Ch14 Property tax

5/21/2018 Ch14 Property tax

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Chapter 14

Property Transactions:Capital Gains and Losses, 1231, and

Recapture Provisions

Copyright 2007 South-Western/Thomson Learning

Comprehensive Volume


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C14 - 2Comprehensive Volume

Taxation of Capital

Gains and Losses

Capital gains and losses mustbe separated

from other types of gains and losses for two

reasons:

Long-term capital gains may be taxed at a

lower rate (0/15, 25, & 28) than ordinary gains

A net capital lossis only deductible up to

$3,000 per year


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Capital Assets

1221 defines capital assets as everythingexcept:

Inventory(stock in trade, held for salein regularcourse of business);

Notes and accounts receivables acquired from the sale

of inventory or performance of services; Realty and depreciable property usedin trade or

business (1231 assets)

Creative works (e.g., art, music, copyrights) when

created by taxpayer(or for which taxpayer takes acarryover basis from the creator)

Certain publications of U.S. government


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Capital Assets

Thus, capital assets are:

Assets held for investment(e.g., stocks, bonds, land)

Personal use assets (e.g., residence, car)

Examples 1 to 7 (pages 4-6)

Miscellaneous assets selected by Congress


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Capital Assets

Dealers in securities

In general, securities are the inventory ofsecurities dealers, thus ordinary assets

However, a dealer can identify securities asan investment and receive capital gaintreatment

Clear identification must be made on the day of

acquisition Example 8 (Page 7)


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Capital Assets

Real property subdivided for sale

Taxpayer may receive capital gain treatment on thesubdivision of real estate if the following requirementsare met:

Taxpayer is not a corporation

Taxpayer is NOT a real estate dealer (developer);

Taxpayer is a RE Investor No substantial improvementsmade to the lots

Taxpayer held the lots for at least 5 years

Capital gain treatment occurs until the year in which thesixth lot is sold

Then up to 5% of the revenue from lot sales is potentialordinary income

Example 9 (Page 8)


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Capital Assets

(slide 6 of 6)

Non-business bad debts

A non-business bad debt is treated as a

short-term capital lossin the year itbecomes completelyworthless

Even if outstanding for more than one year



Sale or Exchange

(slide 1 of 11)

Recognition of capital gains and losses

generally requires a sale or exchange of

assets Sale or exchange is not defined in the

Code

There are some exceptionsto the sale orexchange requirement



Sale or Exchange

Worthless Securities

A security that becomes worthlesscreates a

deductible capital loss without being sold

or exchanged

The Code sets an artificial sale date for

the securities on the last day of the year in

which worthlessness occurs



Sale or Exchange

Worthless securities example:

Calendar year taxpayer purchased stock on

December 5, 2005The stock becomes worthless on April 5, 2006

The loss is deemed to have occurred on

December 31, 2006

The result is a long-term capital loss



Sale or ExchangeRetirement of

Corporate Obligations (Not Covered)



Sale or ExchangeOptions

Sale or ExchangePatents

Sale or ExchangeFranchises,

Trademarks, and Trade Names

NOT COVERED



a e or xc ange

Lease Cancellation Payments

Lessee treatment Treated as received in exchange for underlying leased

property Capital gain results if asset leased was a capital asset

(e.g., personal use )Example 19 (page 14)

Ordinary income results if asset leased was an ordinaryasset (e.g., used in lessees business and lease has existed forone year or less when canceled)

Lessor treatment Payments received are ordinary income (rents)

Example 20 (page 14-15)

H ldi P i d



Holding Period

Short-term

Asset held for 1 year or less Long-term

Asset held for morethan 1 year Holding period starts

on the day after the property is acquiredandincludes the day of disposition

01/01/07 to 12/31/07 =>01/02/07 to 12/31/07 01/02/07 to 01/01/08=

1 Year for CG purposes

01/01/07 to 01/02/08 =>01/02/07 to 01/02/08 >1 Year for CG purposes

Examples 21 and 22 (Page 15)



Holding Period

Short sales (Review)

Taxpayer sells borrowed securities and then repays

the lender with substantially identical securities

Gain or loss is not recognized until the short sale is

closed

The holding periodfor a short sale is determined by

how long the property used for repayment is held

Usually Short Term



Tax Treatment of Capital

Gains and Losses

Non-corporate taxpayers (for 2008 year):

Net long-term capital gain is eligible for

one or more of four alternative tax rates:0%/15%,25%, and 28% The 25% rate applies to un-recaptured 1250 gain

and is related to gain from disposition of 1231assets

The 28% rate applies to collectibles

The 0%/15% rates apply to any remainingnet long-term capital gain;0% => 15% or Less Bracket



Tax Treatment of Capital Gains and Losses

Non-corporate taxpayersCapital gains and losses must be netted by holding period

-Short-term capital gains and losses are netted (NSTCG/L)

-Long-term capital gains and losses are netted (NLTCG/L)

If possible, long-term gains or losses are thennetted with short-term gains or losses

If the result is a loss: The capital loss deduction is limited to a maximum deduction of

$3,000

Unused amounts retain their character and

carry-forward indefinitely as NLTCL or NSTCL

Problems: 59, 62, 63, 64, 65 & 66 (pages 58-59)

-What is taxpayers AGI




Gains and Losses (slide 6 of 7)

When there are both short and long-termcapital gains and losses, a complicated ordering

procedure (NETTING)is required because the

long-term capital gains may be taxed at various

rates.

Examples 33, 34, and 35 (Pages 21 -22)




Gains and Losses (slide 6 of 7)

STCL Carries Forward as STCL -35%

LTCL Carries Forward as LTCL -28%

Example 36 (page 23)



Tax Treatment of Capital Gains and Losses

Corporate taxpayers (LO. 6Page 28)

Differences in corporate capital treatment

There is a NCG alternative tax rate of 35 %

Since the max corporate tax rate is 35 %,

the alternative tax is not beneficial

Capital losses can only offset capital gains

(i.e., no $3,000 deduction in excess of capital gains)

Net capital losses are carried back 3 years andcarried forward 5 years as short-term losses

Problem 67 (page 59)

1231 A t


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1231 Assets

1231 assets defined:Depreciableand real property

usedin a business or for production of income

and held greater than 1 year

Land (1231) -Pure 1231 Ppty.

Equipment (1245) -Depreciable Ppty.

Real Estate -Buildings (1250) -Depreciable Ppty.

Also include:Timber, coal, iron, livestock, un-harvested crops

Certain purchased intangibles: Football Player Contract


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1231 Assets

1231 property does not include the following: Property not held for the long-term holding period

Non-personal use property where casualty losses

exceed casualty gains for the taxable year

Inventory and property held primarily for saletocustomers

Copyrights, literary, musical, or artistic

compositions and certain U.S. governmentpublications

Accounts receivable and notes receivablearising inthe ordinary course of a trade or business


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1231 Assets

If transactions involving 1231 assets result in:Net1231 loss= Ordinary loss

Net1231 gain= Long-term capital gain

Net1231 loss => 1231 loss - 1231 gain

Net1231 gain => 1231 gain1231 loss

Provides the best of potential results for the taxpayer

Ordinary lossthat is fully deductibleFORAGI

Gains subject to the lower capital gainstax rates


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Look-back Provision For

Net 1231 Gain

There would be an advantage to haveall 1231 losses (ordinary losses) in adifferent year from gains (long-term capital

gains)

To control manipulation,net1231 gains are treated as ordinary

income to the extent that the taxpayer hasnon-recaptured net 1231 losses in the prior5 year period


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1231 Netting Procedure(slide 2 of 2)

Look-back Provision:

Net 1231 gain is offset against

non-recaptured net 1231 losses

from 5 prior tax years

Gain offset by look-back

losses is ordinary gain

Remaining gain

is LTCG

Net Gain


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Look-back Provision Example

Taxpayer had the following 1231 gains andlosses:

2004 $ 4,000 loss

2005 10,000 loss

=> 2006 16,000 gain

In 2006, taxpayers net 1231 gain of $16,000 will

be treated as:

-$14,000 of Ordinary Income and-$2,000 of 1231 Gain(long-term capital gain)

Depreciation Recapture


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Assets subject to depreciation or cost recovery

are subject to depreciation recapturewhen disposed of at a GAIN

Losses on depreciable assets receive 1231 loss treatment

= Ordinary Loss (after NETTING with 1231 Gains)

NO recapture occurs in loss situations!!

Examples:

Cost=$100 & A/D=$20; =>A/B=80; Sold@ $60=> Loss 20 => 1231 Loss=> Not subject to Recapture

Cost= 100 & A/D= 60; =>A/B=40; Sold@ 120

=>Gain $80 =$60 (Depreciation Recapture Gain) + $20 Excess gain


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(slide 2 of 3)

Depreciation recapture characterizes

gainsthat would otherwise be capital or

1231 as ordinary incomeThe Code contains two major recapture

provisions

1245: Equipments

1250: Buildings


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Depreciation recapture provisions

generally override all other Code

SectionsThere are exceptions to depreciation recapture

rules, for example:

In dispositions where all gain is not recognized

e.g., like-kind exchanges, involuntary conversions

Where gain is not recognized at all

e.g., gifts and inheritances


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1245 Recapture (Equipment & ..)

Depreciation recapture for 1245 propertyApplies to tangible and intangible personal

property (personalty), and

non-residential realty using acceleratedmethods of ACRS(placed in service 1981-86)

Recapture potential is entire amount of

accumulated depreciation for asset

Method of depreciation does not matter

Examples 54, 55, 56, 57 & 58 (Pages 37-39)

Problems 72, 73, 74, 76, 80 & 81 (Pages 60-62)


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1245 Recapture

When gain on the disposition of a 1245 assetis less than the total amount of accumulated

depreciation:

- The total gain will be treated as depreciation

recapture (i.e., ordinary income)

When the gain on the disposition of a 1245

asset is greater than the total amount of

accumulated depreciation: Total accumulated depreciation will be recaptured

as ordinary income, and

The gain in excess of depreciation recapture will be

1231 gain or capital gain


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1250 Recapture

Depreciation recapture for 1250 property

Applies to depreciable real property

Exception:Non-residential realty classified as1245 property (i.e., placed in service after 1980

and before 1987, and accelerated depreciation used)

1250 Recapture


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1250 Recapture

Depreciation recapture (Ordinary Gain

Potential) for 1250 property:

Recapture potential(OG Potential) is limited

to:

Excess of accelerated depreciationtaken onasset overstraight-line depreciation (if

straight-line depreciation had been used).

=>ACRS Dep. in excess of MACRS Dep.=>Assets placed in service before 1987.

Example 59 (Page 41)


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1250 Recapture

Straight-line depreciationon real property

If straight-line depreciation has been taken on

real property, no depreciation recapturepotential (OG Potential) exists under 1250

All real property acquired after 1986

must use straight-line depreciation

Therefore, no depreciation recapture potential

for such property

Therefore, no ORDINARY GAI N potential.


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Real Estate 25% Gain

Straight-line depreciationon real propertyAlso called un-recaptured 1250gainor 25% gain

- Maximum amount of 25% gain is:

SL depreciation taken on real propertysold at a recognized gain.

- Problems 75, 78(a), and 85


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Comprehensi e Vol me

Real Estate 25% Gain

Limited to recognized gain when total gain

is less than or equal to depreciation taken

True for Depreciable RE Placed in service

after 1986.

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Ch14 Property tax