1. 5-1 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

2. 5-2 PROPERTY TRANSACTIONS: CAPITAL GAINS & LOSSES (1 of 2)  Determination of gain or loss  Basis considerations  Definition of a capital asset  Tax treatment for capital gains and losses of noncorporate taxpayers  Tax treatment for capital gains and losses of corporate taxpayers Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

3. 5-3 PROPERTY TRANSACTIONS: CAPITAL GAINS & LOSSES (2 of 2)  Sale or exchange  Holding period  Tax planning considerations  Compliance and procedural considerations Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

4. 5-4 Determination of Gain or Loss Gain/Loss Realized (1 of 2)  Amount realized less the assets’ adjusted basis  Amount realized Money + FMV of property received + Taxpayer’s debt assumed by buyer - Costs of sale Amount Realized Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

5. 5-5 Determination of Gain or Loss Gain/Loss Realized (2 of 2)  Determination of basis Original basis (cost) + Capital additions (e.g., improvements) - Capital recoveries (e.g., depreciation) Adjusted basis  Gain or loss realized Amount realized - Adjusted basis _ Gain (loss) realized Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

6. 5-6 Determination of Gain or Loss Gain/Loss Recognized  Recognized gain or loss may be less than realized gain or loss due to special statutory provisions  E.g., like-kind exchanges, involuntary conversions Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7. 5-7 Basis Considerations  Cost of acquired property  Property received as a gift  Property received from a decedent  Property converted from personal use to business use  Allocation of basis Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

8. 5-8 Cost of Acquired Property (1 of 2)  Generally the beginning basis of an asset  Uniform capitalization rules  Requires certain period costs to be capitalized that are not capitalized for financial accounting purposes  Affect inventory and other property used in a taxpayer’s business Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

9. 5-9 Cost of Acquired Property (2 of 2)  Capitalization of interest  Construction period debt capitalized  Applies to real estate and assets with class life ≥ 20 years  Identification problems  Specific identification may not be possible  Tax law requires a FIFO approach Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

10. 5-10 Property Received as a Gift (1 of 2)  Amount of gift  FMV less annual exclusion amount  Annual exclusion amount $13,000  Donee generally takes carryover basis  Gain basis  Donor’s basis plus a gift tax adjustment Gift tax paid X (FMV at gift time – donor’s basis) Amount of gift Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11. 5-11 Property Received as a Gift (2 of 2)  Loss basis  Lesser of  Gain basis or  FMV at date of gift  Gain basis used to calculate depreciation  Depreciation subtracted from both gain and loss basis upon disposition Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

12. 5-12 Property Received from a Decedent (1 of 2)  Basis of inherited property  FMV at date of death, or  Alternate valuation date (AVD)  Six months from date of death or disposition date if not held for six months  AVD only available if FMV of total assets decreased over the six-month period Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

13. 5-13 Property Received from a Decedent (2 of 2)  Basis of inherited property  Estate tax repealed for 2010 only upon election by taxpayer’s estate  Basis of inherited property lesser of FMV or basis  Appreciation limited to $1.3M Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

14. 5-14 Property Converted from Personal Use to Business Use  Basis is lower of personal use adjusted basis or property’s FMV at conversion  Prevents depreciation on decline in value when asset was personal-use asset Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

15. 5-15 Allocation of Basis (1 of 2)  Basket purchase  Acquisition cost must be allocated to individual assets on basis of relative FMV  Common costs  Capitalized and allocated based on relative FMV Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

16. 5-16 Allocation of Basis (2 of 2)  Nontaxable stock dividends received  Allocate basis of old shares to basis of old shares plus new shares  Nontaxable stock rights received  If FMV of stock rights < 15% of FMV of stock, basis is $0 unless elect to allocate  Must allocate if value ≥ 15% of stock’s FMV Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

17. 5-17 Definition of a Capital Asset  Capital asset defined by §1221  Definition is other than what is listed as NOT a capital asset, including  Inventory, depreciable property, real property used in a trade or business  Election for self-created musical works  Influence of the courts  Other relevant IRC provisions Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

18. 5-18 Election for Self-Created Musical Works  A taxpayer may make a special election to treat sale or exchange of musical compositions or copyrights as sale or exchange of a capital asset Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

19. 5-19 Influence of the Courts  Corn Products Refining CO doctrine  Created nonstatutory exception to definition of capital asset when asset purchased for business purposes  Arkansas Best Corporation  Limited Corn Products doctrine  Stock is within definition of capital asset  Motivation for acquiring assets is irrelevant Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

20. 5-20 Other IRC Provisions Relevant to Capital Gains and Losses  Dealers in securities  Securities treated as inventory  Real property subdivided for sale  Non-dealers in real estate can treat as capital asset  Dealers treat as inventory  Nonbusiness bad debt  Deductible as short-term capital loss Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

21. 5-21 Tax Treatment for Capital Gains & Losses of Noncorp Taxpayers  Capital gains  Adjusted net capital gains (ANCG)  Capital losses Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

22. 5-22 Capital Gains (1 of 2)  Assets held ≤ 1 year are short-term  Assets held > 1 year are long-term  Net capital gain (NCG)  Excess of net LTCG over net STCL  NCG may receive favorable tax treatment  Must first determine STCG, STCL, LTCG, and LTCL Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

23. 5-23 Capital Gains (2 of 2)  Net short-term capital gain (NSTCG)  Excess of STCGs over STCLs  Net short-term capital loss (NSTCL)  Excess of STCLs over STCGs  Net long-term capital gain (NLTCG)  Excess of LTCGs over LTCLs  Net long-term capital loss (NLTCL)  Excess of LTCLs over LTCGs Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

24. 5-24 Adjusted Net Capital Gains (ANCG)  Four types of net capital gains 1. Collectibles gain 2. Taxable gain from sale of §1202 stock  0%, 25%, or 50% 3. Unrecaptured §1250 gain 4. All other LTCGs  Group 4 gets 0% or 15% rate  Groups 1 & 2 taxed at max of 28%  Group 3 taxed at max of 25% Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

25. 5-25 Capital Losses  Net capital losses (NSTCL or NLTCL) offset ordinary income to a $3,000 maximum, with an unlimited carryover to future years  Net capital losses applied to net capital gains by groups described previously from highest (28%) to lowest (0% or 15%) Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

26. 5-26 Tax Treatment for Capital Gains & Losses of Corp Taxpayers  Corporations do NOT receive preferential tax rates on NCGs  Corps cannot deduct net capital losses  Corps carryback NCLs 3 years and then carryforward 5 years  Capital loss carryovers are treated as STCLs Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

27. 5-27 Sale or Exchange  Worthless securities  Retirement of debt instruments  Options  Patents  Franchises, trademarks, and trade names  Lease cancellation payments Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

28. 5-28 Worthless Securities  Securities that become totally worthless in a tax year are treated as a capital loss on the last day of the year  Securities in affiliated corporations  Not considered a capital asset Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

29. 5-29 Retirement of Debt Instruments  Original issue discount  Not treated as capital gain upon retirement  Amortized over the life of the bond  Applies to cash and accrual taxpayers  Market discount bonds  Acquired on secondary market  Discount treated as ordinary income Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

30. 5-30 Options  Exercised  Basis in option added to basis stock purchased  Sold or allowed to expire  Treated as sale or exchange Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

31. 5-31 Patents  Gain may be treated as LTCG  Requirements for LTCG treatment  Must be transfer of substantially all rights  LTCG treatment only applies to holder  Individual whose efforts created patent or one who purchases rights from creator  Corps cannot be a “holder” Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

32. 5-32 Franchises, Trademarks, and Trade Names  §1253 treats exchanges of franchises, trademarks, and trade names as exchanges of capital assets  Includes renewals  Licensing not treated as a sale  Cannot retain significant power, right, or continuing interest in asset Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

33. 5-33 Lease Cancellation Payments  Payments received by lessor  Treated as ordinary income  Payments received by lessee  Considered amounts received in exchange for the lease  Treatment depends whether or not lease is a capital asset Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

34. 5-34 Holding Period  Property received as a gift  Property received from a decedent  Always long term  Nontaxable exchanges  Receipt of nontaxable stock dividends and stock rights  Justification for preferential treatment of net capital gains Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

35. 5-35 Property Received as a Gift  If donee’s adjusted basis determined by reference to donor’s adjusted basis  Donor’s holding period added to donee’s holding period  If donee’s adjusted basis is FMV at date of gift  Holding period begins on day after the date of gift Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

36. 5-36 Nontaxable Exchanges  Holding period of qualified property received generally includes holding period of qualified property given up Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

37. 5-37 Receipt of Nontaxable Stock Dividends and Stock Rights  Generally includes the holding period of the underlying stock  If stock rights are exercised, holding period for stock purchased begins with date of exercise Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

38. 5-38 Justification for Preferential Treatment of Net Capital Gains  Mobility of capital  Mitigation of the effects of inflation and the progressive tax system  Lowers the cost of capital Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

39. 5-39 Tax Planning Considerations  Selection of property to transfer by gift  Consider annual exclusion  Unwise to gift depreciated property  Selection of property to transfer at time of death  Retain highly appreciated property until death  Sell loss property before death Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

40. 5-40 Compliance and Procedural Considerations  Documentation of basis  Form 706 (Fed. Estate Tax return) required to determine FMV of assets  Brokers required to furnish IRS with sales proceeds for sales and cost basis for purchases  Capital gains and losses reported by individuals on Schedule D Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

41. Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard.newmark@PhDuh.com 5-41 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall