Chapter 8 Capital Gains and Losses Income Tax Fundamentals 2011 Gerald E. Whittenburg & Martha Altus-Buller Student’s Copy 2011 Cengage Learning

Define a Capital Asset 2011 Cengage Learning A capital asset is any asset other than inventory, receivables, copyrights, certain U.S. Government publications and depreciable or real property used in a trade or business. Capital assets are defined by exception

Capital Gains and Losses  Sale/exchange of capital asset results in a capital gain or loss °Although not defined precisely – “sale” is receipt of cash or release of debt and “exchange” requires transfer of ownership ◦ Capital gains and losses receive special tax treatment ◦ Tax treatment based on length of time property has been owned 2011 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 slides 2011 Cengage Learning Realization of gain or loss requires the “sale or exchange” of an asset.

Amount Realized Amount Realized = Gross sales price - Selling expenses  Gross sales price is the amount received by the seller from the buyer ° Cash and fair market value (FMV) of property received plus ° Seller’s liability assumed by or paid for by the buyer ° Less selling expenses (costs paid to transfer property) 2011 Cengage Learning

Adjusted Basis Original cost plus: Capital improvements* less: Accumulated depreciation Adjusted basis *Items that significantly result in increase to property value or increased useful life 2011 Cengage Learning

Net Capital Gains  There are complex capital gain rules based on type of capital gain  Study the table “Capital Gains & Applicable Tax Rates” in Section 8.4 and note the following: ◦ Short-term capital gains are taxed at ordinary income rates ◦ Long-term capital gains are taxed at preferred rates, (see next slide) depending on which bracket a taxpayer is normally in ◦ Unrecaptured §1250 gain has differing rates, depending on which bracket a taxpayer is normally in 2011 Cengage Learning

Net Capital Losses  Note that net capital losses (short-term and long-term) limited to $3,000/year with an indefinite carry forward  Must maintain ‘nature’ of capital loss (i.e. – short-term or long-term) when carrying it forward ° In subsequent years, must deduct STCL first Note: Must comply with ordering rules 2011 Cengage Learning

Section 1231 Assets  §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 and include: ◦ 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 2011 Cengage Learning

Depreciation Recapture 2011 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 taxed at 25%

Casualty Gains & Losses: Personal  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  $500 floor (per event)  10% of AGI per year ◦ Shown as itemized deduction on Schedule A  Casualty gain occurs when insurance reimbursement > adjusted basis of property 2011 Cengage Learning

Casualty Gains & Losses: Business  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 2011 Cengage Learning

Installment Sales - Form 6252  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 ◦ However, 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 2011 Cengage Learning

§1031 Like-Kind Exchanges  No gain/loss recognized when an exchange of like- kind property occurs (deferred gain/loss) ◦ Like-kind property transactions occur when  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 cas h received in an exchange or any property (inventory, stocks, bonds, or other securities) that is not like-kind 2011 Cengage Learning