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

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

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

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 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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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