Essentials of taxation 2016 cengage chapter 08

Chapter Property Transactions: Capital Gains and Losses, § 1231, and Recapture Provisions Essentials of Taxation © 2016 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part The Big Picture (slide of 4) • Alice owns land that she received from her father 10 years ago as a gift – The land was purchased by her father in 1992 for $2,000 and was worth $10,000 at the time of the gift • The property is currently worth about $50,000 • If Alice sells the land, you previously determined that she would have a taxable gain of $48,000 The Big Picture (slide of 4) • Alice also owns 500 shares of AppleCo stock – 300 shares were inherited when Alice’s grandfather died – Alice’s grandfather paid $12,000 for the AppleCo shares, and they were worth $30,000 at the time of his death • If Alice sells those shares for $120 each, you previously determined that she would have a $6,000 taxable gain • The other 200 shares were purchased by Alice two months ago for $28,000 – If Alice sells those shares for $120 each, you determined that she would have a recognized loss of $4,000 • Nine months ago, Alice purchased 100 shares of Eagle Company stock for $5,000 The Big Picture (slide of 4) • Nine months ago Alice invested $50,000 in a 50% interest in a patent that Kathy, an unemployed inventor, had obtained for a special battery she had developed to power ‘‘green’’ cars – To date, Kathy has been unable to market the battery to an auto manufacturer or supplier • Alice also purchased a franchise from Orange, Inc., for $100,000 which she subsequently sells ot Mauve, Inc for $101,000 nine months later • Alice owns a house that she inherited from her grandmother two years ago – The fair market value of the house at the date of her grandmother’s death was $475,000 – Alice will recognize a $125,000 gain on the sale of the property The Big Picture (slide of 4) • Finally Alice’s new husband sold depreciable equipment used in his sole proprietorship – The business purchased a $50,000 machine and deducted $35,000 of depreciation before selling it for $60,000 • Now Alice would like to know more about the gains and losses and the tax liability that she and her husband can expect from these transactions – Read the chapter and formulate your response Taxation of Capital Gains and Losses • Capital gains and losses must be separated from other types of gains and losses for two reasons: – Long-term capital gains may be taxed at a lower rate than ordinary gains – A net capital loss is only deductible up to $3,000 per year Taxation of Capital Gains and Losses • Capital gains and losses must be separated from other types of gains and losses for two reasons: – Long-term capital gains may be taxed at a lower rate than ordinary gains – A net capital loss is only deductible up to $3,000 per year Proper Classification of Gains and Losses • Depends on three characteristics: – The tax status of the property • Capital asset, §1231 asset, or ordinary asset – The manner of the property’s disposition • By sale, exchange, casualty, theft, or condemnation – The holding period of the property • Short term and long term Capital Assets (slide of 5) Đ1221 defines capital assets as everything except: Inventory (stock in trade) – Notes and accounts receivables acquired from the sale of inventory or performance of services – Realty and depreciable property used in a trade or business (Đ1231 assets) Capital Assets (slide of 5) §1221 defines capital assets as everything except (cont’d): – Certain copyrights; literary, musical, or artistic compositions; or letters, memoranda, or similar property • Taxpayers may elect to treat a sale or exchange of certain musical compositions or copyrights in musical works as the disposition of a capital asset – Certain publications of U.S government – Supplies of a type regularly used or consumed in the ordinary course of a business 10 Đ1250 Recapture (slide of 3) Section 1250 recapture rarely applies since only the amount of additional depreciation is subject to recapture – To have additional depreciation, accelerated depreciation must have been taken on the asset • Straight-line depreciation is not recaptured (except for property held one year or less) – Depreciable real property placed in service after 1986 can generally only be depreciated using the straight-line method • Therefore, no depreciation recapture potential for such property – § 1250 does not apply if the real property is sold at a loss 74 §1250 Recapture (slide of 3) The Đ 1250 recapture rules also apply to the following property for which accelerated depreciation was used: – Additional first-year depreciation [§ 168(k)] exceeding straight-line depreciation taken on leasehold improvements, qualified restaurant property, and qualified retail improvement property – Immediate expense deduction [§ 179(f)] exceeding straightline depreciation taken on leasehold improvements, qualified restaurant property, and qualified retail improvement property 75 Real Estate 25% Gain (slide of 2) • Also called unrecaptured §1250 gain or 25% gain – 25% gain is some or all of the §1231 gain treated as long-term capital gain – Used in the alternative tax computation for net capital gain 76 Real Estate 25% Gain (slide of 2) • Maximum amount of 25% gain is depreciation taken on real property sold at a recognized gain reduced by: – Certain §1250 and §1245 depreciation recapture – Losses from other §1231 assets – §1231 lookback losses • Limited to recognized gain when total gain is less than depreciation taken 77 Related Effects of Recapture (slide of 5) • Gifts – The carryover basis of gifts, from donor to donee, also carries over depreciation recapture potential associated with asset – That is, donee steps into shoes of donor with regard to depreciation recapture potential 78 Related Effects of Recapture (slide of 5) • Inheritance – Death is only way to eliminate recapture potential – That is, depreciation recapture potential does not carry over from decedent to heir 79 Related Effects of Recapture (slide of 5) • Charitable contributions – Recapture potential reduces the amount of charitable contribution deductions that are based on FMV 80 Related Effects of Recapture (slide of 5) • Nontaxable transactions – When the transferee carries over the basis of the transferor, the recapture potential also carries over • Included in this category are transfers of property pursuant to the following: – – – – Nontaxable incorporations under § 351 Certain liquidations of subsidiary companies under § 332 Nontaxable contributions to a partnership under § 721 Nontaxable reorganizations – Gain may be recognized in these transactions if boot is received • If gain is recognized, it is treated as ordinary income to the extent of the recapture potential or recognized gain, whichever is lower 81 Related Effects of Recapture (slide of 5) • Like-kind exchanges and involuntary conversions – Property received in these transactions have a substituted basis • Basis of former property and its recapture potential is substituted for basis of new property – Any gain recognized on the transaction will first be treated as depreciation recapture, then as Đ1231 or capital gain Any remaining recapture potential carries over 82 Refocus On The Big Picture (slide of 5) • The land, stock, franchise, and home owned by Alice are all capital assets and will produce the following capital gain or loss when sold – Long-term capital gain of $48,000 from the sale of the land, – Long-term capital gain of $6,000 from the sale of 300 shares of inherited AppleCo stock, – Short-term capital loss of $4,000 from the sale of the other 200 shares of AppleCo stock, – A short-term capital gain of $1,000 from the sale of the franchise, and – $125,000 of long-term capital gain from the sale of the house 83 Refocus On The Big Picture (slide of 5) • For the patent, since Alice is a ‘‘holder’’ of the patent, it will qualify for the beneficial capital gain rate regardless of the holding period if the patent should produce income in excess of her $50,000 investment • However, if she loses money on the investment, she will be able to deduct only $3,000 of the loss per year (assuming no other capital gains) 84 Refocus On The Big Picture (slide of 5) • The depreciable property owned by Alice’s husband is § 1231 property – The $45,000 gain from the sale of the property ($60,000 amount realized - $15,000 basis) is subject to depreciation recapture under § 1245 – Accordingly, the first $35,000 of the gain (up to the amount of depreciation taken on the property) is taxed as ordinary income – The remaining $10,000 is given long-term capital gain treatment 85 Refocus On The Big Picture (slide of 5) • As a result of these transactions, Alice and her husband have: – A net long-term capital gain of $189,000 ($48,000 + $6,000 + $125,000 + $10,000), and – A net short-term capital loss of $3,000 • The long-term capital gain and short-term capital loss are netted, so the final result is a net capital gain of $186,000, which is taxed at the 15% or 20% tax rate • Alice and her husband also report $35,000 of ordinary income on their joint income tax return because of the depreciation recapture provisions 86 Refocus On The Big Picture (slide of 5) What If? • What if the depreciable business property was worth only $10,000 when it was sold? – In this case, there is no depreciation recapture, and the $5,000 loss is deductible as an ordinary loss under § 1231 87 If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr Donald R Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta © 2016 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 88 ... Picture - Example 12 Holder Of A Patent (slide of 2) • Return to the facts of The Big Picture on p 8-1 and continuing with the facts of Example 11 • Kathy is clearly a holder of the patent – She is... these transactions – Read the chapter and formulate your response Taxation of Capital Gains and Losses • Capital gains and losses must be separated from other types of gains and losses for two... a sale or exchange of certain musical compositions or copyrights in musical works as the disposition of a capital asset – Certain publications of U.S government – Supplies of a type regularly