cch federal taxation basic principles chapter 11 property transactions: nonrecognition of gains and...

CCH Federal TaxationBasic Principles

Chapter 11Property Transactions:

Nonrecognition of Gains and Losses

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CCH Federal Taxation Basic Principles 2 of 66

Chapter 11 Exhibits 1. Sale of a Principal Residence—General Rules 2. Sale of Home by Married Taxpayers—General Rules 3. Sale of Home by Married Taxpayers—Examples 4. Sale of Home by Divorced or Separated Taxpayers—Ownership

Requirement 5. Sale of Home by Divorced or Separated Taxpayers—Occupancy

Requirement 6. Sale of Home by Widowed Taxpayers 7. Sale of Home Due to Unforeseen Circumstances 8. Sale of Home by Incapacitated Taxpayers 9. Sale of Home by U.S. Citizens Temporarily Working Abroad10. Like-Kind Exchanges—Tangible Property11. Like-Kind Exchanges—Intangible Property 12. Like-Kind Exchanges—Tax Treatment for Gain or Loss13. Like-Kind Exchanges—Time Limitations14. Like-Kind Exchanges—Holding Period Rules

Chapter 11, Exhibit Contents A


Chapter 11 Exhibits

15. Involuntary Conversions—What Qualifies

16. Involuntary Conversions—Time Limitations

17. Involuntary Conversions—Holding Period Rules

18. Involuntary Conversions—Template for Problem Solving

19. Installment Method—Eligible Property

20. Installment Method—Four-Step Computation

21. Installment Method— Example

22. Installment Method— Solution Step One

23. Installment Method— Solution Step Two

24. Installment Method— Solution Step Three

25. Installment Method— Solution Step Four

Chapter 11, Exhibit Contents B


Sale of a Principal Residence—General Rules

Amount and tax effect of the exclusion

$250,000 (Married individuals filing jointly may exclude up to $500,000.)

This is a permanent exclusion, not just a deferral or rollover of gain until a later time. Moreover, there is no reinvestment requirement.

Chapter 11, Exhibit 1a


Qualifying for the exclusion To qualify for the exclusion, a taxpayer must: Own and use the property as a principal residence for an

aggregate of at least two of the five years preceding the sale or exchange; and,

Not claim the exclusion during the two years immediately preceding the sale.

Chapter 11, Exhibit 1b



Example.

Fred, a single individual, owns and occupies his home during all of 20x1 and 20x2. He rents it to a tenant during all of 20x3, 20x4 and 20x5. He sells it on December 31, 20x5, realizing a $200,000 gain. If Fred had not taken exclusion on the sale of any other principal residence during 20x4 and 20x5, he may be entitled to exclude all of the $200,000 gain in 20x5.

Chapter 11, Exhibit 1c



Short-term absences

Absences due to short-term illness, business travel and vacation generally count as occupancy. Under certain situations, taxpayers may be able to claim the exclusion even though they fail to meet either the one-sale-every-two-years limitation or the two-out-of-five-year holding period requirement.

Chapter 11, Exhibit 1d



Rules of eligibility to claim an exclusion on a joint return

The maximum exclusion that can be claimed on a joint return is either $250,000 or $500,000. Three requirements for these maximum exclusion amounts are summarized in the following charts.


Sale of Home by Married Taxpayers—General Rules



Three Requirements:

Maximum $500,000 Exclusion


Minimum Two-Year Ownership:

Either spouse owns the principal residence for an aggregate of at least two of the five years immediately preceding the sale or exchange.

Either spouse owns the principal residence for an aggregate of at least two of the five years immediately preceding the sale or exchange.



Three Requirements:



Minimum Two-Year Occupancy:

Both spouses, while married, occupy the dwelling as their principal residence for an aggregate of at least two of the five years immediately preceding the sale or exchange.

The owner-spouse occupies the dwelling as a principal residence for an aggregate of at least two of the five years immediately preceding the sale or exchange. This two-year occupancy requirement can be met either before or during marriage.




Three Requirements:



Maximum Two-Year Frequency:

Neither spouse claimed the exclusion within two years preceding the sale.

The owner-spouse has not claimed the exclusion within two years preceding the sale.

(Note that a non-owner-spouse’s ineligibility does not bar the owner-spouse from claiming a $250,000 exclusion on a joint return.)




Sale of Home by Married Taxpayers

Example 1.

While single, Greg and Lynne live in separate principal residences for over two years. On January 1, 20x1, they marry and move into a new house. Later that year they convert their former principal residences into rental properties. On June 31, 20x3, Lynne sells her former principal residence at a $600,000 gain. How much of Lynne’s gain may be excluded on a joint return?



Answer: $250,000.

Only Lynne occupied the home as her principal residence during two of the five years preceding the sale.(Note: Had Greg and Lynne decided to use Lynne’s home as their principal residence during any two of the five years preceding sale, they could have claimed a $500,000 exclusion even though Greg was not an owner.)




Example 2.

Continuing from example 1 above, on December 31, 20x3, the couple sells the new principal residence at a $700,000 gain. How much of the gain may be excluded on their joint return?




Answer: None.

Lynne had used her exclusion on June 30, 20x3, within two years preceding the December 31, 20x3 sale.

(Note: If they had sold Greg’s rental home instead of their jointly-owned principal residence, a $250,000 exclusion would have been available on their joint return. Greg would still be considered to have owned and occupied the rental house as his principal residence during two of the five years preceding sale, i.e. the two years preceding marriage. He would not have had to wait two years from June 30, 200x3, (the effective date of Lynne’s exclusion) to become eligible because a non-owner-spouse’s ineligibility does not bar the owner-spouse from claiming a $250,000 exclusion on a joint return.)




If a residence is transferred to a taxpayer under a divorce or separation instrument, the time during which the taxpayer’s spouse or former spouse owned the residence is added to the taxpayer’s period of ownership.


Sale of Home by Divorced or Separated Taxpayers—Ownership Requirement


Example. John has owned his principal residence for several years. On January 1, 20x1, he marries Tina. After one year of sharing a principal residence, the marriage turns sour, John moves into an apartment and they divorce. Pursuant to a divorce decree, John transfers ownership in the house to Tina on December 31, 20x1 and she immediately sells it at a $300,000 gain. Although she did not own the residence for two years, Tina can claim a $250,000 exclusion. She is deemed to have owned the house as her ex-spouse owned it, thus satisfying the two-out-of-five-year ownership requirement.





Recap of John and Tina Analysis:

Actual Ownership

Deemed Ownership:

Actual Occupancy:

Deemed Occupancy:

20x0: John Tina John Tina

20x1: John Tina John and Tina Tina

Observation: Tina owned the house for only one day and occupied it for one year. Nevertheless, she is deemed to have owned, the residence for two years.



Sale of Home by Divorced or Separated Taxpayers—Occupancy Requirement

A taxpayer who owns a residence is deemed to have occupied it as a principal residence while the taxpayer’s spouse or former spouse is given use of the residence under the terms of a divorce separation.



Example.Colleen purchases her principal residence on January 1, 20x1, and marries Stan that same day. After one year of living together in Colleen’s home, the marriage turns sour and they divorce. On January 1, 20x2, Colleen moves into an apartment, and under the terms of a divorce decree, Stan is allowed to live in the house for an additional year before Colleen can sell it. On January 1, 20x3, Colleen sells the house realizing a $500,000 gain. Despite not occupying the house for a full two years, Colleen can claim a $250,000 exclusion. She is deemed to have occupied the house during the one year her ex-spouse occupied it, thus satisfying the two-out-of-five-year occupancy period requirement.




Observation: Colleen actually occupied the house for only one year, 20x1. However, she is deemed to have occupied it for two years, including 20x2, the year her ex-spouse occupied it.

Colleen StanColleen20x2:

ColleenColleen and StanColleen20x1:

Deemed Usage:Actual Usage:Actual Ownership

Recap of Colleen and Stan Analysis:




Sale of Home by Widowed Taxpayers

A surviving spouse’s period of ownership and occupancy includes the period during which a deceased spouse owned and occupied the residence.



Example. Joe, a single individual, has owned and occupied his principal residence for over two years. On January 1, 20x2, he marries Sue and they begin living together in Joe’s house. Three weeks later, Joe dies and ownership of the house is transferred to Sue. Sue immediately sells the house. Despite not owning and occupying the residence for two years, Sue can claim a $500,000 exclusion on their joint return (Joe’s final return). She is deemed to have owned and occupied the house during the period in which her deceased spouse owned and occupied it, thus satisfying the two-out-of-five-year holding period requirement. If she delays the sale until a later year, then as a single taxpayer, her maximum exclusion would drop to $250,000.




Recap of Joe and Sue Analysis

Actual Ownership and Occupancy:

Deemed Ownership and Occupancy:

Less than 1 month Joe and Sue Sue

Balance of 2 years Joe Sue

Observation: Although actually owning and occupying the principal residence for less than one month, Sue is deemed to have owned and occupied it during the period in which her deceased spouse owned and occupied it.




Sale of Home Due to Unforeseen Circumstances

If a change in place of employment, health or other unforeseen circumstances precipitate a sale or exchange before any of the three requirements (i.e., the two-year ownership, occupancy or frequency requirements) are satisfied, the exclusion may be prorated. The extent to which “unforeseen circumstances” qualify is to be determined by IRS regulations.



Available exclusion(g) = (a) x (f)

Pro rata fraction(f) = [lesser of (b) (c) or (d)] (e)

24 months(e)

# months since the previous sale to which the exclusion applied. (Use “24 months” if no previous sale.)

(d)

Aggregate # months of occupancy during the five year period ending on the date of sale.

(c)

Aggregate # months of ownership during the five year period ending on the date of sale.

(b)

Available exclusion (i.e., $250,000 or $500,000).(a)

Formula forProrating the Exclusion Where Unforeseen Circumstances Apply




Example.

On January 1, 20x1, Burke purchases a townhouse in Boston for $450,000. Later in the year, he accepts an offer of employment in Atlanta. On November 1, 20x1, he sells his townhouse at a $30,000 gain. His change in place of employment enables him to claim a portion of the $250,000 exclusion. Because he owned and occupied the townhouse for 10 months, his available exclusion is $104,167 ($250,000 x 10 24) and he recognizes no gain.




Sale of Home by Incapacitated Taxpayers

If an individual becomes physically or mentally incapable of self-care, the individual is deemed to use a residence as a principal residence during the time in which the individual owns the residence and resides in a licensed care facility (e.g., a nursing home). In order for this rule to apply, the taxpayer must have owned and used the residence as a principal residence for an aggregate period of at least one year during the five years preceding the sale or exchange.



Example. On January 1, 20x1, Patrick purchases a house that he occupies as his principal residence. On January 1, 20x2, he moves into a nursing home due to a sudden decline in health. On January 1, 20x3, he sells his house, realizing a $100,000 gain. Patrick’s one-year ownership of the house while under the care of a licensed medical facility is now deemed to be one-year usage since he had previously used the house for at least one year during the five years preceding the sale of the house. His one-year occupancy of the house plus the additional one year of ownership while incapacitated, satisfies the two-out-of-five-year occupancy requirement, and he can claim the exclusion.




Note: If Patrick had moved into the nursing home before January 1, 20x2, he would not have been able to claim the exclusion. since he had not previously used the house for at least one year.




Sale of Home by U.S. Citizens Temporarily Working Abroad

Code section 121(a) states that the two-out-of-five-year holding period requirement is satisfied if “property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more.” Congress intended the word “used” to encompass something more than absentee-ownership. Until Congress provides specific relief to U.S. citizens working abroad, the term “used” should be construed to mean something akin to physical occupancy, not an extended absence while working abroad.



Example.

Kevin purchases a house on January 1, 20x1, which he uses as a principal residence. On January 1, 20x2, he accepts a temporary assignment overseas, leaving his house unoccupied. After one year overseas, Kevin decides to sell his house. On January 1, 20x3, he realizes a $200,000 gain on the sale. Although he owned the house for two years preceding the sale, he did not physically occupy it for two years, thus he cannot claim the exclusion.

Sale of Home by U.S. Citizens Temporarily Working Abroad



Like-Kind Exchanges—Tangible Property

General Rule for Qualifying Property

Tangible personal and real property held for business or investment may qualify. The rules are rigid for all tangible personal property and flexible for all real property. Inventory and personal-use property do NOT qualify. Certain intangible property may qualify.



Examples: Real for real is OK (e.g., timberland for a bowling alley). Tangible personal for tangible personal may be OK (e.g., printer for a computer is OK since both properties fall within the same General Asset Class described below; a computer for a delivery truck is NOT OK since they fall within different General Asset Classes.) Personal for real, or vice versa, is NOT OK (e.g., delivery truck for a warehouse). Inventory for anything is NOT OK (e.g., computer held for resale in exchange for a computer used in an accounting department). Personal-use property for anything is NOT OK (e.g., a principal residence for a rental home).




General Asset Classes for Tangible Personal Property

Rev. Proc. 87-56, [1987-2 C.B. 674] describes types of depreciable tangible personal property that frequently are used in businesses.




Personal property within the same Asset Class qualifies for Code Sec. 1031 treatment, if used for business or investment purposes.


Industrial steam and electric generation and/or distribution systems00.4

Vessels, barges, tugs and similar water-transportation equip., except those used in marine construction

00.28

Trailers and trailer-mounted containers00.27

Tractor units for use on public roads00.26

Railroad cars and locomotives, except those owned by RR transportation cos.00.25

Heavy general purpose trucks00.242

Light general purpose trucks00.241

Buses00.23

Automobiles and taxis00.22

Airplanes (airframes & engines), except those used in commercial or contract carrying of passengers or freight, and all helicopters (airframes & engines)

00.21

Data handling equipment, except computers00.13

Information systems (computers and peripheral equipment)00.12

Office furniture, fixtures, and equipment00.11

DescriptionAsset Class #:



Like-Kind Exchanges—Intangible Property

Code Sec. 1.1031(a)(2) allows Code Sec. 1031 application to exchanges of intangible personal property that occur after 4/10/91.

Types of Code Sec. 197 intangible personal property

Intangible personal property includes: copyrights, covenants not to compete, formulas, franchises, goodwill, patents, processes, trademarks or trade names.



Code Sec. 197 Property that Qualifies for Code Sec. 1031 TreatmentNo General Asset Classes are provided for Code Sec. 197 property. To qualify, the Code Sec. 197 property must be of the same nature or character (e.g., a copyright for a patent is NOT OK; it must be a patent for a patent, or a copyright for a copyright). In addition, the nature or character of the underlying property to which the Code Sec. 197 relates must be like-kind (e.g., a patent on a factory machine for a patent on an airplane engine is NOT OK; however, a patent on an airplane engine for a patent on a helicopter engine IS OK).

Like-Kind Exchanges—Intangible Property



Like-Kind Exchanges—Tax Treatment for Gain or Loss

Mandatory RuleA portion of realized gain or loss may be recognizable. Deferral of any remaining gain or loss is mandatory, not elective. Here are the rules for recognizing gain or loss:

Code Sec. 1031 recognized gain = The lesser of: 1. Realized gain (i.e., FMV of all consideration received –

basis of all consideration given – depreciation recapture,if any)

2. Net boot received (i.e., FMV of boot received - basis ofboot given)



Code Sec. 1031 losses are only recognized when boot is given with a FMV below basis. Depreciation recapture is always taxable immediately as ordinary income in a gain recognized situation.




Boot defined

Boot is cash or other property received or given in a Code Sec. 1031 exchange that is not “like-kind.” For example, if land is exchanged for land, and a truck is included in the exchange, the truck is boot. Conversely, if a truck is exchanged for a truck, and land is included in the exchange, the land is boot. Cash is always boot.




Net boot received (NBR)

“Net boot received” however is a tricky concept. Generally, 3 rules apply to NBR: 1. Mortgage relief may be offset by any boot given, except

boot in rule 3 below.2. Mortgage assumptions may offset only mortgage relief.3. The basis of inventory, stock and other intangible

property given may not offset the FMV of any bootreceived.




Review the following examples below to grasp these rules.

Net Boot Received Computations:

3211 & 2Rule #

100NBR100NBR40NBR40NBR= NBR

(60)Stock(60)Mtg. Ass.(60)Cash(60)Mtg. Ass.- Given

100Cash100Cash100Mtg. Relief100Mtg. ReliefRec’d

Example 4Example 3Example 2Example 1


Chapter 11, Exhibit 12e


Recognized gain or loss from boot given = [FMV – Basis], regardless of realized gain or loss on the Code Sec. 1031 exchange. [Reg. 1.1031(d)-1(e)].


Chapter 11, Exhibit 12f


Like-Kind Exchanges—Time Limitations

Time LimitationTwo time limitations govern like-kind exchanges under the Starker rule (named after a landmark court case):

1. Identification requirement. Like-kind property to be

received must be identified within 45 days of the date that the like-kind property is given.

2. Receipt requirement. Like-kind property must be

received within 180 days of the date that the like-kind property is given.



Starker transactions: “Giving Before Receiving” May Be OK

Giving like-kind property and subsequently receiving like-kind property would qualify for Code Sec. 1031 if the 45-day and 180-day time constraints were met. This is known as a “Starker transaction.”

Like-Kind Exchanges—Starker Transactions



Reverse-Starker transactions: “Receiving Before Giving” NOT OK Receiving like-kind property before giving like-kind property is known as a “reverse-Starker” transaction. IRS TAKES THE POSITION THAT Code Sec. 1031 DOES NOT APPLY TO REVERSE-STARKER TRANSACTIONS! [Preamble to final regulations, 56 Fed. Reg. 19933 (5/1/91)] Thus, in a two-party exchange where like-kind property is exchanged at different times, one party may qualify for Code Sec. 1031 while the other party may not!

Like-Kind Exchanges—Reverse Starker Transactions



Techniques involving leasehold interests, options to purchase, or qualified intermediaries may be used to avoid the reverse-Starker problem.

Rev. Proc. 2000-37 creates a safe harbor for certain post-September 14, 2000 reverse Starker transactions. This involves “parking” the properties to be exchanged with an “exchange accommodation titleholder’ until a qualified exchange can occur.

Like-Kind Exchanges—Avoiding Reverse Starkers



Like-Kind Exchanges—Holding Period Rules

The holding period of like-kind property and boot are:

1. Like-kind property received. Same as the holding period of the like-kind property given.

2. Boot received. Begins on the day AFTER receipt.

Chapter 11, Exhibit 14


Involuntary Conversions—What Qualifies

Qualified Events

Code Sec. 1033 applies to involuntary conversions occurring through casualty, theft or condemnation. A casualty qualifies for special tax treatment if it is caused by some sudden event such as fire, storm or shipwreck. Termite damage would not qualify. A condemnation qualifies if there is confirmation that property is going to be taken for public purposes. News reports are not deemed to be confirmations.



Mandatory/Elective RulesThe nature of the replacement property dictates whether Code Sec. 1033 is mandatory or elective: 1. Like-kind replacement. If the award is like-kind replacement, gains but NOT losses must be postponed. 2. Dissimilar replacement. If the award is cash or other

NON-like kind replacement, Code Sec. 1033 may be elected for gains but NOT losses.




Qualifying Like-Kind PropertyCode Sec. 1033 is more restrictive than Code Sec. 1031, except for the replacement of condemned real property. Generally, Code Sec. 1033 replacement property must be used in substantially the same way as the involuntary conversion property.

Real for real is not always OK; (e.g., timberland - a bowling alley, unless one of the real properties had been condemned. Only condemned real property gets the same like-kind flexibility afforded Code Sec. 1031 property)Personal for personal is not always OK; (e.g., delivery truck business - car; however a delivery truck for a delivery truck, or a business car for a business car, is OK.)




Involuntary Conversions—Time Limitations

Two time limitations govern like-kind replacement of involuntary conversions property:

1. Earliest date to replace involuntary conversion. The earlier of:

(a) Date of disposition of the involuntary conversion property; or

(b) Earliest date of threat of disposition. (Note that casualties and thefts occur "suddenly," therefore (b) would apply only to condemnations.)



2. Latest date to replace involuntary conversion. Like-kind property must be received or purchased:

(a) Condemned real property. Within 3 years after the end of the taxable year in which gain is first realized.

(b) All other qualified property. Within 2 years after the end of the taxable year in which gain is realized for:

(i) Real casualty or theft property;

(ii) Personal property.


Involuntary Conversions—Time Limitations


Involuntary Conversions—Holding Period Rules

The holding period of like-kind property and boot are the same as under Code Sec. 1031:

1. Like-kind property received. Same as holding period of the involuntarily-converted property.

2. Non like-kind property received. Begins on the day AFTER receipt.



Involuntary Conversions—Template for Problem Solving

(a) Ins. Proceeds 100 100 100

(b) FMV replacement prop. 75 75 175

(c) AB old prop. 85 55 55

(d) = (a) – (c) Realized gain 15 45 45

(e) = (a) –(b) Limit on recognized gain 25 25 0 (cannot be negative)

(f) = < of (d) or (e)

Recognized gain 15 25 0

(g) = (d) – (f) Postponed gain 0 20 0

(h) = (b) – (g) AB new property 75 55 175



Installment Method—Eligible Property


The installment method applies to gains (but not losses) from the sale of certain property where the seller will receive at least one payment after the year of sale. However, the installment method is not available for the following property:

Inventory. Stock or securities traded on an established market. Depreciation recapture from Code Sec. 1245 or Code

Sec. 1250 property.


Installment Method—Four-Step Computation


Installment method computations require four steps:

1. Allocate installment payments between principal and interest.

2. Compute ordinary income (“OI”) and Code Sec. 1231 gain. (If the property had been held long-term for investment purposes, rather than business purposes, then the gain would be classified as a long-term capital gain (LTCG), rather than a Code Sec. 1231 gain.)

3. Compute the gross profit %.

4. Compute recognized gain on the down payment and deferred gain on the installment payments.


Installment Method—Example

FACTS:

A tract of land is sold under the following terms:

1. Date of contract: .........................................................……11/11/x1

2. Sales price of land: ..…………………………….....……....$50,000

3. Seller’s original purchase price: ..........................................$38,000

4. Terms: $8,000 cash down; 8% compounded semiannually (meets AFR requirements), resulting in 6 payments of $8,012 due on 5/11 and 11/1.

QUESTION: What are the tax consequences to seller in 20x1 – 20x4?



Installment Method—Solution Step One SOLUTION:

STEP 1: Allocate $8,012 installment payments between principal and interest.

($42,000 installment loan = $50,000 sales price - 8,000 down payment)

(a) (b) (c) =

(a) x (8% 2)*

(d) =

(b) - (c)

(e) =

(a) - (d)

Payment Due Date

Loan Beg. Balance

Installment Received

Interest

Income

Principal Payment

Loan End. Balance

5/11/x2 42,000 8,012 1,680 6,332 35,668

11/11/x2 35,668 8,012 1,427 6,585 29,083

5/11/x3 29,083 8,012 1,163 6,849 22,234

11/11/x3 22,234 8,012 889 7,123 15,111

5/11/x4 15,111 8,012 604 7,408 7,703

11/11/x4 7,703 8,012 308 7,703 0

* (8% is by 2 because interest is compounded semi-annually.)



Installment Method—Solution Step One

STEP ONE: CONTRACT INTEREST RATE

The contract interest rate would be divided by two if payments were received by the seller semi-annually. If installments were monthly, divide the rate by 12 and show 12 rows of computations; if quarterly installments, divide by 4, and so on.



Imputed interest rate

Imputed interest computations would have been required if:

1. The installment contract price exceeded $3,000; AND

2. The interest rate charged was less than the applicable federal rate. [Sects. 483 and 1274.]

This would require a slight modification to the illustration above -- i.e., column (c) would be based on the AFR rate, not the 8% contract rate. The rest of the schedule would flow as shown above.

Note that the interest portion of annual installment payments must be computed using semi-annual compounding. [Secs. 1274(a), 1273(a) and 1272(a)]

Installment Method—Solution Step One



Installment Method—Solution Step Two

12,000 Deferred gain(i)=(g) - (h)

N/A Ord. income from Code Sec. 1245 depr’n. recapture(h)

12,000 Realized gain = Amount realized -seller’s basis(g)=(c) - (f)

38,000= Seller’s adjusted basis(f)=(d) - (e)

N/A- Accumulated depreciation (e)

38,000 Seller’s original cost(d)

50,000= Amount realized(c)=(a)+(b)

42,000+ Installment note payable to seller(b)

8,000 Cash down payment(a)

STEP 2: COMPUTE DEFERRED GAIN



Installment Method—Solution Step Three

STEP 3: COMPUTE GROSS PROFIT %

(j) = (a) + (b) Contract Price =

Cash Down Payment + Installment N/P

50,000

(k) = (i) (k) GP % = Deferred gain Contract Price 24%



Installment Method—Solution Step Four


STEP 4: COMPUTE RECOGNIZED GAIN

Year Principal Received Gross Profit % Recognized Gain

‘x1 $8,000 (down payment) 24% 1,920

‘x2 $12,917 (6,332 + 6,585) 24% 3,100

‘x3 $13,972 (6,849 + 7,123) 24% 3,353

‘x4 $15,111(7,408 + 7,703) 24% 3,627

Note: “Principal received” was computed on the previous page.


Code Sec. 1245 and 1250 Depreciation Recapture. The full amount of any depreciation recapture must be recognized in the year of sale, even ifno payments are received in that year. [Code Sec. 453(i)] The remaininggain is Code Sec. 1231 gain or long-term capital gain.

Contract Price. The contract price should NOT include seller’s debtrelief (i.e., seller debt assumed by buyer).

Post-May 6, 1997 Installments on Pre-May 7, 1997 Contract. If Code Sec. 1231 property (or capital gain property) is sold under an installmentsales contract entered into prior to May 7, 1997 installments receivedafter May 6, 1997 are the lower rate (i.e., 10%, 15%, 20%, or 25%rates) under the new law. Of course, if the property consists of“collectibles, then the maximum capital gain rate is 28% under current law.

Installment Method—Solution Step Four


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