Income Tax Fundamentals 2009 Gerald E. Whittenburg & Martha Altus-Buller Student’s Copy 2009 Cengage Learning

A capital asset is any asset other than inventory, receivables, copyrights, certain US Government publications and depreciable or real property used in a trade or business. Capital assets are defined by exception 2009 Cengage Learning

 Sale/exchange of capital asset results in a capital gain or loss Capital gains and losses receive special tax treatment Tax treatment based on length of time property has been owned  Assets excluded from definition of capital asset result in ordinary income or loss 2009 Cengage Learning

Realized Gains/Losses vs. Recognized Gains/Losses Amount realized* less:Adjusted basis of property* Realized gain (loss) less:Allowed gain deferral* Recognized gain (loss ) * Models for these items are found on the next screens Realization of gain or loss requires the “sale or exchange” of an asset Cengage Learning

Amount Realized = Gross sales price - Selling expenses Gross sales price is the amount received by the seller from the buyer Cash and FMV of property or received plus Seller’s liability assumed by or paid for by the buyer less selling expenses (costs paid to transfer property) 2009 Cengage Learning

Adjusted Basis Original cost plus: Capital improvements* less: Accumulated depreciation Adjusted basis * Items that significantly result in increase to property value or increase useful life 2009 Cengage Learning

 There are complex capital gain rules based on type of capital gain  Study the table “Capital Gains & Applicable Tax Rates” in Section 8.4and note the following: Short-term capital gains are taxed at ordinary income rates Long-term capital gains are taxed at preferred rates, depending on which bracket a taxpayer is normally in Unrecaptured §1250 gain has differing rates, depending on which bracket a taxpayer is normally in 2009 Cengage Learning

 Net capital losses (short-term and long-term) limited to $3000/year with indefinite carry forward  Must maintain ‘nature’ when carry forward (LTCL or STCL) In subsequent years, must deduct STCL first Must comply with ordering rules found on p Cengage Learning

 §1231 assets are not capital assets, but they are given special tax treatment  Asset must be held > 12 months and used in a trade or business Depreciable real or personal property used in trade or business Timber, coal, or domestic iron ore Livestock [not poultry] held for certain purposes Unharvested crops on land used in trade 2009 Cengage Learning

 Prevents taxpayers from receiving the dual benefits of a depreciation deduction and capital gain treatment upon sale of the asset Requires gains to be treated as ordinary to the extent of prior depreciation deductions  §1245 recapture  §1250 recapture  “Unrecaptured depreciation” previously taken on real estate – 25% 2009 Cengage Learning

 Casualty loss is the lesser of Property’s adjusted basis or Decline in the value of the property (repair cost) Deductible loss is reduced by  Insurance proceeds received  $100 per event  10% of AGI per year Itemized deduction on Schedule A  Casualty gain occurs when insurance reimbursement > adjusted basis of property 2009 Cengage Learning

 Business casualty and theft losses result from damage caused by a sudden, unexpected and/or unusual event For property fully destroyed, deduct adjusted basis For property partially destroyed, deduct the lesser of the property’s adjusted basis or the decline in the value  Any insurance reimbursement reduces loss  May cause gain 2009 Cengage Learning

 An installment sale occurs when Real or personal property or business/rental property is sold and Note is signed and payments are collected over time  Congress allows taxable gain to be reported as cash received, not when sale completed Can elect to report all the gain in the year of sale  Otherwise, use Form 6252, Installment Sale Income Must recapture any §1245 or §1250 first Then calculate gross profit percentage Then multiply percentage by cash received each year 2009 Cengage Learning

 No gain/loss recognized when an exchange of like-kind property occurs [deferred gain/loss] Like-kind property is  Exchanging real property for real property or  Exchanging personal property for personal property of the same asset class Rules only apply to business or investment property  May have some recognized gain if “boot” is received Boot is defined as:  Cash received in an exchange or  Any property (inventory, stocks, bonds, or other securities) that is not like-kind 2009 Cengage Learning