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LexisNexis Tax Advisor -- Federal Topical § 1J:2.06 (Copy w/ Cite)
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LexisNexis Tax Advisor -- Federal Topical § 1J:2.06
LexisNexis Tax Advisor -- Federal Topical
Copyright 2009, Matthew Bender & Company, Inc., a member of the
LexisNexis Group
Part 1. Computing Federal Income Tax
Vol. 1J Securities Transactions
CHAPTER 1J:2 Capital Gains and Losses **
LexisNexis Tax Advisor -- Federal Topical § 1J:2.06 § 1J:2.06
Computing Capital Gains and Losses [1] Definitions [a] Net
Long-Term Capital Gain or Loss. IRC Section 1222(7) defines "net
long-term capital gain" as the excess of long-term capital gains
realized in the taxable year over long-term capital losses for the
same year. Thus, if total long-term gains for a taxable year
amounted to $10,000 and total long-term losses to $5,000, the net
long-term gain for the year would be $5,000. Conversely, if the
amount of gain and loss were reversed, the taxpayer would realize a
net long-term capital loss of $5,000.1 [b] Net Short-Term Capital
Gain or Loss. Net short-term capital gains and losses are
determined in the same fashion as those which are long-term, that
is, net short- term gain is the excess of short-term gains over
short-term losses,2 and net short-term loss, the excess of such
losses over such gains.3 [c] Net Capital Gain and Net Capital Loss.
A taxpayer is deemed to have a net capital gain in any year in
which the taxpayer's net long-term capital gain exceeds the
taxpayer's net short-term capital loss.4 The taxpayer has a net
capital loss whenever the losses for the year (long- and short-term
taken together) exceed the amount allowed as a loss deduction under
IRC Section 1211.5 (If the taxpayer is a corporation, the amount of
any loss carried back or forward to the year in question is
excluded from the computation of net
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capital loss.)6 [2] The Noncorporate Taxpayer [a] Treatment of
Capital Gains [i] In General. Prior to the Tax Reform Act of 1986,
the preferential treatment for taxpayers other than corporations
was derived from the deduction from gross income of 60 percent of
the net capital gain of the taxable year.7 The Act repealed the
special treatment, subjecting net capital gains to the same rates
as ordinary income. The increase in tax rates brought about by the
Omnibus Budget Reconciliation Acts of 1990 and 1993 returned
preferential treatment for long-term capital gains to the Code, but
did so by capping the rate of tax imposed on such gains at 28
percent.8 The Taxpayer Relief Act of 1997 placed different and
additional caps on the tax imposed on net capital gains, the
differences depending on the holding period and type of asset. The
Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced the
rates even further for taxable years prior to January 1, 2009.9 The
rates prescribed by that legislation for taxable years ending after
May 5, 2003 are-:10
Rate (%) Application
5
Gain from the sale of assets held more than 12 months (adjusted net
capital gain), if the taxpayer's regular rate of tax is 15 percent
or less.11 Adjusted net capital gain does not include collectibles
gain, unrecaptured Section 1250 gain, or Section 1202 gain.12 The
rate is reduced to zero for taxable years beginning after
2007.
10
Collectibles gain, Section 1202 gain, and unrecaptured Section 1250
gain realized by a taxpayer whose regular rate of tax is 10
percent.
15
Adjusted net capital gain realized by a taxpayer whose regular rate
of tax is greater than 15 percent.13 The rate also applies to
collectibles gain, Section 1202 gain, and unrecaptured Section 1250
gain realized by a person whose regular rate of tax is 15
percent.
25
Unrecaptured Section 1250 gain (gain to the extent of prior
depreciation deductions realized on the sale of depreciable real
property held for more than 12 months), if the taxpayer's regular
rate of tax is greater than 25 percent.14
The creation of various categories of net capital gain requires a
special sequence of netting of capital gains and losses.15
Short-term capital losses (including short-term capital loss
carryovers) are applied, first, to reduce short-term capital gains.
If there is a resulting net short-term capital loss, it is applied
to reduce any net long-term capital gain from the 28-percent group,
then to reduce gain from the 25-percent group, and, finally, to
reduce net gain from the 15-percent group (5 percent for gain that
would otherwise be taxed at 10 or 15 percent). The netting of
long-term capital gains and losses calls for a net loss from the
28-percent group (including long-term capital loss carryovers) to
be used, first, to reduce gain from the 25-percent group, and then
to reduce gain from the 15-percent group. A net loss from the
15-percent group first reduces net gain from the 28-percent group
and, then, net gain from the 25-percent group. The regulations
provide for the treatment of look-through capital gain that arises
from the sale or exchange of an interest in a partnership, S
corporation or nongrantor trust held for more than one year.
Look-through capital gain is the share of collectibles gain
allocable to an interest in a partnership, S corporation, or trust,
plus the share of Section 1250 capital gain allocable to an
interest in a partnership.16 The share of collectibles gain taken
into account is the amount of net gain that would be allocated to
the partner, shareholder, or beneficiary if the partnership,
corporation, or trust transferred all of its collectibles for cash
equal to the fair market value of the assets in a fully taxable
transaction immediately before the transfer of the interest; a
similar rule applies to Section 1250 capital gain.17 Any capital
gain remaining after accounting for look-
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through capital gain is treated in the normal way by the partner,
shareholder, or beneficiary.18 For years beginning after 2002 and
ending before 2010, net capital gain is increased by the amount of
qualified dividend income, namely, dividends received from domestic
corporations and qualified foreign corporations.19 Tax years from
2008 through 2010 will be subject to various temporary and
transitional rules. Taxation of long-term capital gains from sales
or exchanges of securities during these years will be based on
three principles: First, the basic tax rate for long-term capital
gain and qualified dividend income will be 15 percent. This is the
rate that will apply to ordinary sales of securities, that is,
sales which are not affected by recapture, special capital gains
rates for collectibles, etc. Second, if the taxpayer’s income would
otherwise be taxed at the 10 or 15 percent tax bracket, then a zero
percent capital gains rate will apply.
Example: In the year 2008, for a married couple filing jointly, the
25 percent marginal bracket starts with taxable income of $65,100.
If a couple has $70,000 of taxable income, $10,000 of which is
attributable to long-term capital gains, then we look at the
marginal bracket that the $10,000 would be in. Thus, hypothetically
applying regular rates, $5,100 of that long-term capital gain would
be taxed at 15 percent, and $4,900 would be taxed at 25 percent.
The $4,900 is subject to the basic long-term capitals gains rate of
15 percent, and the $5,100 is not subject to taxes at all. After
calculating the 15 percent tax on $4,900, that product is adding to
the tax at the regular rates that would apply to the remaining
$60,000 of taxable income. If that same couple had $65,100 or less
of taxable income, including long-term capital gains, then there
would be no tax at all on their long-term capital gains and only
their other income would be taxable.
Third, the scope of the so-called “kiddie tax,” an ever-present
consideration when calculating tax liability on investment income,
has been expanded in recent years. In the Small Business and Work
Opportunity Act of 2007 (the “2007 Small Business Act”),20 there
were several changes made to the scope of individuals covered by
the kiddie tax, that is individuals whose investment income over an
amount exempt from the kiddie tax ($1,800 in 2008) would be taxed
at the parent’s marginal bracket:
(1) Prior law enacted in 2006 applied the kiddie tax to individuals
who had not attained age 18 at the end of the year. The 2007 Small
Business Act extended the kiddie tax to cover individuals who had
not attained age 19 at the end of the year.
(2) The 2007 Small Business Act further applied the kiddie tax to
an individual who had not attained age 24 at the end of the year if
he or she is a full-time student for at least five months of the
year, and the individual’s earned income (salary and net income
from self-employment) is not more than half of his or her support
for the year.
These expanded rules are applicable to tax years after enactment
date May 25, 2007, which means for individuals on a calendar year
they are first effective with calendar year 2008. Based on tax law
in effect as of the end of 2008, the foregoing will determine how
qualified dividends and long-term capital gains from sales and
exchanges of securities will be taxed in the years 2008 to 2010.
Although the tax law is scheduled to return to its pre-2001 state
after 2010, the likelihood is that some intervening legislation
will be enacted that will continue the lower rates, although
perhaps in some modified form. Excluded for the definition of
qualified dividend is any dividend received from a tax-exempt
corporation, any amount allowed as a deduction for dividends paid
by mutual savings banks, and any amount allowed as a deduction for
dividends paid on employer securities to pension plan
participants.21 Also excluded is any dividend on a share of stock
(i) with respect to which the holding period requirements of IRC
Section 246(c) are not met, substituting "60 days" for "45 days"
each time it appears and "121-day period" for "91-day period," or
(ii) to the extent that the taxpayer is under an obligation
(whether pursuant to a short sale or otherwise) to make related
payments with respect to positions in substantially similar or
related property.22 A qualified foreign corporation is defined as
any corporation incorporated in a possession of the United States,
or any corporation that is eligible for benefits of a comprehensive
income tax treaty with the United States that the Secretary of the
Treasury determines is satisfactory for purposes of the definition
of a qualified foreign corporation and that includes an exchange of
information program.23 A foreign corporation can be treated as a
qualified corporation if the stock with respect to which the
dividend is paid is readily tradable on an established securities
market in the United States.24 A corporation cannot be a qualified
foreign corporation if, in the year the dividend is paid, the
corporation is a foreign personal holding company, a foreign
investment company, or a passive foreign investment
company.25
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Three special rules apply. Qualified dividend income does not
include any amount taken into account as investment income under
IRC Section 163(d)(4)(B).26 If a taxpayer receives, with respect to
a share of stock, qualified dividend income from one or more
dividends that are extraordinary dividends (within the meaning of
IRC Section 1059(c)), any loss on a sale or exchange of the share
is treated as long-term capital loss to the extent of the
dividends.27 Any dividend received from a regulated investment
company or real estate investment trust is subject to the
limitations prescribed in IRC Sections 854 and 857.28 [ii] Gain on
Sale or Exchange of Qualified Small Business Stock. IRC Section
1202(a)(1), added by the Omnibus Budget Reconciliation Act of 1993,
provides a noncorporate taxpayer with an exclusion from gross
income of 50 percent of any gain from the sale or exchange of
qualified small business stock held for more than five years.29
However, if the taxpayer has such gain ("eligible gain") for a
taxable year from one or more dispositions of stock issued by any
corporation, the aggregate amount of eligible gain from
dispositions of qualified small business stock of that corporation
in the taxable year cannot exceed the greater of (a) $10 million
($5 million in the case of a separate return by a married
individual)30 reduced by the amount of eligible gain excluded from
gross income for prior taxable years and attributable to
dispositions of stock issued by the corporation, or (b) ten times
the aggregate adjusted bases of qualified small business stock
issued by the corporation and disposed of by the taxpayer during
the taxable year.31 Stock is qualified small business stock
if:
(1) it is originally issued by a C corporation after August 10,
1993;
(2) the corporation is a qualified small business; and
(3) the stock is acquired by the taxpayer at its original issue
(directly or through an underwriter) either in exchange for money
or other property (not including stock), or as compensation for
services provided to the issuing corporation, other than as an
underwriter of the stock.32
Stock acquired by the taxpayer is not treated as qualified small
business stock if, in one or more purchases during the four- year
period beginning on the date two years before the issuance of the
stock, the issuing corporation purchased (directly or indirectly)
more than a de minimis amount of its stock from the taxpayer or a
person related to the taxpayer within the meaning of IRC Section
267(b) or 707(b).33 Stock issued by a corporation is also not
qualified small business stock if, in one or more purchases during
the two-year period beginning on the date one year before the
issuance of the stock, the corporation purchases more than a de
minimis amount of its stock and the purchased stock has an
aggregate value (at the time of the respective purchases) exceeding
5 percent of the aggregate value of its stock as of the beginning
of the two- year period.34 If any transaction is treated as a
distribution in redemption of the stock of the corporation under
IRC Section 304(a), the corporation is treated as if it purchased
an amount of its stock equal to the amount treated as a
distribution under Section 304.35 A transfer of stock to an
employee or independent contractor (or to a beneficiary of an
employee or independent contractor) is not treated as a purchase of
stock by the issuing corporation.36 A stock purchase is disregarded
if the stock is acquired in the following circumstances:
(1) The stock was acquired by the seller in connection with the
performance of services as an employee or director and the stock is
purchased from the seller incident to the seller's retirement or
other bona fide termination of such services;
(2) Prior to a decedent's death, the stock (or an option to acquire
the stock) was held by the decedent or the decedent's spouse (or by
both), by the decedent and a joint tenant, or by a trust revocable
by the decedent or the decedent's spouse (or both), and, within
three years and nine months from the date of the decedent's death,
the stock is purchased from the decedent's estate, beneficiary,
heir, surviving joint tenant, surviving spouse, or from a trust
established by the decedent or decedent's spouse;
(3) The stock is purchased incident to the disability or mental
incompetence of the selling shareholder; or
(4) The stock is purchased incident to the divorce of the selling
shareholder.37
For purposes of IRC Section 1202, any domestic C corporation can be
a qualified small business if:
(1) the aggregate gross assets of the corporation (or any
predecessor) at all times on or after August 10, 1993, and before
issuance of the stock, did not exceed $50 million;
(2) the aggregate gross assets of the corporation immediately after
the issuance (determined by taking into account
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amounts received in the issuance) do not exceed $50 million; and
(3)
the corporation agrees to submit such reports to the Service and to
shareholders as the Service may require to carry out the purposes
of IRC Section 1202.38
All corporations that are members of the same parent-subsidiary
controlled group are treated as one corporation for this purpose.39
Stock will not be treated as qualified small business stock unless,
during substantially all of the taxpayer's holding period for the
stock, at least 80 percent (by value) of the assets of the
corporation are used by it in the active conduct of one or more
qualified trades or businesses, and the corporation is not:
(1) a domestic international sales corporation (DISC) or former
DISC;
(2) a corporation with respect to which an election under IRC
Section 936 is in effect or that has a direct or indirect
subsidiary with respect to which such an election is in
effect;
(3) a regulated investment company (RIC), real estate investment
trust (REIT), or real estate mortgage investment conduit (REMIC);
or
(4) a cooperative.40
For this purpose, a qualified trade or business is any trade or
business other than:
(1) trade or business involving the performance of services in the
fields of health, law, engineering, architecture, accounting,
actuarial science, performing arts, consulting, athletics,
financial services, or any trade or business where the principal
asset is the reputation or skill of one or more of its
employees;
(2) any banking, insurance, financing, leasing, investing, or
similar business;
(3) any farming business (including the business of raising or
harvesting trees);
(4) any business involving the production or extraction of products
of a character with respect to which a deduction for depletion is
allowable under IRC Section 613 or 613A; or
(5) any business of operating a hotel, motel, restaurant or similar
business.41
A corporation will fail the active business requirement for any
period during which more than 10 percent of the value of its net
assets consists of stock or securities in other corporations that
are not subsidiaries; a special exception is provided for assets
held as part of the working capital of the corporation.42 It will
fail the requirement for any period during which more than 10
percent of the total value of its assets consists of real property
that is not used in the active conduct of a qualified trade or
business.43 On the other hand, the active business requirement is
automatically met for any period during which the corporation
qualifies as a specialized small business investment company that
is licensed to operate under Section 3(d) of the Small Business
Investment Act of 1958 (as in effect on May 13, 1993).44 IRC
Section 1202(g) governs the treatment of the holder of an interest
in a pass-through entity (partnership, S corporation, regulated
investment company, or common trust fund) that sells or exchanges
qualified small business stock. First, in determining whether the
stock qualifies as qualified small business stock, the entity is
treated as an individual and must have held the stock for more than
five years.45 Second, the taxpayer must have held the interest in
the pass-through entity at the time it acquired the stock and at
all times thereafter until the disposition of the stock by the
entity.46 Third, the amount excludable by the taxpayer is limited
to the interest held by the taxpayer in the pass-through entity at
the time the qualified small business stock was acquired.47
Pursuant to IRC Section 1202(j), a taxpayer with an offsetting
short position with respect to any qualified small business stock
is not permitted to take advantage of the exclusion provided by IRC
Section 1202(a) unless the stock was held by the taxpayer for more
than five years as of the first day on which there was a short
position, and the taxpayer elects to recognize gain as if the stock
were sold on that day at its fair market value. The taxpayer is
deemed to have an offsetting short position with respect to any
qualified small business stock if:
(1) the taxpayer has made a short sale of substantially identical
property;
(2) the taxpayer has acquired an option to sell substantially
identical property at a fixed price; or
(3) to the extent provided in regulations, the taxpayer has entered
into any other transaction that substantially
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reduces the risk of loss from holding the qualified small business
stock.48
Two other consequences derive from the sale of qualified small
business stock come within the ambit of IRC Section 1202. The first
is that 42 percent of the excluded gain is treated as an item of
tax preference for minimum tax purposes.49 The second imposes a
penalty for failure to file any report required under IRC Section
1202.50 A second provision, IRC Section 1045(a) permits a
noncorporate taxpayer to elect to roll over tax-free gain from the
sale or exchange of qualified small business stock held for more
than six months if the taxpayer uses the proceeds of sale to
purchase other qualified small business stock within 60 days of the
sale.51 Thus, gain from the sale is recognized only if the amount
realized on the sale exceeds the cost of the new stock. Generally,
the holding period of the stock purchased will include the holding
period of the stock sold, except for determining whether the
six-month holding period is met.52 A partnership that sells
qualified small business stock held for more than six months and
purchases replacement qualified small business stock can elect to
roll over the gain under IRC Section 1045.53 An eligible partner of
a partnership that sells qualified small business stock can make
the election if the partner purchases replacement qualified small
business stock directly or through a partnership in which the
taxpayer is a partner (directly or through an upper-tier
partnership).54 A taxpayer (other than a C corporation) that sells
qualified small business stock and elects to roll over the gain can
satisfy the replacement qualified small business stock requirement
with qualified small business stock that is purchased within the
60- day period by a partnership in which the taxpayer is a partner
on the day the replacement stock is purchased.55 A partnership that
holds qualified small business stock for more than six months,
sells the stock and purchases replacement stock can make an
election under IRC Section 1045.56 If the partnership makes the
election, each partner does not recognize its distributive share of
Section 1045 gain unless the partner opts out of the election.57
Partnership Section 1045 gain equals the partnership’s gain from
the sale of the stock reduced by the greater of (i) the amount of
gain from the sale of the stock treated as ordinary income, or (ii)
the excess of the amount realized by the partnership on the sale
over the total cost of all replacement qualified small business
stock purchased by the partnership (excluding the cost of any
replacement stock purchased by the partnership that is otherwise
taken into account under IRC Section 1045).58 A partner’s
distributive share of partnership Section 1045 gain must be in the
same proportion as the partner’s share of the partnership’s gain
from the sale of the qualified small business stock.59 The quid pro
quo for nonrecognition is a basis adjustment. The amount of gain
not recognized is applied to reduce the basis of any qualified
small business stock acquired during the 60-day period.60 The
election under IRC Section 1045 must be made on or before the later
of December 31, 1998, or the due date (including extensions) for
filing the income tax return for the taxable year in which the
qualified small business stock is sold.61 The election is made
by:
(1) reporting the entire gain from the sale of qualified small
business stock on Schedule D of the taxpayer's return;
(2) writing "section 1045 rollover" directly below the line on
which the gain is reported; and
(3) entering the amount of deferred gain on the same line as (2) as
a loss.
The election is revocable only with the prior written consent of
the Commissioner. [iii] Gain on Sale or Exchange of DC Zone Asset.
A belief that one of the major problems faced by the District of
Columbia was insufficient economic activity led Congress to
provide, among other things, for a zero percent rate for qualified
capital gain from the sale or exchange of any DC Zone asset held
for more than five years.62 Qualified capital gain is defined as
any gain recognized on the sale or exchange of a capital asset or
property used in the trade or business (as defined in IRC Section
1231(b)).63 It does not include any gain
(1) attributable to periods before January 1, 1998, or after
December 31, 2007;
(2) that would be treated as ordinary income under IRC Section 1245
or under IRC Section 1250 if that provision applied to all
depreciation rather than additional depreciation;
(3) that is attributable to real property, or an intangible asset,
that is not an integral part of a DC Zone business; or
(4) attributable, directly or indirectly, in whole or in part, to a
transaction with a related person.64
A DC Zone asset can be any DC Zone business stock, any DC Zone
partnership interest, or any DC Zone business property.65 DC Zone
business stock is defined as any stock in a domestic corporation
that is originally issued after December 31, 1997, if:
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(1) the stock is acquired by the taxpayer before January 1, 2003,
at its original issue (directly or through an underwriter) solely
in exchange for cash;
(2) as of the time the stock was issued, the corporation was a DC
Zone corporation (or, in the case of a new corporation, the
corporation was being organized for purposes of being a DC Zone
business); and
(3) during substantially all of the taxpayer's holding period for
the stock the corporation qualified as a DC Zone business.66
A rule similar to IRC Section 1202(c)(3), discussed in §
1J:2.06[2][a][ii], applies for purposes of the rules relating to DC
Zone business stock.67 A DC Zone partnership interest is defined as
any capital or profits interest in a domestic partnership that is
originally issued after December 31, 1997, if:
(1) the interest was acquired by the taxpayer before January 1,
2003, from the partnership solely in exchange for cash;
(2) as of the time the interest was acquired, the partnership was a
DC Zone business (or, in the case of a new partnership, the
partnership was being organized for purposes of being a DC Zone
business); and
(3) during substantially all of the taxpayer's holding period for
the interest, the partnership qualified as a DC Zone
business.68
DC Zone property is tangible property if:
(1) the property was acquired by the taxpayer by purchase after
December 31, 1997, and before January 1, 2003;
(2) the original use of the property in the DC Zone begins with the
taxpayer; and
(3) during substantially all of the taxpayer's period for the
property, substantially all of the use of the property was in a DC
Zone business of the taxpayer.69
The first two requirements are treated as met with respect to
property that is substantially improved by the taxpayer before
January 1, 2003, and any land on which the property is located.70
Any DC Zone business stock, DC Zone partnership interest, or DC
Zone property acquired on or after January 1, 2003, will be treated
as a DC Zone asset if it was such in the hands of a prior holder.71
If any asset ceases to be DC Zone business stock, DC Zone
partnership interest, or DC Zone property because the corporation
or partnership no longer qualifies as a DC Zone business or the
property is no longer used in a DC Zone business, after the
five-year period beginning on the date the taxpayer acquired the
asset, the asset will continue to be treated as a DC Zone asset,
except that the amount of capital gain excluded from income will be
limited to the amount that would be qualified capital gain if the
property had been sold on the date of cessation.72 A DC Zone
business means any entity that is an enterprise zone business (as
defined in IRC Section 1397C), determined
(1) without regard to the requirement that at least 35 percent of
the business's employees must be residents of an empowerment
zone;
(2) by requiring that at least 80 percent of a qualified business
entity's total gross income be derived from the active conduct of a
trade or business; and
(3) by treating no area other than the DC Zone as an empowerment
zone or enterprise zone.73
[iv] Renewal Community Capital Gain. Pursuant to IRC Section
1400F(a), gross income does not include any qualified capital gain
from the sale or exchange of a qualified community asset held for
more than five years. Qualified capital gain is any gain recognized
on the sale or exchange of a capital asset, or property used in a
trade or business (as defined in IRC Section 1231(b)), provided the
gain is attributable to the period beginning after January 1, 2002
and ending December 31, 2014.74 A qualified community asset is any
qualified community stock, any qualified community partnership
interest, or any qualified
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community business property.75 Qualified community stock is any
stock of a domestic corporation if (i) the stock is acquired by the
taxpayer after December 31, 2001, and before January 1, 2010, at
its original issue (directly or through an underwriter) from the
corporation solely in exchange for cash, (ii) as of the time the
stock was issued, the corporation was a renewal community business
(or, in the case of a new corporation, was being organized for
purposes of being a renewal community business), and (iii) during
substantially all of the taxpayer's holding period for the stock,
the corporation qualified as a renewal community business.76 A
qualified community partnership interest is any capital or profits
interest in a domestic partnership that meets the same time and
business requirements that are imposed for qualified community
stock.77 Qualified community business property consists of tangible
property if (a) the property was acquired by the taxpayer by
purchase after December 31, 2001, and before January 1, 2010, (b)
the original use of the property in the renewal community begins
with the taxpayer, and (c) during substantially all of the
taxpayer's holding period for the property, substantially all of
the use of the property was in a renewal community business of the
taxpayer.78 Property that is substantially improved by the taxpayer
before January 10, 2010, and any land on which such property is
located also can be treated as qualified community business
property.79 [v] Gain on Rollover of Empowerment Zone Investments.
IRC Section 1397B(a) provides that, at the election of the
taxpayer, any gain realized on the sale of a qualified empowerment
zone asset held by the taxpayer for more than one year will be
recognized only to the extent that the amount realized exceeds (1)
the cost of any qualified empowerment zone asset (with respect to
the same zone as the asset sold) purchased by the taxpayer during
the 60-day period beginning on the date of the sale, reduced by (2)
any portion of that cost previously taken into account under the
provision.80 The consideration exacted for nonrecognition is a
corresponding reduction in the basis for determining gain or loss
of any qualified empowerment zone asset that is purchased by the
taxpayer during the 60-day period mentioned in the preceding
sentence.81 Nonrecognition does not extend to (a) any gain that is
treated as ordinary income under the Code, or (b) any gain that is
attributable to real property, or to an intangible asset that is
not an integral part of an enterprise zone business.82 The term
"qualified empowerment zone asset" means any property that would be
a qualified community asset (as defined in IRC Section 1400F) if in
that section (1) references to empowerment zones were substituted
for references to renewal communities, (2) references to enterprise
zone businesses (as defined in IRC Section 1397C) were substituted
for references to renewal community businesses, and (3) any
reference to December 31, 2001 is changed to December 21, 2000.83
[b] Treatment of Capital Losses. Capital gains, being gains derived
from dealings in property, form part of gross income, unless
nonrecognition of gain is specifically mandated by some provision
of the Code. Therefore, finding that a transaction qualifies for
capital, as opposed to ordinary, treatment has no effect on
includability. The same is true of capital losses. Whether an
individual may deduct losses incurred in dealings in property is
governed solely by IRC Section 165(c). Unless incurred in a trade
or business, or in a transaction for profit, the loss cannot be
deducted even if the "capital" label has been affixed.84 The
ensuing discussion will assume that the threshold question of
deductibility has been resolved in favor of the taxpayer. [i]
Limiting the Deduction. Although both ordinary losses and capital
losses must meet the same criteria for deduction, the extent to
which capital losses are deductible is limited.85 Total deduction
of capital losses is permitted in any year that capital gains
exceed capital losses. For example, if a taxpayer has long-term
gains of $2,000, long-term losses of $3,000, short-term gains of
$4,000 and short-term losses of $2,000, deduction would be allowed
for all of the long-term losses and all of the short-term losses
since total gains ($6,000) are greater than total losses ($5,000).
The fact that the taxpayer has a net long-term capital loss is of
no moment; the amount of the deduction is tested by reference to
aggregate gains and losses. The impact of the limitation is felt
whenever the sum of the capital losses sustained in a tax year is
greater than the aggregate capital gain for the year. In such
event, IRC Section 1211(b)(1) allows a deduction only to the extent
of the gains realized during the year, plus the lower of (1) $3,000
($1,500 in the case of a husband or wife filing a separate return),
or (2) the excess of capital losses over capital gains. [ii]
Capital Loss Carryover. We have just seen that IRC Section
1211(b)(1) limits the amount of capital loss that can be deducted
in the year in which the loss is sustained. Once losses exceed the
deductible amount the taxpayer must find relief in the carryover
provisions of IRC Section 1212(b).86 We may witness the working of
the latter section by considering the taxpayer with taxable income
greater than $3,000 who sustains a short-term loss of $1,500 and a
long-term loss of $10,500 in the taxpayer's only capital
transactions. The
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deduction in the year of loss is limited to $3,000; the carryover
to the first succeeding year consists of $9,000 of long-term
loss.87 If in that year, the taxpayer realizes no capital gains,
the deduction will be limited to $3,000. The carryover to the next
succeeding year will be $6,000, all of which will be deemed a
long-term capital loss. If, in the second carryover year, a capital
gain of $3,000 is realized, the balance of the carryover loss will
be completely deductible. A special carryback rule comes into play
if the taxpayer has a "net Section 1256 contracts loss"88 for the
taxable year and elects to have the provisions of IRC Section
1212(c) apply.89 The amount of such loss is allowed as a carryback
to each of the three taxable years preceding the loss year, to the
extent the amount does not exceed the net Section 1256 contract
gain for such year90 or increase or produce a net operating loss,
with 40 percent of the amount allowed treated as a short- term
capital loss from Section 1256 contracts and the balance as a
long-term capital loss from such contracts.91 A further consequence
is the effect on the loss carryover rules of IRC Section
1212(b)(1). The amounts carried back are treated as short-term and
long-term capital gains in the same percentages as they are carried
back, thereby reducing the amount of the carryover.92 In addition,
any amount carried forward after the carryback retains its
character as a Section 1256 contracts loss.93 [3] The Corporate
Taxpayer [a] Treatment of Capital Gains [i] In General. The
characterization of gain as capital gain is controlled by the same
criteria whether the taxpayer is a corporation or an individual.
However, unlike noncorporate taxpayers, net capital gains realized
by corporations are taxed at the same rate applied to corporate
ordinary income.94 [ii] Gain on Sale or Exchange of DC Zone Asset.
Pursuant to IRC Section 1400B, the gross income of corporate
taxpayers does not include qualified capital gain from the sale or
exchange of a DC Zone asset held for more than five years. See §
1J:2.06[2][a][iii] for a discussion of IRC Section 1400B. [b]
Treatment of Capital Losses [i] Limiting the Deduction. As in the
case of noncorporate taxpayers, the extent to which capital losses
are allowed as a deduction is limited. However, in the case of a
corporation, capital losses are allowed only to the extent of
capital gains, and no part of any excess loss may be offset against
ordinary income.95 The entire excess forms part of the
corporation's capital loss carryover. [ii] Capital Loss Carryover.
Perhaps the only similarity in the manner in which corporations and
noncorporate taxpayers handle capital loss carryovers is in
treating the loss as one sustained in the year to which it is
carried. The first difference is that, if a corporation cannot
fully deduct a long-term capital loss in the year incurred, the
nondeductible portion is treated as a short-term loss when carried
to another year. The second difference concerns the period to which
losses may be carried. The corporate taxpayer that suffers a
capital loss has a carryover period of five years and a capital
loss carryback to each of the three years preceding the loss
year.96 However, if the corporation is a regulated investment
company there is no carryback, but the loss may be carried forward
for a period of eight years.97 Special rules attend the carryback
of a capital loss. It may not be carried back if attributable to a
foreign expropriation loss, or98 if it increases or produces a net
operating loss (as defined in IRC Section 172(c)) for the taxable
year to which the loss is carried back.99100 Furthermore, a loss
may not be carried back to a year for which the taxpayer was a
regulated investment company or a real estate investment trust. The
entire net capital loss for any taxable year must first be carried
to the earliest year to which the loss can be carried. Normally,
this will be the third year preceding the loss year unless
carryback to such year is prohibited by any of the reasons
previously mentioned. If net capital gains101 in the year to which
the loss is first carried are insufficient to absorb the entire
loss, the balance of the loss is carried, in order, to the other
years to which it can be carried, until completely deducted or
until the period limitation bars further deduction. Although the
statute does not specifically provide the order of deduction, it is
assumed that if losses incurred in two years are carried back or
carried forward to the same year, the earlier incurred loss is the
first to be deducted.102 On October 3, 2008, the President signed
into law the Emergency Economic Stabilization Act of 2008.103 This
is the comprehensive legislation generally known for its $700
billion bailout of financial institutions.
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The Act, intended as a multifaceted approach to the financial
crises, consisted of three separately-titled divisions: the
Emergency Economic Stabilization Act of 2008, the Energy
Improvement and Extension Act of 2008, and the Tax Extenders and
Alternative Minimum Tax Relief Act of 2008. Most of the Act is
beyond the scope of this book, however, the tax provisions that are
relevant to this book are mostly contained within the last
division, sometimes referred to as the “Extenders Act” or
“TEAMTRA.” Although most of the tax provisions of the Act are in
the third division, the first division contains some tax provisions
as well. The first division is the bail-out core of this massive
legislation, centering around a “Troubled Assets Relief Program,”
or TARP. Tax provisions of TARP include a special rule regarding
financial institutions (as defined by IRC Section 582(c)(2))
holding preferred stock in the Federal National Mortgage
Association (“Fannie Mae”) or the Federal Home Loan Mortgage
Corporation (“Freddie Mac”).104 The Act permits losses on these to
be treated as ordinary losses rather than as capital losses. This
relief provision generally entitles these corporate preferred
shareholders to deduct loses currently, rather than to carry them
forward, in case there were inadequate capital gains against which
capital losses could be taken (which would likely be the case for
these financial institutions). This relief applies to such stock
which either:
(1) was held by the applicable financial institution on September
6, 2008, or
(2) (was sold or exchanged by the applicable financial institution
on or after January 1, 2008, and before September 7, 2008.
105
The Act authorizes regulations to extend ordinary loss treatment to
preferred stock not owned by the financial institution on September
6, 2008, if:
(1) the financial institution sells or exchanges applicable
preferred stock after September 6, 2008, which the institution did
not hold on such date, but the basis of which in the hands of the
institution at the time of the sale or exchange is the same as the
basis in the hands of the person which held such stock on such
date, or
(2) the financial institution is a partner in a partnership which
either (a) held such stock on September 6, 2008, and later sold or
exchanged such stock, or (b) sold or exchanged such stock after
September 6, 2008.106
This relief provisions applies only to corporations. Noncorporate
taxpayers will continue to be able to deduct these losses only to
the extent of gains (plus $3,000 in the case of individual
taxpayers), with the excess losses carried forward to future years.
FOOTNOTES (**) Written by Martin L. Fried, Crandall Melvin
Professor of Wills and Trusts, Syracuse University, Syracuse, New
York. Chapter excerpted from M. Fried, Taxation of Security
Transactions (LexisNexis Matthew Bender & Co., Inc.). Updated
by Patricia A. Tyler, J.D., LL.M., LexisNexis Federal Tax Analyst.
(1) IRC § 1222(8). (2) IRC § 1222(5). (3) IRC § 1222(6). (4) IRC §
1222(11). (5) IRC § 1222(10). (6) IRC § 1222(10). (7) IRC § 1202
prior to its repeal by the Tax Reform Act of 1986. (8) IRC § 1(h).
Notice 2004-39, 2004-1 CB 982, provides guidance to regulated
investment companies, real estate
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investment trusts, and their shareholders in applying IRC § 1(h) to
capital gain dividends of the entities. (9) Jobs and Growth Tax
Relief Reconciliation Act of 2003, § 303. The rates revert to
pre-2003 rates for taxable years beginning after Dec 31, 2010. (10)
Transitional rules are provided for years that include May 6, 2003.
(11) IRC § 1(h)(1)(B). For years 2003-2010, adjusted net capital
gain is increased by the amount of qualified dividend
income.Adjusted net capital gain must be reduced by the amount of
such gain that the taxpayer elects to treat as investment income
for purposes of IRC § 163(d)(4)(B). (12) IRC § 1(h)(3). Generally,
collectibles gain is gain from the sale of any work of art, any rug
or antique, any metal or gem, any stamp or coin, or any alcoholic
beverage. IRC §§ 1(h)(5)(A), 408(m)(2).Any gain from the sale of an
interest in a partnership, S corporation, or trust that is
attributable to unrealized appreciation in the value of
collectibles is treated as gain from the sale of a collectible. IRC
§ 1(h)(5)(B). Rules similar to the rules of IRC § 751 apply for
this purpose.For stock acquired before Dec 22, 2000, IRC § 1202
gain is an amount equal to the gain excluded from gross income
under IRC § 1202(a). For stock acquired after Dec 21, 2000, IRC §
1202 gain is the excess of (a) the gain that would be excluded from
gross income under IRC § 1202 but for the percentage limitation in
IRC § 1202(a), over (b) the gain excluded from gross income under
IRC § 1202. IRC § 1(h)(7). (13) IRC § 1(h)(1)(C). (14) Regulations
provide that, if capital gain from an installment sale of real
property includes unrecaptured Section 1250 gain taxed at 25
percent as well as capital gain taxed at 15 or 5 percent, the
taxpayer must account for the 25-percent gain before any of the 15-
or 5-percent gain is included in income. Treas Reg §
1.453-12(a).The regulations also provide that Section 1231 gain
from an installment sale that is recharacterized as ordinary income
under either IRC § 1231(a) or IRC § 1231(c) is deemed to consist
first of 25-percent gain and then of 15- or 5-percent gain. (15)
Notice 97-59, 1997-2 CB 309. See Notice 98-20, 1998-1 CB 776, for
use of the netting rules in determining how a charitable remainder
trust characterizes capital gain distributions. 1998-1 CB 776,
Notice 98-20 was modified by Notice 99- 17, 1999-1 CB 871, to
reflect later legislative changes. (16) Treas Reg § 1.1(h)-1(b)(1).
In determining whether a partnership, S corporation, or trust has
gain from collectibles, the partnership, corporation or trust shall
be treated as owning its proportionate share of any partnership, S
corporation, or trust in which it owns an interest directly or
indirectly through a chain of such entities. This tiered-entity
rule also applies with respect to Section 1250 capital gain of a
partnership. Treas Reg § 1.1(h)-1(d). (17) Treas Reg §
1.1(h)-1(b)(2)(ii), (3)(ii). The rules do not apply to a
transaction that is treated, for federal income tax purposes, as a
redemption of an interest in a partnership, S corporation, or
trust. (18) Treas Reg § 1.1(h)-1(c).If less than all of the
realized gain is recognized upon the sale of the interest, the same
methodology applies to determine the collectibles gain recognized
by the transferor, except that the partnership, S corporation, or
trust is treated as transferring only a proportionate amount of
each of its collectibles determined as a fraction that is the
amount of gain recognized in the sale or exchange over the amount
of gain realized in the transaction. Treas Reg §
1.1(h)-1(b)(2)(ii). The same calculation is made when there is
Section 1250 gain and not all of the gain is recognized upon the
sale or exchange of a partnership interest. Treas Reg §
1.1(h)-1(b)(3)(ii). (19) IRC § 1(h)(11)(A), (B)(i). Rules similar
to the rules contained in IRC § 904(b)(2)(B) (capital gain rate
differential) apply in determining any limitation on the foreign
tax credit for dividends received from a foreign corporation. IRC §
1(h)(11)(C) (iv). See § 1J:26.02[4][e][i] for a discussion of IRC §
904(2)(b)(B).The Service has determined that it is appropriate for
a partner of an electing large partnership to take into account
separately the partner's distributive share of the partnership's
dividends received that are qualified dividend income. 2004-1 CB
489, Notice 2004-5. (20) This was a part of the U.S. Troop
Readiness, Veterans' Care, Katrina Recovery, Iraq Accountability
Appropriations Act (Pub L No 110-28, May 25, 2007). (21) IRC §
1(h)(11)(B)(ii). (22) IRC § 1(h)(11)(B)(iii). The rules of IRC §
246(c)(1) can be found in § 1J:5.04[2][a][v]. (23) IRC §
1(h)(11)(C)(i). Notice 2006-101, 2006-47 IRB 930, contains the
current list of US tax treaties that meet this requirement. (24)
IRC § 1(h)(11)(C)(ii). Common or ordinary stock, or an American
depositary receipt in respect of such stock, is considered readily
tradable on an established securities market in the US if it is
listed on a national securities exchange that is registered under §
6 of the Securities Exchange Act of 1934 or on the Nasdaq Stock
Market. As of Sept 30, 2002 registered national exchanges include
the American Stock Exchange, the Boston Stock Exchange, the
Cincinnati Stock
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Exchange, the Chicago Stock Exchange, the New York Stock Exchange,
the Philadelphia Stock Exchange, and the Pacific Exchange,
Inc.Notice 2003-71, 2003-2 CB 922. (25) IRC § 1(h)(11)(C)(iii).
2004-2 C.B. 724, Notice 2004-70, provides guidance regarding the
extent to which distributions, inclusions, and other amounts
received by, or included in the income of, individual shareholders
as ordinary income from controlled foreign corporations, foreign
personal holding companies, foreign investment companies, and
passive foreign investment companies may be treated as qualified
dividend income. (26) IRC § 1(h)(11)(D)(i). (27) IRC §
1(h)(11)(D)(ii). (28) IRC § 1(h)(11)(D)(iii). Regulated investment
companies are the subject of Chapter 1J:15; real estate investment
trusts are the subject of Chapter 1J:17. (29) If qualified small
business stock is acquired after Dec 21, 2000, in a corporation
that is a qualified business entity in an enterprise zone during
substantially all of the taxpayer's holding period for the stock,
the amount of excluded gain increases to 60 percent. IRC §
1202(a)(2)(A). The provision does not apply to gain attributable to
periods after Dec 31, 2014. IRC § 1202(a)(2)(C).The District of
Columbia Enterprise Zone is not treated as an empowerment zone for
purposes of IRC § 1202 (a)(2). IRC § 1202(a)(2)(D). (30) IRC §
1202(b)(3)(A). The limitation is applied on a
shareholder-by-shareholder basis. HR Rep No 213, 103d Cong, 1st
Sess 13 (1993). (31) IRC § 1202(b)(1). The adjusted basis of any
stock is determined without regard to any addition to basis after
the date on which the stock was originally issued. Contributed
property is valued at its fair market value on the date of
contribution. HR Rep No 213, 103d Cong, 1st Sess 13-14 (1993).In
the case of a joint return, the amount of excludable gain is
allocated equally between the spouses for purposes of applying the
limitation in subsequent taxable years. IRC § 1202(b)(3)(B). (32)
IRC § 1202(c)(1). If property other than money or stock is
exchanged for stock, the basis of the acquired stock cannot be less
than the fair market value of the property exchanged. IRC §
1202(i)(1)(B). If the adjusted basis of any qualified small basis
stock is adjusted by reason of a contribution to capital after the
date on which the stock was originally issued, in determining the
amount of the adjustment the basis of the contributed property is
treated as not less than its fair market value on the date of
contribution. IRC § 1202(i)(2).Stock in a corporation acquired on
the conversion of other stock in the corporation that is qualified
small business stock in the hands of the taxpayer is treated as
qualified small business stock held during the period that the
converted stock was held. IRC § 1202(f)(2). Qualified small
business stock acquired by gift, at death, or from a partnership by
a partner will also be considered qualified small business stock in
the hands of the transferee. IRC § 1202(h)(1), (2). The same holds
true for incorporating transfers governed by IRC § 351 or
reorganizations defined in IRC § 368, but only to the extent of the
gain that would have been realized had the transfer been deemed
taxable. The latter limitation does not apply if the issuing
corporation is a qualified small business corporation at the time
of the transfer. IRC § 1202(h)(4). (33) IRC § 1202(c)(3)(A); Treas
Reg § 1.1202-2(a)(1). For this purpose, stock acquired from the
taxpayer or a related person exceeds a de minimis amount if the
aggregate amount paid for the stock exceeds $10,000 and more than 2
percent of the stock held by the taxpayer is acquired. In
ascertaining whether the 2-percent limit is exceeded, the
percentage of stock acquired in any single purchase is determined
by dividing the stock's value (as of the time of purchase) by the
value (as of the time of purchase) of all stock held, directly or
indirectly, by the taxpayer and related persons immediately before
the purchase. The percentage of stock acquired in multiple
purchases is the sum of the percentages determined for each
separate purchase. Treas Reg § 1.1202-2(a)(2). (34) IRC §
1202(c)(3)(B); Treas Reg § 1.1202-2(b)(1). Stock exceeds a de
minimis amount only if the aggregate amount paid for the stock
exceeds $10,000 and more than 2 percent of all outstanding stock is
purchased. In ascertaining whether the 2-percent limit is exceeded,
the percentage of stock acquired in any single purchase is
determined by dividing the stock's value (as of the time of
purchase) by the value (as of the time of purchase) of all stock
outstanding immediately before the purchase. The percentage of
stock acquired in multiple purchases is the sum of the percentages
determined for each separate purchase. Treas Reg § 1.1202-2(b)(2).
(35) IRC § 1202(c)(3)(C). (36) Treas Reg § 1.1202-2(c). (37) Treas
Reg § 1.1202-2(d). (38) IRC § 1202(d)(1). The term "aggregate gross
assets" means the amount of cash and the aggregate adjusted bases
of other property held by the corporation. IRC § 1202(d)(2)(A). The
adjusted basis of any property contributed to the corporation (or
other property with a basis determined in whole or in part by
reference to the adjusted basis of the property
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so contributed) is determined as if the basis of the property
immediately after the contribution were its fair market value at
that time. IRC § 1202(d)(2)(B). (39) IRC § 1202(d)(3)(A). The term
"parent-subsidiary controlled group" means any controlled group of
corporations as defined in IRC § 1563(a)(1), except that the
required ownership level is reduced from 80 percent to 50 percent.
IRC § 1202 (d)(3)(B). (40) IRC §§ 1202(c)(2)(A), 1202(e)(1), (4). A
parent is deemed to own its ratable share of the assets and conduct
its ratable share of the business of any subsidiary in which it
owns at least 50 percent of all classes of stock entitled to vote
or 50 percent in value of all of the outstanding stock of the
subsidiary corporation. IRC § 1202(e)(5)(A), (C). If in connection
with any future qualified trade or business, a corporation is
engaged in start-up activities described in IRC § 195(c)(1)(A),
activities resulting in the payment or incurring of expenditures
that can be treated as research and experimental expenditures under
IRC § 174, or activities with respect to in-house research expenses
described in IRC § 41(b)(4), then assets used in such activities
are treated as used in the active conduct of a trade or business.
IRC § 1202(e)(2). (41) IRC § 1202(e)(3). (42) IRC § 1202(e)(5)(B).
Assets are categorized as working capital if held as part of the
reasonably required working capital needs of a qualified trade or
business, or held for investment and reasonably expected to be used
within two years to finance research and experimentation or
increases in the working capital needs of a qualified trade or
business. IRC § 1202 (e)(6). (43) IRC § 1202(e)(7). (44) IRC §
1202(c)(2)(B). (45) IRC § 1202(g)(2)(A). (46) IRC § 1202(g)(2)(B).
(47) IRC § 1202(g)(3). In applying the per-issuer limitation of IRC
§ 1202(b), the taxpayer's proportionate share of the adjusted basis
of the pass-through entity in the stock is taken into account. (48)
IRC § 1202(j)(2). A taxpayer is treated as holding an offsetting
short position with respect to qualified small business stock if
such a position is held by any person related to the taxpayer
within the meaning of IRC § 267(b) or 707(b). IRC § 1202(j)(2).
(49) IRC § 57(a)(7). For taxable years ending before May 6, 1997,
50 percent of the excluded gain was an item of tax preference. (50)
IRC § 6652(k). The penalty is $50 for each failure to file. It is
increased to $100 if the failure is due to negligence or
intentional disregard.No penalty is imposed on any failure that is
shown to be due to reasonable cause and not willful neglect. (51)
The replacement stock must meet the active business requirement for
qualified small business stock only for the first six months
following the purchase. IRC § 1045(b)(4)(B).Rules similar to the
rules contained in IRC § 1202(f), (g), (h), (i), (j) and (k) apply
to IRC § 1045(a). IRC § 1045(b)(5). (52) IRC § 1045(b)(4)(A). (53)
Treas Reg § 1.1045-1(a). (54) Id.; Treas Reg §§ 1.1045-1(c)(1)(i),
1.1045-1(g)(3)(i). (55) Treas Reg § 1.1045-1(a). (56) Treas Reg §
1.1045-1(b)(1). (57) Id.; Treas Reg § 1.1045-1(b)(4). (58) Treas
Reg § 1.1045-1(b)(1). The adjusted basis of a partner’s interest in
a partnership is not increased under IRC § 705 (a)(1) by gain from
a partnership’s sale of qualified small business stock that is not
recognized by the partner as a result of a partnership election
under IRC § 1045. Treas Reg § 1.1045-1(b)(3)(i). (59) Treas Reg §
1.1045-1(b)(2). (60) IRC § 1045(b)(3). The basis of a partnership’s
replacement qualified small business stock is reduced by the amount
of
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gain from its sale of qualified small business stock that is not
recognized by a partner as a result of the partnership’s election
under IRC § 1045. Treas Reg § 1.1045-1(b)(3)(ii). (61) Rev Proc
98-48, 1998-2 CB 367. A taxpayer with more than one sale of
qualified small business stock that qualifies for the election can
make the election for any one or more of the sales. (62) IRC §
1400B(a). The legislation is part of the package creating the
District of Columbia Enterprise Zone. See IRC § 1400. Notice 98-57,
1998-2 CB 669, identifies the census tracts in the District of
Columbia constituting the District of Columbia Enterprise Zone for
purposes of IRC § 1400 and the DC Zone for purposes of IRC § 1400B.
(63) IRC § 1400B(e)(1). (64) IRC § 1400B(e)(2), (3), (4), (5).
Persons are related if described in IRC § 267(b) or IRC §
707(b)(1).In the case of the sale or exchange of an interest in a
partnership, or stock in an S corporation, that was a DC Zone
business during substantially all of the period the taxpayer held
the interest or stock, the amount of qualified capital gain is
determined without regard to any gain attributable to real
property, or an intangible asset, that is not an integral part of a
DC Zone business, and any gain attributable to periods before
January 1, 1998, or after December 31, 2007. IRC § 1400B(g). (65)
IRC § 1400B(b)(1). The termination of the designation of the DC
Zone is disregarded for purposes of determining whether any
property is a DC Zone asset. IRC § 1400B(b)(5). (66) IRC §
1400B(b)(2)(A). (67) IRC § 1400B(b)(2)(B). IRC § 1202(c)(3)
contains rules relating to purchases by a corporation of its own
stock for purposes of the 50 percent gain exclusion for small
business stock. Rules contained in IRC § 1202(g), (h), (i)(2), and
(j) also apply for purposes of IRC § 1400B. (68) IRC § 1400B(b)(3).
A rule similar to IRC § 1202(c)(3) applies for purposes of
determining whether a partnership interest is a DC Zone partnership
interest. (69) IRC § 1400B(b)(4)(A). Purchase here has the same
definition as in IRC § 179(d)(2). In general, this means the
property cannot be acquired from a related party or a member of the
same controlled group, and cannot have a substituted basis or a
basis determined under IRC § 1014 (property acquired from a
decedent). (70) IRC § 1400B(b)(4)(B)(i). Property is treated as
substantially improved by the taxpayer only if, during any 24-month
period beginning after December 31, 1997, additions to basis with
respect to such property exceed the greater of the amount equal to
the adjusted basis of the property at the beginning of the 24-month
period in the hands of the taxpayer, or $5,000. IRC §
1400B(b)(4)(B)(ii). (71) IRC § 1400B(b)(6). (72) IRC § 1400B(b)(7).
(73) IRC § 1400B(c). See § 1J:23.03[3][c][ii] for a discussion of
IRC § 1397C. (74) IRC § 1400F(c)(1), (2). Rules similar to those
contained in IRC § 1400B(e)(3), (4), and (5), relating to gain that
is not qualified gain on the sale or exchange of a DC Zone asset
apply here. IRC § 1400F(c)(3). In addition, rules similar to the
rules of IRC § 1400B(b)(5), (6), and (7), and IRC § 1400B(f), and
(g) are also applicable, except that IRC § 1400B(g)(2) is applied
by substituting Jan 1, 2002, for Jan 1, 1998, and Dec 31, 2014, for
Dec 31, 2008. IRC § 1400F(d). See § 1J:2.06[2] [a][iii] for a
discussion of the provisions relating to sales or exchanges of DC
Zone assets. (75) IRC § 1400F(b)(1). (76) IRC § 1400F(b)(2)(A). A
rule similar to the rule of IRC § 1202(c)(3) is applicable here.
IRC § 1400F(b)(2)(B). See § 1J:2.06[2][a][ii] for a discussion of
IRC § 1202(c)(3).A renewal community business is any entity or
proprietorship that would be a qualified business entity or
qualified proprietorship under IRC § 1397C if reference to renewal
communities were substituted for references to empowerment zones in
that section. IRC § 1400G. See § 1J:23.03[3][b][ii] for a
discussion of IRC § 1397C. (77) IRC § 1400F(b)(3). (78) IRC §
1400F(b)(4)(A). The definition of purchase for this purpose is
found in IRC § 179(d)(2). (79) IRC § 1400F(b)(4)(B). Property is
substantially improved only if, during any 24-month period
beginning after Dec 31, 2001, additions to the basis of the
property in the hands of the taxpayer exceed the greater of (i) an
amount equal to the
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adjusted basis of the property at the beginning of the 24-month
period in the hands of the taxpayer, or (ii) $5,000. (80) In
determining whether nonrecognition treatment applies, (i) the
taxpayer's holding period for the qualified empowerment zone asset
that is sold, and for any qualified empowerment zone asset that is
acquired during the 60-day period beginning with the sale, is
determined without regard to IRC § 1223, and (ii) only the first
year of the taxpayer's holding period of the asset acquired during
the 60-day period is taken into account in considering whether a
corporation or partnership qualifies as a renewal community
business or property is used in a renewal community business. IRC §
1397B(b) (5). Rev Proc 2002-62, 2002-2 CB 682, sets forth the
procedure for making the election under IRC § 1397B(a).The District
of Columbia Enterprise Zone is not treated as an empowerment zone
for purposes of IRC § 1397B(b)(1)(B). (81) IRC § 1397B(b)(4). The
reduction is on a first-acquired, first-reduced basis. The
reduction does not apply for purposes of IRC § 1202.A taxpayer is
treated as having purchased any property if, but for the reduction
in basis, the unadjusted basis of the property in the hands of the
taxpayer would be a cost basis. IRC § 1397B(b)(3). (82) IRC §
1397B(b)(2). (83) IRC § 1397B(b)(1)(A). (84) To be allowable as a
deduction under IRC § 165(a), a loss must be evidenced by a closed
and completed transaction, fixed by an identifiable event or
events, and actually sustained during the taxable year. A decline
in the value of stock acquired on the open market, even if due to
accounting fraud or other illegal misconduct of officers or
directors of the corporation, does not result in an allowable
deduction unless the stock becomes wholly worthless. Notice
2004-27, 2004-1 CB 782. (85) IRC § 165(f) limits the deduction to
the extent allowed in IRC §§ 1211 and 1212.The Fourth Circuit
upheld a conviction for willfully making and subscribing false tax
returns on which the taxpayer claimed ordinary losses on securities
traded for his own account. Since the taxpayer was not a dealer,
the losses were capital losses subject to the limitation on
deductibility. US v Diamond, 788 F2d 1025 (4th Cir 1986). (86) The
deduction can be taken only by the taxpayer who actually sustains
the loss. Therefore, excess capital losses incurred by a decedent
before his death do not give rise to a capital loss carryover for
his estate. Rev Rul 74-175, 1974-1 CB 52. However, an excess loss
incurred by one spouse can be carried over and deducted on joint
returns. PLR 8510053. (87) IRC § 1212(b), added by the Revenue Act
of 1964, Pub L No 88-272, 88th Cong, 2d Sess, § 230(a), became
effective for taxable years beginning after Dec 31, 1963. Prior to
this amendment any loss carried over was considered a short-term
capital loss even if it had been a long-term loss in the year
originally sustained. Furthermore, pre-1964 losses could be carried
over only to the five succeeding years, not indefinitely, as is now
the case.In determining the extent to which losses carried over are
offset by gains realized in the succeeding year, the excess
deduction is considered a short-term capital gain. IRC §
1212(b)(2).The amount of the loss carryover from one carryover year
to another is affected by the amount that could have been deducted
in the first of the years, even though the taxpayer does not claim
a loss deduction in that year. Rev Rul 76-177, 1976-1 CB 224. A
taxpayer, who did not report a loss in the year in which it was
incurred, was entitled to carry over the loss to a subsequent year
to offset gains realized in the later year, after adjustment as
provided in Rev Rul 76-177. Lang v Commissioner, TC Memo 1983-318.
(88) The term "net Section 1256 contracts loss" means the lesser
of: (1) the net capital loss for the taxable year taking into
account only gains and losses from Section 1256 contracts, namely,
regulated futures contracts, foreign currency contracts, nonequity
options, and dealer equity options; or (2) the amount of any
capital loss carryover to the succeeding taxable year. IRC §§
1212(c)(4), 1256(b). (89) The provision does not apply to estates
or trusts. IRC § 1212(c)(7)(B).An Illinois district court has held
that losses from IRC § 1256 contracts that are part of a mixed
straddle can be carried back under IRC § 1212(c). Roberts v US, 734
F Supp 314 (ND Ill 1990). (90) The term "net Section 1256 contracts
gain" means the lesser of the capital gain net income for the year
taking into account only gains and losses from Section 1256
contracts, or the capital gain net income for the year. The net
Section 1256 gain for any taxable year before the loss year is
computed without regard to the net Section 1256 contracts loss for
the loss year or for any taxable year thereafter. IRC § 1212(c)(5).
(91) IRC § 1212(c)(1), (3). (92) IRC § 1212(c)(6)(A). (93) IRC §
1212(c)(6)(B).
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(94) IRC §§ 11, 1201(a). (95) IRC § 1211(a). (96) IRC §
1212(a)(1)(A). This conforms the treatment of capital losses with
that of net operating losses under § 172(b)(1) of the Code.IRC §
383 may become operative to limit the extent to which capital
losses may otherwise be carried over if certain changes occur in
the ownership of the corporation. (97) IRC § 1212(a)(1)(C)(i). (98)
IRC § 1212(a)(1)(A)(i). The ten-year carryforward is still
available for such losses. IRC § 1212(a)(1)(C)(ii). (99) IRC §
1212(a)(1)(A)(ii). (100) IRC § 1212(a)(3). (101) Net capital gain
is to be given the meaning set forth in IRC § 1222(9), except when
a net capital loss cannot be carried back in full to a preceding
taxable year because it would increase or produce a net operating
loss; the net capital gain for such prior year shall not be treated
as greater than the amount of loss which can be carried back to the
year. IRC § 1212(a) (1). (102) This is the procedure followed in
the case of net operating losses, Treas Reg § 1.172-4(a)(3), and
pre-1970 net capital losses, Treas Reg § 1.1212-1(a)(1)(ii), Ex
(a). (103) Pub L No 110-343. (104) Emergency Economic Stabilization
Act of 2008, Pub L No 110-343, Division A, § 301. (105) Emergency
Economic Stabilization Act of 2008, Pub L No 110-343, Division A, §
301(b) and (c)(2). (106) Emergency Economic Stabilization Act of
2008, Pub L No 110-343, Division A, § 301(d).
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