5-1 ©2008 prentice hall, inc.. 5-2 ©2008 prentice hall, inc. property transactions: capital gains...

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PROPERTY PROPERTY TRANSACTIONS: CAPITAL TRANSACTIONS: CAPITAL

GAINS & LOSSESGAINS & LOSSES (1 of 2) (1 of 2)

Determination of gain or lossBasis considerationsDefinition of a capital assetTax treatment for capital gains and

losses of noncorporate taxpayersTax treatment for capital gains and

losses of corporate taxpayers


PROPERTY PROPERTY TRANSACTIONS: CAPITAL TRANSACTIONS: CAPITAL

GAINS & LOSSESGAINS & LOSSES (2 of 2) (2 of 2)

Sale or exchangeHolding periodJustification for preferential

treatment of net capital gainsTax planning considerationsCompliance and procedural

considerations


Determination of Gain or Determination of Gain or LossLoss

Gain/Loss Realized (1 of 2)Gain/Loss Realized (1 of 2)

Realized gain or lossAmount realized less the assets’

adjusted basisAmount realized

Money+ FMV of property received + Taxpayer’s debt assumed by buyer- Costs of sale

Amount Realized



Gain/Loss Realized (2 of 2)Gain/Loss Realized (2 of 2)

Determination of basis Original basis (cost)

+ Additions (e.g., capital improvements)

- Reductions (e.g., depreciation, depletion) Adjusted basis



Gain/Loss RecognizedGain/Loss Recognized

Recognized gain or loss may be less than realized gain or loss due to special statutory provisionsE.g., like-kind exchanges,

involuntary conversions


Basis ConsiderationsBasis Considerations

Cost of acquired propertyProperty received as a giftProperty received from a

decedentProperty converted from personal

use to business useAllocation of basis


Cost of Acquired Property(1 of 2)

Generally the beginning basis of an asset

Uniform capitalization rulesRequires certain period costs to be

capitalized that are not capitalized for financial accounting purposes

Affect inventory and other property used in a taxpayer’s business


Cost of Acquired Property(2 of 2)

Capitalization of interestConstruction period debt capitalized

Applies to real estate and assets with class life ≥ 20 years

Identification problemsSpecific identification may not be

possibleTax law requires a FIFO approach


Property Received as a Gift(1 of 2)

Gain basisDonor’s basis plus a gift tax adjustmentGift tax paid X (FMV at gift time – donor’s basis)

Amount of gift

Loss basisLesser of

Gain basis or FMV at date of gift


Property Received as a Gift(2 of 2)

Gain basis used to calculate depreciationDepreciation subtracted from both

gain and loss basis upon disposition


Property Received from a Decedent

Basis of inherited propertyFMV at date of death, orAlternate valuation date (AVD)

Six months from date of death or disposition date if not held for six months


Property Converted from Personal Use to Business

Use

Basis is lower of personal use adjusted basis or property’s FMV at conversion


Allocation of Basis(1 of 2)

Basket purchaseAcquisition cost must be allocated

to individual assets on basis of relative FMV

Common costsCapitalized and allocated based

on relative FMV


Allocation of Basis(2 of 2)

Nontaxable stock dividends receivedAllocate basis of old shares to basis of old

shares plus new sharesNontaxable stock rights received

If FMV of stock rights < 15% of FMV of stock, basis is $0 unless elect to allocateMust allocate if value ≥ 15% of stock’s FMV


Definition of a Capital Definition of a Capital AssetAsset

Capital asset defined by §1221Definition is other than what is listed

as NOT a capital asset, includingInventory, depreciable property, real

property used in a trade or business

Influence of the courtsOther IRC provisions relevant to

capital gains and losses


Influence of the Courts

Corn Products Refining CO doctrineCreated nonstatutory exception to

definition of capital asset when asset purchased for business purposes

Arkansas Best CorporationLimited Corn Products doctrine

Stock is outside definition of capital assetMotivation for acquiring assets is irrelevant


Other IRC Provisions Relevant to Capital Gains

and Losses

Dealers in securitiesSecurities treated as inventory

Real property subdivided for saleNon-dealers in real estate can treat

as capital assetDealers treat as inventory

Nonbusiness bad debtDeductible as short-term capital loss


Tax Treatment for Capital Tax Treatment for Capital Gains & Losses of Gains & Losses of

Noncorp TaxpayersNoncorp Taxpayers

Capital gainsAdjusted net capital gains

(ANCG)Capital losses


Capital Gains(1 of 2)

Assets held ≤ 1 year are short-termAssets held > 1 year are long-termNet capital gain (NCG)

Excess of net LTCG over net STCLNCG may receive favorable tax

treatmentMust first determine STCG, STCL,

LTCG, and LTCL


Capital Gains(2 of 2)

Net short-term capital gain (NSTCG) Excess of STCGs over STCLs

Net short-term capital loss (NSTCL)Excess of STCLs over STCGs

Net long-term capital gain (NLTCG) Excess of LTCGs over LTCLs

Net long-term capital loss (NLTCL)Excess of LTCLs over LTCGs


Adjusted Net Capital Gains (ANCG)

Four types of net capital gains1. Collectibles gain2. 50% of gain from sale of §1202 stock3. Unrecaptured §1250 gain4. All other LTCGs Group 4 gets 5% or 15% rate Groups 1 & 2 taxed at max of 28% Group 3 taxed at max of 25%


Capital Losses

Net capital losses (NSTCL or NLTCL) offset ordinary income to a $3,000 maximum, with an unlimited carryover to future years

Net capital losses applied to net capital gains by groups described previously from highest (28%) to lowest (5% or 15%)


Tax Treatment for Capital Tax Treatment for Capital Gains & Losses of Corp Gains & Losses of Corp

TaxpayersTaxpayers

Corporations do not receive preferential tax rates on NCGs

Corps cannot deduct net capital losses

Corps carryback NCLs 3 years and then carryforward 5 yearsCapital loss carryovers are treated as

STCLs


Sale or ExchangeSale or Exchange

Worthless securitiesRetirement of debt instrumentsOptionsPatentsFranchises, trademarks, and

trade names


Worthless Securities

Securities that become totally worthless in a tax year are treated as a capital loss on the last day of the year

Securities in affiliated corporationsNot considered a capital asset


Retirement Of Debt Instruments

Original issue discountNot treated as capital gain upon

retirementAmortized over the life of the bond

Applies to cash and accrual taxpayers

Market discount bondsAcquired on secondary marketDiscount treated as ordinary income


Options

ExercisedBasis in option added to basis

stock purchasedSold or allowed to expire

Treated as sale or exchange


Patents

Gain may be treated as LTCGRequirements for LTCG treatment

Must be transfer of substantially all rights

LTCG treatment only applies to holder Individual whose efforts created patent or

one who purchases rights from creator


Franchises, Trademarks, and Trade Names

§1253 treats exchanges of franchises, trademarks, and trade names as exchanges of capital assetsIncludes renewals


Holding PeriodHolding Period

Property received as a giftProperty received from a

decedentAlways long term

Nontaxable exchangesReceipt of nontaxable stock

dividends and stock rights


Property Received as a Gift

If donee’s adjusted basis determined by reference to donor’s adjusted basisDonor’s holding period added to donee’s

holding period If donee’s adjusted basis is FMV at date

of giftHolding period begins on day after the date

of gift


Nontaxable Exchanges

Holding period of qualified property received generally includes holding period of qualified property given up


Receipt of Nontaxable Stock Dividends and Stock Rights

Generally includes the holding period of the underlying stock

If stock rights are exercised, holding period for stock purchased begins with date of exercise


Justification for Justification for Preferential Treatment of Preferential Treatment of

Net Capital GainsNet Capital Gains

Mobility of capitalMitigation of the effects of

inflation and the progressive tax system

Lowers the cost of capital


Tax Planning Tax Planning ConsiderationsConsiderations

Selection of property to transfer by giftConsider annual exclusionUnwise to gift depreciated property

Selection of property to transfer at time of deathRetain highly appreciated property until

deathSell loss property before death


Compliance and Compliance and Procedural Procedural

ConsiderationsConsiderations

Capital gains and losses reported by individuals on Schedule D

To improve compliance, brokers required to furnish IRS with info pertaining to each customerReported to taxpayer on Form 1099-BUse Schedule D to reconcile amounts

shown on Form 1099-B

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