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Chapter
8
Property Dispositions
Realized Gain or Loss
Amount realized on disposition
MINUS adjusted basis of property (e.g. cost accumulated tax depreciation = “NBV”)
= Realized gain or loss.
GENERALLY, realized (economic) gains and
losses on disposition are recognized (result in
taxable income or deductions) unless there is a
specific exception. See Chapter 8.
Unrealized (mere appreciation or decline in value)
gains and losses are neither realized nor
recognized.
Amount Realized
Cash received
FMV of any property received, including buyer’s
note
Relief of debt. AP3.
Reduce the amount realized by selling costs such
as sales commissions, broker fees.
No adjustment for “inflationary gains.”
Installment Sale Method
Permits deferral of gain recognition until cash is
received on the sale.
Gain recognized this year = (cash this year) x (total
gain / total sales price).
Not allowed for sales of publicly traded stock or for
inventory, or to delay recognition of depreciation
recapture.
Financial accounting uses accrual accounting, so
installment sales method for tax creates a
temporary book-tax difference.
Related Party Losses
Relative:
family = spouse, sibling, ancestors, lineal descendants
Q10
50% controlled corporations
Losses realized on sale of property between
related parties are NONdeductible.
Future gain (but NOT loss) by relative can be offset
by disallowed loss.
Character of Gain or Loss - Overview
Tax or deduct
at ordinary rates
Ordinary
Section1231
net gain
Capital
Net capital gains and
losses: Individual may
deduct $3000 net loss.
Net LT gain taxed at
lower rates.
Capital Asset (negatively) Defined
Capital assets (under Section1221) are everything
EXCEPT:
1) inventory
2) accounts receivable
3) supplies
4) real or depreciable property used in a trade or
business (this is the same as Section 1231
property)
Capital Asset (negatively) Defined
5) copyright, compositions, artistic efforts created
by taxpayer. (exception - patents by inventors are
capital assets).
6) certain U.S. government publications
7) Commodities derivative financial instruments
held by a dealer
8) Hedging transaction properties.
Capital Losses
Only deduct capital losses UP TO capital gains.
Excess of capital loss over capital gains
Individual taxpayers:
can deduct $3000 of net losses per year against ordinary
income
carryforward excess indefinitely against capital gains
Corporation
NO deduction for net loss in current year
carry back 3 years and forward 5 years against capital gains
Capital Gains
Individuals obtain preferential taxation on long-term
(> 1 year) capital gains - generally 20% tax rate
(15% as result of 2003 Tax Act). See Chapter 16.
Corporations pay tax at regular tax rates.
Section 1231 Assets
Real or depreciable property used in a trade or
business. Q1
GENERAL rule.
Net Section 1231 gains and losses
IF NET GAIN => add to capital gains and losses. Result
is possible lower tax rate on 1231 net gains.
IF NET LOSS => add to ordinary gains and losses. Can
also offset salary, interest, dividends, etc. Result is
ordinary rate benefit of 1231 net losses.
Depreciation Recapture
Gain on each separate asset may be subject to
depreciation recapture.
Depreciation recapture does NOT apply if the asset
is sold at a loss, nor can it increase the amount of
the gain.
For sales of depreciable personalty and
amortizable intangibles, the gain is characterized as
ordinary up to the amount of accumulated
depreciation.
Why? because depreciation has resulted in prior
deductions at ordinary rates.
Depreciation Recapture
REALTY:
Special rules apply to pre-1986 depreciation on
accelerated methods: most of this property is
fully depreciated, so rules seldom apply.
Corporations must recapture 20% of amount
that would have been ordinary had it been
personalty (lesser of gain or depreciation)..
Individuals treat lesser of gain or depreciation
as a capital gain subject to a special 25% tax
rate - see chapter 16.
Section 1231 Netting
After all depreciation recapture, NET the remaining
Section1231 gains with Section 1231 losses.
If a net loss, treat as an ordinary loss and combine
with other ordinary income and losses.
If a net gain, then the net gain is treated as a
capital gain UNLESS:
Section 1231 Look Back Rule
The net 1231 gain is treated as ordinary income
recapture to the extent of unrecaptured Section
1231 losses during the prior five years.
EXAMPLE: Start business in 1990. Section 1231
gains and losses.
1998 net gain $10 treated as capital.
1999 net loss ($15) treated as ordinary.
2000 net gain $23 treated as $15 ordinary
(recapture 1991) and $8 capital.
2001 net loss ($40) treated as ordinary.
2002 net gain $6 treated as ordinary. Still have
$34 unrecaptured loss from 1993.
2003 net gain $50 treated as $34 ordinary, $16
capital.