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PROPERTY TRANSACTIONS: CAPITAL GAINS & LOSSES (1 of 2)

PROPERTY TRANSACTIONS: CAPITAL GAINS & LOSSES (1 of 2). Determination of gain or loss Basis considerations Definition of a capital asset Tax treatment for capital gains and losses of noncorporate taxpayers Tax treatment for capital gains and losses of corporate taxpayers.

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PROPERTY TRANSACTIONS: CAPITAL GAINS & LOSSES (1 of 2)

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  1. ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  2. PROPERTY TRANSACTIONS: CAPITAL GAINS & LOSSES (1 of 2) • Determination of gain or loss • Basis considerations • Definition of a capital asset • Tax treatment for capital gains and losses of noncorporate taxpayers • Tax treatment for capital gains and losses of corporate taxpayers ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  3. PROPERTY TRANSACTIONS: CAPITAL GAINS & LOSSES (2 of 2) • Sale or exchange • Holding period • Justification for preferential treatment of net capital gains • Tax planning considerations • Compliance and procedural considerations ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  4. Determination of Gain or LossGain/Loss Realized (1 of 2) • Realized gain or loss • Amount realized less the assets’ adjusted basis • Amount realized Money + FMV of property received + Taxpayer’s debt assumed by buyer - Costs of sale Amount Realized ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  5. Determination of Gain or LossGain/Loss Realized (2 of 2) • Determination of basis Original basis (cost) + Capital additions (e.g., improvements) - Capital recoveries (e.g., depreciation) Adjusted basis ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  6. Determination of Gain or LossGain/Loss Recognized • Recognized gain or loss may be less than realized gain or loss due to special statutory provisions • E.g., like-kind exchanges, involuntary conversions ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  7. Basis Considerations • Cost of acquired property • Property received as a gift • Property received from a decedent • Property converted from personal use to business use • Allocation of basis ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  8. Cost of Acquired Property(1 of 2) • Generally the beginning basis of an asset • Uniform capitalization rules • Requires 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 ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  9. Cost of Acquired Property(2 of 2) • Capitalization of interest • Construction period debt capitalized • Applies to real estate and assets with class life ≥ 20 years • Identification problems • Specific identification may not be possible • Tax law requires a FIFO approach ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  10. Property Received as a Gift(1 of 2) • Gain basis • Donor’s basis plus a gift tax adjustment Gift tax paid X (FMV at gift time – donor’s basis) Amount of gift • Loss basis • Lesser of • Gain basis or • FMV at date of gift ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  11. Property Received as a Gift(2 of 2) • Gain basis used to calculate depreciation • Depreciation subtracted from both gain and loss basis upon disposition ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  12. 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 6 months • AVD only available if FMV of total assets decreased over the 6-month period ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  13. Property Converted from Personal Use to Business Use • Basis is lower of personal use adjusted basis or property’s FMV at conversion • Prevents depreciation on decline in value when asset was personal-use asset ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  14. Allocation of Basis(1 of 2) • Basket purchase • Acquisition cost must be allocated to individual assets on basis of relative FMV • Common costs • Capitalized and allocated based on relative FMV ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  15. Allocation of Basis(2 of 2) • Nontaxable stock dividends received • Allocate basis of old shares to basis of old shares plus new shares • Nontaxable stock rights received • If FMV of stock rights < 15% of FMV of stock, basis is $0 unless elect to allocate • Must allocate if value ≥ 15% of stock’s FMV ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  16. Definition of a Capital Asset • Capital asset defined by §1221 • Definition is other than what is listed as NOT a capital asset, including • Inventory, depreciable property, real property used in a trade or business • Influence of the courts • Other IRC provisions relevant to capital gains and losses ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  17. Influence of the Courts • Corn Products Refining CO doctrine • Created nonstatutory exception to definition of capital asset when asset purchased for business purposes • Arkansas Best Corporation • Limited Corn Products doctrine • Stock is outside definition of capital asset • Motivation for acquiring assets is irrelevant ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  18. Other IRC Provisions Relevant to Capital Gains and Losses • Dealers in securities • Securities treated as inventory • Real property subdivided for sale • Non-dealers in real estate can treat as capital asset • Dealers treat as inventory • Nonbusiness bad debt • Deductible as short-term capital loss ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  19. Tax Treatment for Capital Gains & Losses of Noncorp Taxpayers • Capital gains • Adjusted net capital gains (ANCG) • Capital losses ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  20. Capital Gains(1 of 2) • Assets held ≤ 1 year are short-term • Assets held > 1 year are long-term • Net capital gain (NCG) • Excess of net LTCG over net STCL • NCG may receive favorable tax treatment • Must first determine STCG, STCL, LTCG, and LTCL ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  21. 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 ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  22. Adjusted Net Capital Gains (ANCG) • Four types of net capital gains • Collectibles gain • 50% of gain from sale of §1202 stock • Unrecaptured §1250 gain • All other LTCGs • Group 4 gets 0% or 15% rate • Groups 1 & 2 taxed at max of 28% • Group 3 taxed at max of 25% ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  23. 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 (0% or 15%) ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  24. Tax Treatment for Capital Gains & Losses of Corp Taxpayers • Corporations do NOT receive preferential tax rates on NCGs • Corps cannot deduct net capital losses • Corps carryback NCLs 3 years and then carryforward 5 years • Capital loss carryovers are treated as STCLs ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  25. Sale or Exchange • Worthless securities • Retirement of debt instruments • Options • Patents • Franchises, trademarks, and trade names ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  26. 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 corporations • Not considered a capital asset ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  27. Retirement Of Debt Instruments • Original issue discount • Not treated as capital gain upon retirement • Amortized over the life of the bond • Applies to cash and accrual taxpayers • Market discount bonds • Acquired on secondary market • Discount treated as ordinary income ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  28. Options • Exercised • Basis in option added to basis stock purchased • Sold or allowed to expire • Treated as sale or exchange ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  29. Patents • Gain may be treated as LTCG • Requirements 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 • Corps cannot be a “holder” ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  30. Franchises, Trademarks, and Trade Names • §1253 treats exchanges of franchises, trademarks, and trade names as exchanges of capital assets • Includes renewals ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  31. Holding Period • Property received as a gift • Property received from a decedent • Always long term • Nontaxable exchanges • Receipt of nontaxable stock dividends and stock rights ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  32. Property Received as a Gift • If donee’s adjusted basis determined by reference to donor’s adjusted basis • Donor’s holding period added to donee’s holding period • If donee’s adjusted basis is FMV at date of gift • Holding period begins on day after the date of gift ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  33. Nontaxable Exchanges • Holding period of qualified property received generally includes holding period of qualified property given up ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  34. 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 ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  35. Justification for Preferential Treatment of Net Capital Gains • Mobility of capital • Mitigation of the effects of inflation and the progressive tax system • Lowers the cost of capital ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  36. Tax Planning Considerations • Selection of property to transfer by gift • Consider annual exclusion • Unwise to gift depreciated property • Selection of property to transfer at time of death • Retain highly appreciated property until death • Sell loss property before death ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  37. Compliance and Procedural Considerations • Capital gains and losses reported by individuals on Schedule D • To improve compliance, brokers required to furnish IRS with info pertaining to each customer • Reported to taxpayer on Form 1099-B • Use Schedule D to reconcile amounts shown on Form 1099-B ©2009 Pearson Education, Inc. Publishing as Prentice Hall

  38. ©2009 Pearson Education, Inc. Publishing as Prentice Hall

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