©2013, College for Financial Planning, all rights reserved. Module 3 Income Tax Aspects of Property Acquisitions & Introduction to Property Dispositions CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Income Tax Planning

Learning Objectives 3–1: Identify the type of property in a situation. 3–2: Analyze a situation to determine the correct treatment for property-related expenditures. 3–3: Analyze a situation to calculate the adjusted basis of property. 3–4: Analyze a situation to calculate the cost recovery deductions over the recovery period. 3–5: Analyze a situation to calculate the election or deduction amount under Section –6: Analyze a situation to calculate the amount of cost recovery recapture, or unrecaptured Section 1250 income. 3–7: Analyze a situation to determine the tax treatment of Section 1231 property transactions. 3-2

Questions to Get Us Warmed Up 3-3

Learning Objectives 3–1: Identify the type of property in a situation. 3–2: Analyze a situation to determine the correct treatment for property-related expenditures. 3–3: Analyze a situation to calculate the adjusted basis of property. 3–4: Analyze a situation to calculate the cost recovery deductions over the recovery period. 3–5: Analyze a situation to calculate the election or deduction amount under Section –6: Analyze a situation to calculate the amount of cost recovery recapture, or unrecaptured Section 1250 income. 3–7: Analyze a situation to determine the tax treatment of Section 1231 property transactions. 3-4

Types of Property 3-5 Realty Land, anything permanently affixed or attached to the land, and certain items that cannot easily be removed Personalty (sometimes known as “personal property”) Any type of property that is not realty, including such items as automobiles, jewelry, clothing, equipment, and furniture

Types of Property 3-6 Tangible Property Property that has physical existence and can be touched and felt Intangible Property Property, such as a leasehold interest in real estate or a stock certificate, that has no physical existence of its own, but represents the evidence of ownership or value

Types of Property 3-7 Trade or Business Property used on a regular and continuous basis in the taxpayer’s trade, business, or occupation to produce income Production of Income Property that does not require a significant amount of the taxpayer’s time or attention

Types of Property 3-8 Inventory Property held for resale in the normal course of a trade or business Personal Use (NOT the same as personal property) Property held for the taxpayer’s personal pleasure or enjoyment

Property-Related Expenditures 3-9 Not Currently Deductible Those incurred purely for personal reasons by the taxpayer (generally) Exception: Itemized deductions Currently Deductible Ordinary and necessary expenses incurred to carry on a trade or business—§162 expenses Capitalized and Amortized or Depreciated The purchase of property or improvements to property that extend beyond the taxable year or that provide a benefit for more than one tax year

Tax Basis 3-10 Purchased Property Original costs plus acquisition costs and cost of subsequent capital improvements, less amount of cost recovery deduction claimed Inherited Property Generally, equal to fair market value (FMV) on decedent’s death, or FMV on alternate valuation date (exactly six months after decedent’s death) if so elected

Tax Basis 3-11 Property Acquired by Gift Donor’s basis, unless fair market value (FMV) of property on date gifted is lower than donor’s basis: - If eventually sold for less than FMV on date received, basis becomes value on date received - If eventually sold for more than donor’s basis, basis becomes donor’s cost - If eventually sold for value between FMV on date received and donor’s basis, taxpayer reports neither gain nor loss -Tacking of holding period if donor’s basis used

Learning Objectives 3–1: Identify the type of property in a situation. 3–2: Analyze a situation to determine the correct treatment for property-related expenditures. 3–3: Analyze a situation to calculate the adjusted basis of property. 3–4: Analyze a situation to calculate the cost recovery deductions over the recovery period. 3–5: Analyze a situation to calculate the election or deduction amount under Section –6: Analyze a situation to calculate the amount of cost recovery recapture, or unrecaptured Section 1250 income. 3–7: Analyze a situation to determine the tax treatment of Section 1231 property transactions. 3-12

Cost Recovery: MACRS Defined Recover cost of wasting asset over time period approximating asset’s useful life Personalty MACRS table (200% DB w/ ½ year convention) Straight-line option for personalty Section 179 expense election 50% bonus depreciation o May elect out for entire class of property Realty Straight-line mandatory for real estate 3-13

Section 179 Expense Election Election to immediately expense Up to $500,000 (for 2013) of qualifying property Qualifying property Tangible Personalty For use in active conduct of a trade or business Limitations Phaseout for property placed in service over $2 million Taxable income limitation 3-14

Learning Objectives 3–1: Identify the type of property in a situation. 3–2: Analyze a situation to determine the correct treatment for property-related expenditures. 3–3: Analyze a situation to calculate the adjusted basis of property. 3–4: Analyze a situation to calculate the cost recovery deductions over the recovery period. 3–5: Analyze a situation to calculate the election or deduction amount under Section –6: Analyze a situation to calculate the amount of cost recovery recapture, or unrecaptured Section 1250 income. 3–7: Analyze a situation to determine the tax treatment of Section 1231 property transactions. 3-15

Calculate gain realized and recognized. Calculate Section 1245 gain Lesser of: cost recovery deductions taken or gain realized. Calculate Section 1231 gain Gain recognized less Section 1245 gain. Cost Recovery Recapture *Assumes no basis adjustments other than cost recovery deductions Calculating Cost Recovery Recapture on Section 1245 Property*

Section 1245 Recapture Sale Price$15 Cost Basis$10 Depreciation$(7) Adjusted Basis$3 Sale Price$ §1231 Potential LTCG §1245 Income Cost Recovery Recapture Ordinary Income §1231 Ordinary Loss

Unrecaptured Section 1250 Income 3-18 Sale Price$15 Cost Basis$10 S/L Depreciation$(7) Adjusted Basis$3 Sale Price$1 §1231 LTCG Unrecaptured §1250 Income (Type of §1231 gain) 25% LTCG §1231 Ordinary Loss

Section 1231 Lookback Lookback period—5 years If unrecaptured §1231 losses during lookback period Current year net §1231 gains treated as ordinary income 3-19

Review Question 1 A leasehold interest in an apartment building is considered a.tangible realty. b.tangible personalty. c.intangible realty. d.intangible personalty. 3-20

Review Question 2 A taxpayer purchases a new computer for use in his consulting business. He incurs sales taxes and shipping charges in connection with the purchase. Which one of the following correctly describes treatment of the sales taxes and shipping charges? a.Both are currently deductible. b.Both are capitalized. c.The sales taxes are capitalized, and the shipping charges are currently deductible. d.The sales taxes are currently deductible, and the shipping charges are capitalized. 3-21

Review Question 3 Don Reeves purchased a small duplex for use as a rental property. After the property was placed in service, he made some improvements; and later in the year, he made some repairs to the property. Which one of the following statements is correct regarding treatment of the expenditures? a.The improvements and repairs must be capitalized. b.The improvements must be capitalized; the repairs are currently deductible. c.The improvements are currently deductible; the repairs must be capitalized. d.The improvements and repairs are currently deductible. 3-22

Review Question 4 The basis of an asset acquired by inheritance generally is a.the greater of the decedent’s adjusted basis or the fair market value on the date of death. b.the lesser of the decedent’s adjusted basis or the fair market value on the date of death. c.the decedent’s adjusted basis. d.the fair market value on the date of death. 3-23

Review Question 5 This year, Jeff Walker purchased a parcel of raw land on which he could construct a new building for his hardware business. He paid $50,000 for the land and incurred $500 in legal fees associated with the title search. Property taxes on the land have totaled $1,200 annually. What is Jeff’s adjusted basis in the land? a.$50,500 b.$51,200 c.$51,

Review Question 6 Two years ago, Jeff Walker purchased new office equipment for use in his hardware business. The cost of the equipment was $15,000, and freight and installation costs totaled $500. He received a first-year cost recovery deduction of $2,215 and a second-year cost recovery deduction of $3,796. What is Jeff’s adjusted basis in the equipment? a.$8,989 b.$9,489 c.$15,000 d.$15,

Review Question 7 Two years ago, Sam Jones received a gift of 100 shares of common stock from his parents. The fair market value of the stock on the date of the gift was $10 per share. His parents had purchased the stock four years earlier at $3 per share. Sam sold this stock for $12 per share last week. What was Sam’s per share basis in the stock when it was sold? a.$3 b.$10 c.$

Review Question 8 Jerry’s uncle gave him 100 shares of ABC, Inc., common stock. The fair market value of the stock on the date of the gift was $20 per share. Jerry’s uncle had purchased the stock 22 months earlier at $30 per share. Jerry sold his holdings of the stock for $24 per share three weeks ago. What was Jerry’s gain or loss on the sale of the stock? a.($600) b.$0 c.$

Review Question 9 Mary purchased a used pickup truck at a cost of $4,200 with sales taxes of $300, to use in her delivery business. She purchased the pickup (5-year property) and placed it in service on January 1 of the current year. Using MACRS, what is the first-year cost recovery deduction that Mary can claim? a.$450 b.$900 c.$1,

Review Question 10 Bill purchased an automobile at a cost of $7,500 to use in his pizza delivery business. He also paid $500 in sales taxes on the vehicle. He purchased the automobile (5-year property) and placed it in service on March 1 of the current tax year. Using the straight-line method available as an option under MACRS, what is the first-year cost recovery deduction that Bill can claim? a.$750 b.$800 c.$1,500 d.$1,

Review Question 11 Frank Jones owns and operates a small business as a sole proprietor. On August 7, 2013, he purchased equipment (7-year property) at a cost of $625,000 to use in his business. He qualifies for and elects the maximum Section 179 expense deduction. What is the total amount of deductions that Frank can claim in 2013? Use the MACRS table. a.$375,000 b.$500,000 c.$517,863 d.$625,

Review Question 12 Mary Grey purchased office furniture several years ago at a cost of $4,500 to use in her business. She claimed $3,295 of cost recovery deductions. She sold the furniture for $3,000. What is the amount and character of the gain or loss resulting from this disposition? a.$1,500 ordinary loss b.$1,500 capital loss c.$1,795 of ordinary income, $0 long-term capital gain d.$1,795 long-term capital gain, $0 of ordinary income 3-31

Review Question 13 Julio Gallardo owns and operates a manufacturing plant as a sole proprietor. He purchased a machine used in the manufacturing process at a cost of $12,000 several years ago. Julio sold the machine for $16,000 after claiming $3,184 of cost recovery deductions. Calculate the amount and nature (character) of the gain or loss resulting from this disposition. a.$3,184 of ordinary income, $4,000 long-term capital gain b.$4,000 of ordinary income, $3,184 long-term capital gain c.$7,184 of ordinary income d.$7,184 long-term capital gain 3-32

Review Question 14 Which one of the following statements is correct regarding the tax treatment of Section 1231 and 1245? a.Net Section 1231 gains are treated as ordinary income. b.Net Section 1231 gains are treated as long- term capital gains. c.Section 1245 income is treated as capital gain income. d.Section 1245 losses are treated as ordinary losses. 3-33

Review Question 15 During the current year, Peter Langley has Section 1231 gains totaling $8,000. He also has $1,000 of Section 1231 losses. Four years ago, Peter reported a net Section 1231 loss of $2,000. These are the only two years in which Peter has had Section 1231 gains or losses. What is the amount and character of the current year’s Section 1231 gains and losses? a.$2,000 of ordinary income, $5,000 long-term capital gain b.$5,000 of ordinary income, $2,000 long-term capital gain c.$7,000 of ordinary income d.$7,000 long-term capital gain 3-34

Review Question 16 In 2013, Kevin Allen purchased various items of depreciable tangible personal property with a total cost of $528,000 for use in his business. Kevin has taxable income (without regard to the Section 179 deduction) of $116,000 from his business. He also has wages from a part-time job of $14,000. What is the maximum Section 179 expense deduction that Kevin may claim in 2013? a.$116,000 b.$130,000 c.$500,000 d.$528,

©2013, College for Financial Planning, all rights reserved. Module 3 End of Slides CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Income Tax Planning