chapter 5 property transactions: capital gains and losses

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Chapter 5 Property Transactions: Capital Gains and Losses

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Page 1: Chapter 5 Property Transactions: Capital Gains and Losses

Chapter 5

Property Transactions:Capital Gains and Losses

Page 2: Chapter 5 Property Transactions: Capital Gains and Losses

Learning Objectives

• Determine the realized gain or loss from the sale or other disposition of property

• Determine the amount realized from the sale or other disposition of property

• Determine the basis of property

Page 3: Chapter 5 Property Transactions: Capital Gains and Losses

Learning Objectives• Distinguish between capital Distinguish between capital

assets and other assetsassets and other assets• Understand how capital gains Understand how capital gains

and losses affect taxable incomeand losses affect taxable income• Recognize when a sale or Recognize when a sale or

exchange has occurredexchange has occurred• Determine the holding period for Determine the holding period for

an asset when a sale or an asset when a sale or disposition occursdisposition occurs

Page 4: Chapter 5 Property Transactions: Capital Gains and Losses

Determination Of Gain Or Loss

• Realized gain or loss– Amount

realized $ less the assets’ adjusted basis

Page 5: Chapter 5 Property Transactions: Capital Gains and Losses

Determination Of Gains And Losses

• Amount realized consists of money and FMV of property received plus taxpayer’s debt assumed by the buyer less costs of sale

Page 6: Chapter 5 Property Transactions: Capital Gains and Losses

Determination Of Basis Original basis (Cost)+ plus additions

(i.e., Capital improvements)

- less reductions (i.e., Depreciation)

= Adjusted basis

Page 7: Chapter 5 Property Transactions: Capital Gains and Losses

Recognized Gain Or Loss

• The amount of recognized gain or loss on disposition may be less than the realized gain or loss due to special statutory provisions

• Like-kind exchange rules•Involuntary conversions rules

Page 8: Chapter 5 Property Transactions: Capital Gains and Losses

Basis Considerations

In most cases the cost of acquired property is the basis.

Page 9: Chapter 5 Property Transactions: Capital Gains and Losses

Basis Considerations

• Original cost basis includes•Cash•FMV of other property•Debt•Transactional cost

• Uniform capitalization rules are mandated for inventory

Page 10: Chapter 5 Property Transactions: Capital Gains and Losses

Basis Considerations

• Construction period interest and taxes must be capitalized for certain “ long useful life” property

• Homogenous property– Specific identification may not be possible– Tax law requires a FIFO approach

Page 11: Chapter 5 Property Transactions: Capital Gains and Losses

Property Received As A Gift After 1921

• Donee’s adjusted basis for gain is donor’s basis plus a gift tax adjustment

• The donee’s adjusted basis for loss is the lesser of the gain basis or FMV at the date of gift

• The gain basis is used for calculating any depreciation– The amount of depreciation is subtracted from

applicable gain basis or loss basis in the event of disposition

Page 12: Chapter 5 Property Transactions: Capital Gains and Losses

Property Received From A Decedent

• Basis of inherited property– FMV at date of death, or

Alternate valuation date (AVD)• Six months from date of death or

Disposition date if not held for six month

Page 13: Chapter 5 Property Transactions: Capital Gains and Losses

Property Converted From Personal Use To Business

Use

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

Page 14: Chapter 5 Property Transactions: Capital Gains and Losses

Allocation Of Basis

• If multiple assets are acquired for a single purchase price, the acquisition cost must be allocated to individual assets on the basis of their FMV

• See example in textbook on page 5-10.

Page 15: Chapter 5 Property Transactions: Capital Gains and Losses

Definition Of Capital Assets

• For tax purposes capital assets are defined as assets other than inventory, depreciable property, or real property used in a trade or business

Page 16: Chapter 5 Property Transactions: Capital Gains and Losses

Definition Of A Capital Asset

• Influence of the courts– Corn

Products Refining CO

– Arkansas Best Corporation

Page 17: Chapter 5 Property Transactions: Capital Gains and Losses

Other Code Provisions Relevant To Capital Gains

And Losses

• Dealers usually treat securities as inventory

• Non-business bad debts are treated as short-term capital losses

• Certain taxpayers can subdivide land and sell a limited number of lots and retain capital gain treatment

Page 18: Chapter 5 Property Transactions: Capital Gains and Losses

Tax Treatment For Capital Gains And Losses Of Non-

corporate Taxpayers

• Capital gains– Net capital gains result when net long-

term capital gains exceed net short-term capital losses

• Capital losses– Net capital losses offset ordinary

income to a $3,000 maximum, with an unlimited carryover to future years

Page 19: Chapter 5 Property Transactions: Capital Gains and Losses

Long Term Capital Assets

• Capital assets held for more than 12 months.

• Tax rate for Net Capital Gains may be taxed – 5%, 15%, 25%, 28%– Be sure to read this section in the

carefully.

Page 20: Chapter 5 Property Transactions: Capital Gains and Losses

Sale Or Exchange

• Worthless securities – Securities that become totally

worthless in a tax year are treated as a capital loss on the last day of the year

Page 21: Chapter 5 Property Transactions: Capital Gains and Losses

Sale or Exchange

• Retirement of Debt Instruments

• Options

• Patents

• Franchises, Trademarks and Trade Names

• Lease Cancellation Payments

Page 22: Chapter 5 Property Transactions: Capital Gains and Losses

Holding Period

• Holding period for long-term treatment is more than 12 months

• Holding period of more than 5 years

– After December 31, 2000– Maximum rate is 18% (8% for taxpayers

whose tax rate is 15%)

Page 23: Chapter 5 Property Transactions: Capital Gains and Losses

Holding Period

• Property received as a gift– If the donee’s adjusted basis is

determined by reference to the donor’s adjusted basis, the donor’s holding period is added to the donee’s holding period

– If the donee’s adjusted basis is the FMV at date of gift, the holding period begins on the day after the date of gift

Page 24: Chapter 5 Property Transactions: Capital Gains and Losses

Holding Period

• Property received from a decedent is always subject to a long-term holding period

• Non-taxable exchanges– Property given in a tax-free exchange is added to the

holding period of the property received in the exchange

• Non-taxable stock dividends and stock rights– Generally includes the holding period of the underlying

stock

Page 25: Chapter 5 Property Transactions: Capital Gains and Losses

Justification for Preferential Treatment of Net

Capital Gains

• Mobility of capital• Mitigation of the effects of inflation

and the progressive tax system• Lower the cost of capital

Page 26: Chapter 5 Property Transactions: Capital Gains and Losses

Tax Planning Considerations

• Selection of property to transfer by gift– Decision may be influenced by annual

exclusion– Unwise to gift depreciated property

• Selection of property to transfer at time of death– Highly appreciated property should be retained

until death– Loss property should be sold before death

Page 27: Chapter 5 Property Transactions: Capital Gains and Losses

Compliance and Procedural Considerations

• Capital gains and losses are reported by individuals on Schedule D

• To improve taxpayer compliance, every broker is required to furnish the government with information pertaining to each customer.

• This is reported to the taxpayer on Form 1099-B.• Taxpayer must use Schedule D to reconcile

amounts shown on Form 1099-B