30,000) $60,000
($20,000) $20,000
$10,000
($10,000)
($15,000) $25,000
($5,000)
$5,000 ($5,000)
$0
Net capital gain for 2013 is:
$55,000
Four
Buckets
Bob-1
Yr 1
STCG
Yr 1
STCL ($2,400)
Yr 1
LTCG
Yr 1
LTCL ($3,500)
Two
One
Buckets
Bucket
Net
Net
Net
Short-T. Long-T. Gain (Loss) Return
$0
$400
Deduct STCL
Deduct LTCL
Deduction limit this year
Carry over to next year
Four
Buckets
Bob-2
Yr 1
Yr 1
STCG
$0
STCL ($2,400)
Yr 1
LTCG
Yr 1
LTCL ($3,500)
Two
One
Buckets
Bucket
Net
Net
Net
Short-T. Long-T. Gain (Loss) Return
($2,400)
$400
($3,100)
($5,500)
Deduct STCL
Deduct LTCL
Deduction limit this year
Carry over to next year
($2,400)
($600)
($3,000)
($2,500)
Sharon’s Capital Asset Sales-1
Sharon has salary income of $68,000,
a net short-term capital gain of
$15,000, and a net long-term capital
loss of $24,000.
What is Sharon’s adjusted gross
income if she has no other income
items?
Sharon-Cap. Asset Sale Details Capital Ordinary Return
Salary Income (Other AGI)
$68,000
Net L.T. capital gain or loss
15,000
Net S.T. capital loss or loss
(24,000)
Gain (loss) non-cap. asset:
Gain (Loss)-bus. use asset
Sec. 1231 gain (Cap. Gain.)
Net capital gain or loss
Cap. Loss limited to $3,000
Net capital gain or loss in AGI
Adjusted Gross Income
Carryforward
3,000
$68,000
Sharon-Cap. Asset Sale
Details
Capital Ordinary Return
Salary Income (Other AGI)
$68,000
Net L.T. capital gain or loss
$15,000
Net S.T. capital loss or loss
(24,000)
$68,000
(9,000)
Gain (loss) non-cap. asset:
Gain (Loss)-bus. use asset
Sec. 1231 gain (Cap. Gain.)
Net capital gain or loss
(9,000)
Cap. Loss limited to $3,000
(3,000)
Net capital gain or loss in AGI
(3,000)
Adjusted Gross Income
Carryforward
$65,000
($6,000)
Qualified Small Business Stock
• Qualified stock
– Held for more than 5 years
– Purchased directly from corporation
• Corporation with gross assets < $50 million
– Purchased after 8/10/93
• Up to 50% of gain may be excluded
– Limited to the greater of
• 10 times basis in the stock, or
• $10 million for each small business
– Exclusion is based on a 28% rate
Qualified Small Business Stock Rollover Provision
• Individual taxpayers may rollover gain on
Qualified Small Business Stock
–Held more than 6 months
–Replaced with other small business
stock purchased within +/- 60 days
• Basis in new stock is reduced by deferred
gain
• Must recognize gain if the gain realized is
more than the cost of the replacement
stock
Planning Strategies
• Net Capital Gain position
– Sell assets with unrealized losses
• Net Capital Loss position
– Sell assets with unrealized gains
– Optimize at $3,000 (deduct $3,000 from Ord. Inc.)
• Worthless Securities
– Worthlessness deemed to occur on the last day of
the year
– Realized loss = basis in the worthless security
• Basis determination
– FIFO
– Specific identification
Section 1231
1231 Property
1231 Netting
Section 1231 Asset Definition
• Asset used in a trade or
business
–not for investment
• Held long term
Section 1231
• Net Section 1231 gains may
be allowed capital gain
treatment even though they
arise from “ordinary” assets.
• Net Sec. 1231 losses are
ordinary.
Jill had AGI of $100,000,
before these transactions.
Long-term capital gain
$2,000
Short-term capital loss
($8,000)
Loss on sale of business
auto (owned 2 years)
Adjusted gross income?
($4,000)
Jill had AGI of $100,000,
before these transactions.
Long-term capital gain
$2,000
Short-term capital loss
($8,000)
Loss on sale of business
auto (owned 2 years)
($4,000)
Adjusted gross income?
$93,000
Jack had AGI of $100,000,
before these transactions.
Long-term capital gain
$2,000
Short-term capital loss
($8,000)
Gain on sale of business
land (owned 2 years)
Adjusted gross income?
$4,000
Jack had AGI of $100,000,
before these transactions.
Long-term capital gain
$2,000
Short-term capital loss
($8,000)
Gain on sale of business
land (owned 2 years)
$4,000
Adjusted gross income?
$98,000
Section 1231 Netting
1st Step:
Net all business casualty
gains and losses
loss
All gains and losses
are ORDINARY
gain
2nd Step:
Net all other Sec. 1231
gains and losses
loss
gain
gains are taken to Step 3
Section 1231 Netting
Gains from Step 2
3rd Step:
Apply lookback rule
Remaining Sec. 1231 gain is treated as
a net long-term capital gain netted with
other capital gains and losses
Gains are ORDINARY
to the extent of any
previous Sec. 1231 losses
Section 1231 Netting Results
• Net Section 1231 gain is classified as
long-term capital gain
–Lookback rule may reclaim some gains
as ordinary
• to the extent of Section 1231 loss
reported in the previous 5 years
• Net Section 1231 loss is classified as
ordinary loss
Section 1231
Disposition of Rental Activities
• Disposition of rental property held
for the production of income
(investment) yields capital gain or
loss
• Disposition of rental property used
in a trade or business yields
Section 1231 gain or loss
Deprec. Recapture
Section 1245 Recapture
Section 1250 Recapture
Section 1245 Property
Section 1250 Property
Unrecaptured 1250 Gain
Depreciation Recapture
Prevents taxpayers from receiving
the dual benefits of a depreciation
deduction and special Section 1231
gain treatment.
Applies to Sec. 1231 gain property only
Requires gains to be treated as ordinary
to the extent of prior depreciation
deductions
Depreciation Recapture-Section 1245
• Requires full recapture of all
depreciation
–Gains are treated as ordinary
income to the extent of any
depreciation taken
• Any gain in excess of depreciation
is netted under Section 1231
Depreciation Recapture-Section 1245
• Applies to
–Depreciable personal property
and
–Nonresidential real estate placed
in service between 1981 and 1986
and depreciated under ACRS
Depreciation Recapture
• Depreciation recapture converts part or
all of the gain on the sale of depreciable
assets to ordinary income to the extent of
the reduction in basis attributable to
depreciation expense previously claimed
• The amount of income recaptured as
ordinary income can never exceed either
the realized gain or prior depreciation
deductions
• Recapture rules cannot apply to assets on
which there is a realized loss
Section 1245 Full Recapture
• Applies to machinery, equipment,
furniture, and fixtures (but not to
buildings or structural components)
• Any gain on the sale of section 1245
property is ordinary income to the extent
of all depreciation allowed or allowable
for the property
– Any amount expensed under section 179 is
included in the depreciation allowed
– The income recaptured is the lesser of all
depreciation taken or the realized gain
Asset - Section 1245
Owner
Selling Price
Cost
300,000
Accum. Deprec. (S/L) (60,000)
Additional Dep. DDB
Adjusted Basis
Gain
Section 1245 Gain
Section 1231 gain (CG?)
Machine
Individual
$290,000
Asset - Section 1245
Machine
Individual
$290,000
Owner
Selling Price
Cost
300,000
Accum. Deprec. (S/L) (60,000)
Additional Dep. DDB
Adjusted Basis
240,000
Gain
50,000
Section 1245 Gain
50,000
Section 1231 gain (CG?)
Asset - Section 1245
Owner
Selling Price
Cost
300,000
Accum. Deprec. (S/L) (60,000)
Additional Dep. DDB
Adjusted Basis
Gain
Section 1245 Gain
Section 1231 gain (CG?)
Machine
Individual
$320,000
Asset - Sec. 1245
Owner
Selling Price
Cost
300,000
Accum. Deprec. (S/L) (60,000)
Additional Dep. DDB
Adjusted Basis
Gain
Section 1245 Gain
Section 1231 gain (CG?)
Machine
Individual
$320,000
240,000
80,000
60,000
20,000
Asset - Section 1250
Owner
Selling Price
Cost
300,000
Accum. Deprec. (S/L)
(80,000)
Additional Dep. DDB
Adjusted Basis
Gain
Section 1245 Gain
Section 1250 gain
Section 1231 gain (CG?)
Unrecaptured 1250 gain
Apartment
Individual
$250,000
220,000
30,000
30,000
The next slide has an illustration of how
the tax law worked for accelerated
depreciation on residential real estate.
However, only the straight-line method
has been allowed for buildings acquired
in last 25 years.
Buildings bought more than 25 years
ago would actually already be fully
depreciated by now (shorter life used
then).
But this shows how it worked.
Asset - Section 1250
Owner
Selling Price
Cost
300,000
Accum. Deprec. (S/L) (80,000)
Additional Dep. DDB (40,000)
Adjusted Basis
Gain
Section 1245 Gain
Section 1250 gain
Section 1231 gain (CG?)
Apartment
Individual
$250,000
180,000
70,000
40,000
30,000
Depreciation Recapture-Section 1250
• Requires partial recapture of
depreciation
–Gains are treated as ordinary income
to the extent of depreciation taken
in excess of straight-line amount
• Any gain in excess of depreciation is
netted under Section 1231
Depreciation Recapture-Section 1250
• Applies to depreciable real
property
–Not covered by Section 1245 and
–Not depreciated using the
straight-line method
• Eliminates most MACRS realty
Unrecaptured Section 1250 Gain
• Requires that the portion of the gain
attributable to depreciation that is not
Section 1250 recapture is taxed at a
rate of 25%.
• Applies to depreciable real property
sold after 5/7/97.
• Any gain not attributable to
depreciation (SP in excess of original
cost) is a Section 1231 gain taxed at 15%.
Owner
Gail
Asset
Apt Bldg
Selling Price
$390,000
Cost
$400,000
Accum. Dep. (S/L)
(60,000)
Extra depreciation
Adjusted Basis
340,000
Gain
50,000
Section 1245 Gain
Ordinary
Section 1250 Gain
Ordinary
Section 1231 gain UnRecap.25%
Section 1231 gain Cap. Gain-15%
Owner
Gail
Asset
Apt Bldg
Selling Price
$390,000
Cost
$400,000
Accum. Dep. (S/L)
(60,000)
Extra depreciation
Adjusted Basis
340,000
Gain
50,000
Section 1245 Gain
Ordinary
Section 1250 Gain
Ordinary
Section 1231 gain UnRecap.25%
50,000
Section 1231 gain Cap. Gain-15%
Owner
Gus
Asset
Apt Bldg
Selling Price
$410,000
Cost
$400,000
Accum. Dep. (S/L)
(60,000)
Extra depreciation
Adjusted Basis
Gain
Section 1245 Gain
Ordinary
Section 1250 Gain
Ordinary
Section 1231 gain UnRecap.25%
Section 1231 gain Cap. Gain-15%
Owner
Gus
Asset
Apt Bldg
Selling Price
$410,000
Cost
$400,000
Accum. Dep. (S/L)
(60,000)
Extra depreciation
Adjusted Basis
340,000
Gain
70,000
Section 1245 Gain
Ordinary
Section 1250 Gain
Ordinary
Section 1231 gain UnRecap.25%
60,000
Section 1231 gain Cap. Gain-15%
10,000
Section 1231 Look-Back Rules
• Net Section 1231 gains are taxed as ordinary
income to the extent of any unrecaptured net
Section 1231 losses in the five preceding years
– This prevents taxpayers from generating tax
savings by bunching their Section 1231 gains
into one year (to receive tax-favored long-term
capital gains treatment) and losses into
alternate years (deducting the Section 1231
losses in full against ordinary income)
Section 1250 Lookback
Barbara had these Sec. 1231 gains & losses:
Year 1
Year 2
Year 3
Year 4
Gain or
(loss)
$50,000 ($45,000) $20,000 $15,000
How will she treat the $15,000 gain in yr 4?
Ordinary Income
Capital Gain
a.
$5,000
$10,000
b.
$10,000
$5,000
c.
$15,000
$0
d.
$0
$15,000
Added Section 291 Recapture for Corporations
• Section 291 applies to corporate dispositions
of realty (Section 1250 property)
• Converts to ordinary income (as Section 1250
recapture) 20% of any Section 1231 gain that
would have been ordinary income if Section
1245 full recapture applied
– For realty acquired after 1986, Section
1245 full recapture x 20% = Section 291
recapture
– Eliminates some of the capital gains that
would otherwise be available to offset
corporate capital losses
Angel Corporation
Asset
Office Bld
Selling Price
Cost
Accum. Depreciation (S/L)
$500,000
600,000
(200,000)
Extra Depreciation
-
Adjusted Basis
400,000
Gain
100,000
Recapture-Sec. 1250 (Excess Deprec.)
Sec. 1231 gain- before considering 291
Section 291 recapture (20% rule)
Sec. 1231 gain- after considering 291
Angel Corporation
Asset
Office Bld
Selling Price
Cost
Accum. Depreciation (S/L)
$500,000
600,000
(200,000)
Extra Depreciation
-
Adjusted Basis
400,000
Gain
100,000
Recapture-Sec. 1250 (Excess Deprec.)
Sec. 1231 gain- before considering 291
100,000
Section 291 recapture (20% rule)
20,000
Sec. 1231 gain- after considering 291
80,000
Use Asset
s
Buy Asset
$200,000
Selling Price Lo
s
$100,000
$300,000
$200,000
Extra-$50,000
Book Value
$300,000
Original Cost $400,000
SL-$50,000
Case 1
Gain
$400,000
Selling Price $400,000
Buy, Use and Sell Business Asset
Case 2