©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Chapter 8 Capital Gains and Losses Income Tax Fundamentals 2007 Gerald E. Whittenburg & Martha Altus-Buller

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Define a Capital Asset 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!!!

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Capital Gains and Losses  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  Long-term assets are held for > 12 months  Short-term assets are held for < 12 months  Assets excluded from definition of capital asset result in ordinary income or loss

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 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

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Amount Realized 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 by the buyer less  Selling expenses - costs paid to transfer property

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 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

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 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 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

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Net Capital Losses  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. 8-9

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. §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 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  Net §1231 gains may be allowed capital gain treatment even though they arise from business assets!  Net §1231 loss is classified as ordinary loss

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Depreciation Recapture  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%

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 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  $100 per event  10% of AGI per year Itemized deduction on Schedule A  Casualty gain occurs when insurance reimbursement > adjusted basis of property

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 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

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Installment Sales - Form 6252  An installment sale occurs when Real or personal property or business/rental property is sold and Payments are collected over time  Congress allows taxable gain to be reported as cash received, not when transaction 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

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. §1031 Like-Kind Exchanges  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