Transcript Slide 1

Extra Recapture
Materials.
Property
Transactions:
§1231 and Recapture
Provisions
Recapture
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Note from Instructor-1
Capital losses can be deducted from capital
gains, if you have capital gains.
It is critical for us to understand that capital
loss deductions (from ordinary income) are
limited to $3,000 per year for individuals
and to zero for corporations.
In a depression, a corporation may need to
sell (or abandon) excess factories and
equipment. If the loss on the sale is subject
to the capital loss limit, the deduction is of
no value during a depression.
Recapture
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Note from Instructor-2
Therefore, the corporation wants production
assets to be classified as ordinary assets
(not capital assets) so the loss on the sale
can be deducted, possibly creating a net
operating loss to be carried back to another
year-resulting in a refund of back taxes and
a source of much needed cash.
So, businesses want buildings and
equipment to be “non” capital assets.
Recapture
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Note from Instructor-3
The situation changes in boom times
when equipment is being sold at a gain.
Then, individuals want such assets to
be classified as capital assets so they
can take advantage of the 15%
maximum rate on capital gains.
Corporations want the assets to
generate capital gains because they
may have accumulated capital losses
that will offset the capital gains.
Recapture
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Note from Instructor-4
Congress has listened to the lobbyists, and
showed their appreciation for the campaign
contributions.
Buildings and equipment used in a
business, as well as land, are not capital
assets. (Sec. 1221)
However, if you have net gains from the
sale of these assets you are allowed to
“pretend” the assets are capital assets, and
report the gains as capital gains.
(Sec. 1231)
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Note from Instructor-5
This creates a loophole. Buy a $400,000 machine.
Depreciate it very fast – claiming deprec. of say
$100,000. That leaves a book value of $300,000.
Now lets assume you sell it for $400,000.
You have a $100,000 gain. It is capital gain, but.!!
(Sec. 1245) Congress said that to the extent a
gain represents depreciation on personal
property-- that much of the gain is ordinary
income-- and any additional gain is capital gain.
This company will report $100,000 ordinary
income (recaptured) on the sale of the asset.
If they sell the asset for $410,000, there is capital
gain of $10,000. The remaining $100,000 gain is
reported as ordinary income.
Recapture
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Note from Instructor-6
(Sec. 1250) It is more complicated with buildings, because
we may be recapturing only the excess of actual
depreciation taken over what would have been taken with
straight-line method.
Since the law has only allowed straight-line depreciation on
real estate since 1986, our main focus is on buildings on
which straight-line depreciation has been claimed.
It is more complicated for Corporations selling buildings
because they have extra recapture under Sec. 291.
Compare actual depreciation recapture under Sec. 1250
(probably zero) with what would have been recaptured
under Section 1245 (gain up to amount of depreciation
claimed). Subtract 1250 recapture from hypothetical 1245
recapture, and take 20% of this difference. This
computation gives you corporate recapture amount under
Sec. 291.
Recapture
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Cost:
$400,000
Machine INDIV:Machine-S.Price: $410,000.
or Bldg
Amount Tax Rate
Accum.
Deprec.
$100,000
Book Val.
$300,000
Deprec.
(St. Line)
Book
Value
Total Gain $110,000
Ordinary
Cap. Gain
$100,000 Ord. Rate
$10,000
15%
INDIV:Building-S.Price: $410,000.
Amount Tax Rate
Total Gain $110,000
Ordinary
Cap. Gain
Cap. Gain
$0
$100,000
$10,000
25%
15%
Individual T/P is single with Tax. income of $500,000 before sale.
Recapture
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Cost:
$400,000
Deprec.
$ 100,000
Book Val.
$300,000
Machine CORP:Machine-S.Price: $410,000.
or Bldg
Amount Tax Rate
Accum.
Deprec.
(St. Line)
Book
Value
Total Gain
Sec. 1245
Cap. Gain
$110,000
$100,000
$10,000
Ord. Rate
Ord. Rate
Corp:Building-S.Price: $410,000.
Amount Tax Rate
Total Gain $110,000
Sec. 291
$20,000 Ord. Rate
Cap. Gain
$90,000 Ord. Rate
Corp. T/P has Taxable income of $500,000 before this sale.
Sec. 291 recapture is 20% of the unrecaptured depreciation.
Recapture
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Note from Instructor-7
DEPRECIATION RECAPTURE
1221 Depreciable property used in a trade or
business, & real property used in a trade or
bus. are not capital assets.
1231 Capital gain treatment is given to sales,
exchanges, or involuntary conversions of
depreciable or real property used in a trade or
business, if there is a net gain during the year.
(but note rule on non-recaptured sec. 1231 losses)
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Note from Instructor-8
DEPRECIATION RECAPTURE
1245 (Exception to Sec. 1231)
Applies generally to depreciable personal
property. Non-residential real property is also
covered if accelerated depreciation is used.
All depreciation taken is recaptured
(treated as ordinary gain) up to amount of gain.
Recapture
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Note from Instructor-9
DEPRECIATION RECAPTURE
1250 Generally applies to depreciable real
estate. Only excess of actual depreciation
over S/L is recaptured. If S/L is taken, no
depreciation is recaptured.
(Note rule on non-recaptured sec. 1250
(Gain up to unrecaptured depreciation had 25% tax
rate.)
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Note from Instructor-10
Section 291 Recapture
291 An exception to Sec. 1250.
Compare depreciation recaptured under
sec. 1250 with the depreciation that would
be recaptured under 1245 -- if that applied.
20% of the excess of what would be recaptured under
Sec.1245 over actual 1250 recapture is also recaptured.
Sec. 291 only applies to corporations.
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Lookback Example
Taxpayer had the following §1231 gains
and losses:
2007
$ 4,000 loss
2008
10,000 loss
2009
16,000 gain
– In 2009, taxpayer’s net §1231 gain of
$16,000 will be treated as $14,000 of
ordinary income and $2,000 of longterm capital gain
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Lookback Provision - More
Pam had these Section 1231 gains & losses:
Year
Yr. 1
Yr. 2
Yr. 3
Yr. 4
Sec. 1231 gain $50,000 -45,000 $40,000 $15,000
How will Pam report the $15,000 gain in year 4?
Ordinary Income
Capital Gain
$5,000
$10,000
a.
$10,000
$5,000
b.
$15,000
$0
c.
$0
$15,000
d.
Recapture
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§1245 Recapture
Corp. sells for $240,000, equipment which
it had placed in service two years earlier.
The equipment had cost $250,000, and
depreciation deductions of $30,000 had
been taken on the equipment.
The results of the sale are
a. Ordinary income of $20,000.
b. Sec. 1231 gain of $20,000.
c. Capital gain of $20,000.
d. None of the above.
Recapture
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§1245 Recapture
Selling Price ($000)
Cost
Acc. Depreciation
Book Value
Gain
Ordinary Income
Capital Gain
$240
250
(30)
220
20
$20
How is gain reported if this asset is sold for $260,000?
What is the deduction, if the asset is given to charity?
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§1245 Recapture
• Notice on the preceding slide that
all gain was recaptured.
• This is because all gain represented
recapture of prior depreciation.
• You would have to sell the
equipment for more than $250,000
to get any capital gain under
Section 1231.
Recapture
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§1245 Recapture
Taxpayer sold equipment used in his business
for $11,000. The equipment cost $10,000.
TP had properly claimed ACRS deductions
totaling $4,000. Straight-line depreciation, if it
had been used, would have been $2,500.
What is the amount of gain that should be
reported under sections 1231 and 1245?
Section 1231 Section 1245
a.
$5,000
$0
b.
$3,500
$1,500
c.
$1,000
$4,000
d.
$0
$5,000
Recapture
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§1245 Recapture
Selling Price
Cost
Dep.-SL
Dep.-Excess
Book Value
Gain
Ord. Income
Capital Gain
$11,000
$10,000
(2,500)
(1,500)
6,000
$5,000
$4,000
$1,000
Recapture
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Recapture Review - 1
Depreciation Recapture - Individuals
Selling Price
Original Cost
$430,000
$400,000
St.-Line
Accum. Depreciation 100,000
Book Value
Gain
Excess
100,000
300,000
$130,000
Recapture based on asset type
1245
1250
1250
Machine Apartment Office Bld.
Ordinary income - 1245
Ordinary income - 1250
Cap. gain -Unrecaptured (25%)
Cap. gain -Regular CG Rates
Recapture
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Recapture Review - 2
Depreciation Recapture - Individuals
Selling Price
Original Cost
$430,000
$400,000
St.-Line
Accum. Depreciation 100,000
Book Value
Gain
Excess
100,000
300,000
$130,000
Recapture based on asset type
1245
1250
1250
Machine Apartment Office Bld.
$ 100,000
N/A
N/A
Ordinary income - 1245
N/A
Ordinary income - 1250
$ 100,000 $ 100,000
Cap. gain - Unrecaptured (25%)
$ 30,000 $ 30,000 $ 30,000
Cap. gain - Regular CG Rates
Recapture
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