1. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Chapter 11 Property Dispositions Murphy & Higgins Concepts in Federal Taxation, 2012 edition

2. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Concept Review  Under the capital recovery concept, a property’s basis may be recovered before any taxable income is realized from disposal of property  No income or loss is recognized for tax purposes until it has first been realized

3. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Property Disposition Amount realized from disposition less: Adjusted basis of property Realized gain (loss) less: Amount deferred (disallowed) Recognized gain (loss)

4. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Recognized Gains or Losses  Categorized as one of the following: Ordinary gains and losses Capital gains and losses Section 1231 gains and losses Personal use gains and losses

5. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Amount Realized  Amount realized: Gross sales price less selling expenses Gross sales price: Amount received by the seller from the buyer and includes  Cash and FMV of property or services received  Seller’s debt assumed by or paid by the buyer Gross sales price is decreased by amounts given to the buyer by the seller  Buyer’s expenses paid by or assumed by the seller

6. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Effect of Debt Assumption  Assumption of debt is treated as a realization of income similar to paying or receiving cash Assumption of the seller’s debt increases sales price (as if buyer paid cash) Assumption of debt by the seller decreases the sales price (as if buyer received cash)

7. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Gains Amount realized from disposition less:Adjusted basis of property Realized gain (loss) less:Allowed deferral Recognized gain (loss) Ordinary Section 1231 CapitalPersonal Use Character of gain (loss) Loss not deductible Character of Gain or Loss

8. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Capital Gains and Losses  Capital asset: “Any asset other than inventory, receivables, copyrights, assets created by the taxpayer, and depreciable or real property used in a trade or business”  Collectible gain or loss results from the sale or exchange of works of art, gems, metals, antiques, rugs, stamps, wine, etc. held more than 12 months

9. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Capital Asset Definition  A capital asset is NOT: An Inventory item A Receivable Real or depreciable property used in a trade or business A Copyright, literary, musical, or artistic composition, etc., held by the person creating the property or held by a person who received the property as a gift from its creator Certain U.S. government publications

10. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Capital Gains and Losses: Holding Period  Holding period for capital assets is how long the taxpayer owned the asset Long-term means the asset was held for more than 12 months Short-term means the asset was held for < 12 months  Determining holding period is the first step in determining tax treatment

11. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Capital Gains and Losses: Netting Procedures (slide 1 of 3)  The following are treated as long-term gains and losses for the netting procedure Collectible gains and losses Gains on qualified small business stock Unrecaptured Section 1250 gain

12. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Capital Gains and Losses: Netting Procedures (slide 2 of 3) Long-term gains netted against Long-term losses Net Long-term Gain or Loss Short-term gains netted against Short-term losses Net Short-term Gain or Loss = =

13. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Capital Gains and Losses: Netting Procedures (slide 3 of 3)  If one is a loss and one is a gain, then:  If both are losses or both are gains, no further netting is done Net Short-term Gain or Loss netted against Net Long-term Gain or Loss Net Capital Gain or Loss =

14. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Tax Treatment for Net Long-Term Gain Individual Taxpayers  Net long-term gain (minus net collectibles gain, gain on qualified small business stock, and unrecaptured Section 1250 gain) is taxed at a maximum rate of 15%  0% if marginal tax rate < 15%  Collectibles held more than 12 months are taxed at a maximum rate of 28%  50% of the gain on qualified small business stock is excluded, the remainder taxed at a maximum rate of 28%  Unrecaptured Section 1250 gain is taxed at a maximum rate of 25%

15. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Adjusted Net Capital Gains (ANCG)  Are taxed at the 15% or 0% rates  ANCG = NLTG - [Net Collectible Gain + Small Business Gain - NSTCL - LTL carryovers]* - unrecaptured Sec. 1250 gain + Eligible Dividend Income *called: “28% rate gain”

16. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Juan has the following capital gains and losses in the current year: Short-term capital loss $(2,000) Long-term capital gain 12,000 Long-term capital loss carryover (5,000) Collectibles gain 10,000 Tax Treatment for Net Long-Term Gain Individual Taxpayers Example (slide 1 of 3)

17. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Short-term: Short-term capital loss $ (2,000) Long-term: Collectibles gain $10,000 Long-term capital gain 12,000 Long-term capital loss c/o (5,000) Long-term capital gain $ 17,000 Net long-term capital gain $ 15,000 Tax Treatment for Net Long-Term Gain Individual Taxpayers Example (slide 2 of 3)

18. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Results: “28% rate gain” = ($10,000 - $5,000 - $2,000) = $3,000 ANCG = $15,000 - $3,000 = $12,000 NLTCG is added to taxable income Net capital gain, taxed at 15% = $12,000 Collectibles gain, taxed at 28% = $3,000 Tax Treatment for Net Long-Term Gain Individual Taxpayers Example (slide 3 of 3)

19. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Tax Treatment for Net Short-Term Gain Individual Taxpayers  Taxed as ordinary income (i.e., taxpayer’s marginal tax rate)  Corporations do not receive special treatment for capital gains

20. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Tax Treatment for Net Loss  Net Capital Loss Individuals may use only $3,000 to offset other income  Excess loss is carried forward indefinitely and retains its short term or long term class for netting purposes Corporations cannot deduct a net capital loss  Excess loss carried back 3 then forward 5 years to offset capital gains

21. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Qualified Small Business Stock (slide 1 of 2)  Qualified stock Held for more than 5 years Purchased directly from corporation  Corporation with gross assets < $50 million Purchased after 8/10/93  Capital gain exclusion Up to 50% of gain may be excluded (75% for stock purchased after 2/17/09 and before 9/28/10; 100% for stock purchased after 9/27/10 and before 1/1/12)  Limited to the greater of  10 times basis in the stock, or  $10 million for each small business  Exclusion is based on a 28% rate

22. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Qualified Small Business Stock (slide 2 of 2)  Rollover provision Individual taxpayers may rollover gain on Qualified Small Business Stock  Held more than 6 months  Replaced with other small business stock purchased within +/- 60 days Basis in new stock is reduced by deferred gain Must recognize gain if the gain realized is more than the cost of the replacement stock

23. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Planning Strategies  Net Capital Gain position Sell assets with unrealized losses  Net Capital Loss position Sell assets with unrealized gains Optimize at $3,000  Worthless Securities Worthlessness deemed to occur on the last day of the year Realized loss = basis in the worthless security  Basis determination FIFO Specific identification

24. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Section 1231 Property  Eligible assets eligible under Section 1231: Depreciable or Real property used in a trade or business held for more than 12 months Timber, coal, and domestic iron ore Cattle and horses held for draft, breeding, dairy, or sporting purposes held for 24 months or more Other livestock held for draft, breeding, dairy, or sporting purposes held for 12 months or more Unharvested crops Asset used in a trade or business  Not for investment Held long term

25. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Section 1231 Overview  Net Section 1231 gains may be allowed capital gain treatment even though they arise from “ordinary” assets  Net Sec. 1231 losses are ordinary

26. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1st Step: 2nd Step: Net all business casualty gains and losses Net all other Sec. 1231 gains and losses All gains and losses are ORDINARY gain gains are taken to Step3 loss gain Section 1231 Netting (slide 1 of 2)

27. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Gains from Step 2 3rd Step: Apply lookback rule Remaining Sec. 1231 gain is treated as a net long-term capital gain netted with other capital gains and losses Gains are ORDINARY to the extent of any Sec. 1231 Losses deducted in the previous 5 years Section 1231 Netting (slide 2 of 2)

28. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Section 1231 Netting Results  Net Section 1231 gain is classified as long-term capital gain Lookback rule may reclaim some gains as ordinary  To the extent of Section 1231 loss reported in the previous 5 years  Net Section 1231 loss is classified as ordinary loss

29. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Section 1231: Disposition of Rental Activities  Disposition of rental property held for the production of income (investment) yields capital gain or loss  Disposition of rental property used in a trade or business yields Section 1231 gain or loss

30. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Depreciation Recapture  Prevents taxpayers from receiving the dual benefits of a depreciation deduction and special Section 1231 gain treatment  Applies to Section 1231 gain property only  Requires gains to be treated as ordinary to the extent of prior depreciation deductions

31. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Section 1245  Section 1245 Requires full recapture of all depreciation  Gains are treated as ordinary income to the extent of any depreciation taken Any gain in excess of depreciation is netted under Section 1231 Applies to  Depreciable personal property and  Nonresidential real estate placed in service between 1981 and 1986 and depreciated under ACRS

32. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Section 1250  Section 1250 Requires partial recapture of depreciation  Gains are treated as ordinary income to the extent of depreciation taken over straight-line amount Any gain in excess of depreciation in netted under Section 1231 Applies to depreciable real property  Not covered by Section 1245 and  Not depreciated using the straight-line method  Eliminates most MACRS realty

33. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Unrecaptured Section 1250 Gain  Requires that the portion of the gain attributable to depreciation that is not Section 1250 recapture is taxed at a rate of 25%  Applies to depreciable real property sold after 5/7/97  Any gain not attributable to depreciation (in excess of original cost) is a Section 1231 gain taxed at 15%