7-2 LO #1 Calculating a Gain or Loss The difference between the amount realized from the sale and the tax basis of the asset; Amount realized > tax basis = gain Amount realized < tax basis = (loss) Tax basis is the cost of the asset less any accumulated depreciation.
7-3 LO #1 Calculating a Gain or Loss The nature of tax reporting for gains and losses on the sale of property depends primarily on the “use” of the asset rather than on the asset “form.”
7-4 LO #1 Calculating a Gain or Loss Form 4797 – Sales of Business Property –Use to report any and all gains or losses from sale or liquidation of business property. –The form has four parts to it and is very detailed to include all possible situations involving property used in a business Schedule D – Capital Gains and Losses –Use to report any and all gains or losses from sale of property used for investment.
7-5 LO #1 Concept Check 7-1 A gain or loss on a sale is the difference between the cash received and the original cost of the asset. False 2. The gain or loss on the sale of an asset used for investment or in a trade or business operation appears on Form 4797. False 3. When the buyer assumes the seller’s liability, the seller includes this amount in computing the amount realized from the sale. True
7-6 LO # 2 Classifying Assets Ordinary Asset –Ordinary income property is any asset that is “not” a capital asset. Capital Asset (§1221) –Any asset used for personal purposes or investment. Eight exceptions to this definition
7-7 LO # 2 Classifying Assets § 1231 Business Asset –Property used in a trade or business –Subject to depreciation –Held for more than one year Any business asset disposed of within one year of acquisition is an ordinary income asset
7-8 LO # 2 Concept Check 7-2 1. Inventory sold by a company is an ordinary income asset that appears on Form 4797-Sale of Business Assets. False 2. A capital asset includes all of the following except: a. taxpayer vacation home b. inherited property c. property used in a trade or business d. stock portfolio Answer: C
7-9 LO # 2 Concept Check 7-2 3.An ordinary income asset is any short-term asset used in a business. False 4.A §1221 asset is any asset held for investment. True 5. A §1231 asset is any depreciable or nondepreciable property not considered an ordinary income asset. True
7-10 LO # 3 Ordinary Assets Inventory and accounts receivable are not ordinary income assets unless they are sold outside the normal course of business. Sale of business property held less than one year. Gains are taxed at the taxpayer’s regular rate –There is no preferential tax treatment Losses are fully deductible
7-11 LO # 3 Concept Check 7-3 1.When an ordinary asset is sold, the gain or loss is considered a capital gain or loss. False 2. Why is the distinction between ordinary and capital so important? Because of the preferential tax rate treatment on capital gains versus ordinary gains.
7-12 LO # 3 Concept Check 7-3 3.Ordinary gains or losses produced outside the normal course of business relate to the sale of business property held for less than one year or the sale of receivables. True
7-13 LO #4 Capital Assets Tax treatment depends on holding period of the asset. Assets must be held for more than one year for preferential tax treatment. –Exceptions: Property received through a gift or non-taxable exchange has same holding period as the transferor. Property acquired through inheritance is always considered long-term property.
7-14 LO #4 Capital Assets Long term capital gain rates: –5% or 15% for most capital assets –25% rate from depreciable real property used in a trade or business –28% rate from “collectibles” and gains on §1202 (Qualified Small Business Stock) property.
7-15 LO #4 Capital Assets All short-term gains and losses are netted. All long-term gains and losses are netted. The resultant gain or loss determines the deductibility of a loss and the tax rate used for gain.
7-16 LO #4 Concept Check 7-4 1. The tax treatment of a capital gain or loss varies depending on all of the following except: a. the holding period b. the basis of the asset sold c. the taxpayer’s tax bracket d. netting of all gains and losses Answer: B
7-17 LO #4 Concept Check 7-4 2.If property received has the same basis as the basis in the hand of the transferor, the holding period includes the holding period of the transferor. True 3. The holding period of inherited property can be either short-term or long-term to the beneficiary. False
7-18 LO #4 Concept Check 7-4 4. The following are termed “maximum gain rates”: a. 15% and 28% b. 5% and 25% c. 5% and 15% d. 10% and 15% Answer: C
7-19 LO #4 Concept Check 7-4 5. For post May 5, 2003 sales, what are the maximum gain rates: Collectible gains28% §1202 gains28% Unrecaptured §1250 gains25% Taxpayer’s regular tax rate >25% 15% Taxpayer’s regular tax rate < 25% 5%
7-20 LO #5 §1231 Business Assets Recall that §1231 assets are those used in a trade or business that are held for > 1 year. Gains and losses form the sale of §1231 assets are netted before tax rates are applied. A net §1231 gain is taxed as a long- term capital gain subject to recapture provisions
7-21 LO #5 §1231 Business Assets Recapture provisions apply to depreciation taken as a deduction in prior years. Depreciation recapture rules are designed to “transform” some or all of the §1231 gain into an ordinary gain.
7-22 LO #5 §1231 Business Assets Net §1231 gains receive preferential tax rate treatment Net §1231 losses are treated as ordinary losses subject to deductibility provisions of $3,000 per year. Losses disallowed in the current year can be carried over to future years.
7-23 LO #5 §1231 Business Assets §1245 applies to personal trade or business property and is a subset of §1231 property –Tax rate to “recapture” the depreciation portion of a gain is taxed at ordinary rates –Remaining gain, if any, is taxed at preferential rates.
7-24 LO #5 §1231 Business Assets § 1250 applies to buildings – residential or non-residential (commercial) and is a subset of §1231 property –Tax rate to “recapture” the depreciation in excess of straight line and is taxed at 25% –Remaining gain, if any, is taxed at preferential rates
7-25 LO #5 Concept Check 7-5 1.§1231 gains receive preferential tax rate treatment but §1231 losses are limited to $3,000 per year. True 2. The only pure §1231 asset is land used in a trade or business or for investment. True
7-26 LO #5 Concept Check 7-5 3. What is meant by the term “depreciation recapture”? Depreciation recapture rules transform some or all of a §1231 gain into an ordinary gain.
7-27 LO #5 Concept Check 7-5 4. What is the difference between a §1245 asset and a §1250 asset? §1245 assets are personal trade or business property subject to depreciation. §1250 assets include depreciable real property used in a trade of business that has never been considered §1245 property
7-28 LO #5 Concept Check 7-5 5. What is the difference between §1250 “recapture” and “unrecaptured” gain provisions? Unrecaptured gain is taxed at 25% rate for all straight-line depreciation taken on the property. Recaptured gain is taxed at ordinary rates to the extent the depreciation taken exceed straight-line deprecation.
7-29 LO # 6 Special Types of Sales A mutual fund pools resources from various sources and purchases shares of stock in a portfolio Form 1099-DIV is the form sent annually to individual investors in the mutual fund to record dividends, capital gains, and distributions from the fund for the year. Capital gains distributions from mutual funds are reported on Schedule D.
7-30 LO # 6 Special Types of Sales Three methods to calculate the “basis” of shares in a mutual fund purchased throughout a period –First In-First Out – assumes first shares purchased are the first shares to be sold. –Specific Identification – assumes that the shares sold can be identified with a specific purchase. –Average Basis – Calculate the average of shares purchased for a period and an average is used to determine the cost basis of shares sold.
7-31 LO # 6 Special Types of Sales Worthless securities are treated as losses from a sale or exchange of a capital asset on the last day of the taxable year. –Declaration of bankruptcy is not sufficient to indicate worthlessness. –Often difficult to pinpoint exactly when a security becomes worthless to determine a “sale date” for long-term versus short-term treatment.
7-32 LO # 6 Special Types of Sales Investments in § 1244 stock receive ordinary loss treatment on sale or liquidation. –§1244 companies are; small corporations with paid in capital of $1 million or less, stock is issued directly to the taxpayer from the corporation, and during the five most recent taxable years before the stock loss was sustained, derived 50% or more of its gross receipts from a trade or business.
7-33 LO # 6 Special Types of Sales The annual loss on § 1244 stock cannot exceed $50,000 for a single taxpayer or $100,000 for married taxpayers filing a joint return. Purpose of this rule is to allow small corporate business owners the same ordinary loss treatment as would be allowed if the corporation operated as a partnership or sole proprietorship.
7-34 LO # 6 Special Types of Sales Sales of assets given as gifts: –FMV<donor’s adjusted basis at time of gift Use donor’s adjusted basis for a gain Use FMV for a loss –FMV=>donor’s adjusted basis at time of gift Use donor’s adjusted basis for a gain or loss
7-35 LO # 6 Concept Check 7-6 1. Explain the three types of methods used to determine the basis of units in a mutual fund. First In – First Out – First shares purchased are the first shares sold. Specific Identification – Specify exactly which units are for sale from the fund. Average Basis – Take total cost basis and divides by the total units to get an average cost per unit. Can use single or double category.
7-36 LO # 6 Concept Check 7-6 2.It is often difficult to pinpoint exactly when a security becomes worthless, so the loss on a worthless security is treated as occurring on the last day of the taxable year. True 3. The loss from the sale of §1244 stock allows for ordinary loss treatment rather than §1231 capital loss treatment. True
7-37 LO # 6 Concept Check 7-6 4. For any taxable year, the loss on §1244 stock cannot exceed $100,000 regardless of whether the taxpayer files as a single or married filing jointly tax return. False