Chapter 11 Property Dispositions ©2006 South-Western Kevin Murphy Mark Higgins Kevin Murphy Mark Higgins

Chapter 11Chapter 11

Property DispositionsProperty Dispositions

©2006 South-Western©2006 South-Western©2006 South-Western©2006 South-Western

Kevin MurphyKevin MurphyMark HigginsMark Higgins

Kevin MurphyKevin MurphyMark HigginsMark Higgins

Transparency 11 -2Transparency 11 -2© 2006 South-Western© 2006 South-Western

Under the capital recovery concept, a property’s basis may be recovered before any taxable income is realized from disposal of property.

No income or loss is recognized for tax purposes until it has first been realized.

Concept ReviewConcept Review


Property DispositionProperty DispositionProperty DispositionProperty Disposition

Amount realized from dispositionless: Adjusted basis of property

Realized gain (loss)less: Allowed deferral

Recognized gain (loss)


Amount RealizedAmount Realized

Amount realized is gross sales price less selling expenses.Gross sales price is the amount received by

the seller from the buyer and includes Cash and FMV of property or services received Seller’s debt assumed by or paid by the buyer

Gross sales price is decreased by amounts given to the buyer by the seller Buyer’s expenses paid by or assumed by the seller


Effect of Debt AssumptionEffect of Debt Assumption

Assumption of debt is treated as a realization of income similar to paying or receiving cashAssumption of the seller’s debt increases

sales price (as if buyer paid cash)Assumption of debt by the seller decreases

the sales price (as if buyer received cash)


Character of Gain or LossCharacter of Gain or Loss

Amount realized from dispositionless: Adjusted basis of property

Realized gain (loss)less: Allowed deferral

Recognized gain (loss)

Ordinary Section 1231 Capital Personal Use

Character of gain (loss)

GainsLoss not deductible


Capital Gains and LossesCapital Gains and Losses

A capital asset is “any asset other than inventory, receivables, copyrights, assets created by the taxpayer, and depreciable or real property used in a trade or business.”

A collectible gain or loss results from the sale or exchange of works of art, gems, metals, antiques, rugs, stamps, wine, etc. held more than 12 months.


Capital Gains and LossesHolding Period

Capital Gains and LossesHolding Period

The holding period for capital assets is how long the taxpayer owned the asset.Long-term means the asset was held for

more than 12 months.Short-term means the asset was held for

< 12 months.

Determining holding period is the first step in determining tax treatment.


Capital Gains and LossesNetting Procedures


The following are treated as long-term gains and losses for the netting procedure

Collectible gains and losses

Gains on qualified small business stock

Unrecaptured Section 1250 gain




Long-term gains netted againstLong-term losses

Net Long-termGain or Loss

Short-term gains netted againstShort-term losses

Net Short-termGain or Loss

=

=




If one is a loss and one is a gain, then:

If both are losses or both are gains, no further netting is done.

Net Short-term Gain or Lossnetted against

Net Long-term Gain or Loss

Net CapitalGain or Loss=


Tax Treatment for Net Long-term Gain

Individual Taxpayers


Individual Taxpayers Net long-term gain (minus net

collectibles gain, gain on qualified small business stock, and unrecaptured Section 1250 gain) is taxed at a maximum rate of 15%

5% if marginal tax rate < 15%


Adjusted Net Capital Gains (ANCG)

Adjusted Net Capital Gains (ANCG)

Are taxed at the 15% or 5% rates.

ANCG = NLTG - [Net Collectible Gn + Small Business Gain - NSTCL - LTL carryovers]* - unrecaptured Sec. 1250 gain + Eligible Dividend Income

* called: “28% rate gain”


Collectibles held more than 12 months are taxed at a maximum rate of 28%.

50% of the gain on qualified small business stock is excluded, the remainder taxed at a maximum rate of 28%.

Unrecaptured Section 1250 gain is taxed at a maximum rate of 25%.






ExampleExample

Juan has the following capital gains and losses in the current year:

Short-term capital loss $ (2,000)

Long-term capital gain 12,000

Long-term capital loss carryover (5,000)

Collectibles gain 10,000


ExampleExample

Short-term:

Short-term capital loss $ (2,000)

Long-term:

Collectibles gain $10,000

Long-term capital gain 12,000

Long-term capital loss c/o ( 5,000) Long-term capital gain $ 17,000

Net long-term capital gain $ 15,000


ExampleExample

Results:

“28% rate gain” = ($10,000 -$5,000 - $2,000)

= $3,000

ANCG = $15,000 - $3,000 = $12,000

NLTCG is added to taxable income

Net capital gain, taxed at 15% = $12,000

Collectibles gain, taxed at 28% = $3,000


Tax Treatment for Net Short-term Gain


Tax Treatment for Net Short-term Gain

Individual Taxpayers Net short-term capital gain is taxed as

ordinary income (i.e., taxpayer’s marginal tax rate).


Gain Treatment for Corporations

Gain Treatment for Corporations

Corporations do not receive special treatment for capital gains.


Tax Treatment for Net LossTax Treatment for Net Loss

Net Capital LossIndividuals may use only $3,000 to offset

other income Excess loss is carried forward indefinitely and

retains its short term or long term class for netting purposes

Corporations cannot deduct a net capital loss Excess loss carried back 3 then forward 5

years to offset capital gains


Qualified Small Business Stock


Qualified stock Held for more than 5 yearsPurchased directly from corporation

Corporation with gross assets < $50 million

Purchased after 8/10/93


Capital Gain Exclusion onSmall Business Stock

Capital Gain Exclusion onSmall Business Stock

Up to 50% of gain may be excludedLimited to the greater of

10 times basis in the stock, or $10 million for each small business

Exclusion is based on a 28% rate



Rollover Provision


Rollover Provision Individual taxpayers may rollover gain on

Qualified Small Business StockHeld more than 6 monthsReplaced with other small business stock

purchased within +/- 60 days

Basis in new stock is reduced by deferred gain

Must recognize gain if the gain realized is more than the cost of the replacement stock


Planning StrategiesPlanning Strategies

Net Capital Gain positionSell assets with unrealized losses

Net Capital Loss positionSell assets with unrealized gains Optimize at $3,000


Planning StrategiesPlanning Strategies

Worthless SecuritiesWorthlessness deemed to occur on the last

day of the yearRealized loss = basis in the worthless

security

Basis determinationFIFOSpecific identification


Section 1231 AssetDefinition

Section 1231 AssetDefinition

Asset used in a trade or business not for investment

Held long term


Section 1231Section 1231

Net Section 1231 gains may be allowed capital gain treatment even though they arise from “ordinary” assets.

Net Sec. 1231 losses are ordinary.

This is the best of both worlds!


Section 1231 NettingSection 1231 Netting

1st Step:

2nd Step:

Net all business casualty gains and losses

Net all other Sec. 1231gains and losses

All gains and lossesare ORDINARY

gain

gains are taken to Step 3

loss

loss

gain


Section 1231 NettingSection 1231 Netting

Gains from Step 2

3rd Step: Apply lookback rule

Remaining Sec. 1231 gain is treated as a net long-term capital gain netted with

other capital gains and losses

Gains are ORDINARYto the extent of any

previous Sec. 1231 losses


Section 1231 Netting ResultsSection 1231

Netting Results

Net Section 1231 gain is classified as long-term capital gainLookback rule may reclaim some gains as

ordinary to the extent of Section 1231 loss reported in

the previous 5 years

Net Section 1231 loss is classified as ordinary loss


Section 1231Disposition of Rental

Activities

Section 1231Disposition of Rental

Activities Disposition of rental property held for

the production of income (investment) yields capital gain or loss

Disposition of rental property used in a trade or business yields Section 1231 gain or loss


Depreciation RecaptureDepreciation Recapture

Prevents taxpayers from receiving the dual benefits of a depreciation deduction and special Section 1231 gain treatment

I knew it was too good to be true!


Depreciation RecaptureDepreciation Recapture

Applies to Section 1231 gain property only

Requires gains to be treated as ordinary to the extent of prior depreciation deductions


Depreciation RecaptureSection 1245


Requires full recapture of all depreciationGains are treated as ordinary income to

the extent of any depreciation taken

Any gain in excess of depreciation is netted under Section 1231




Applies to Depreciable personal property andNonresidential real estate placed in service

between 1981 and 1986 and depreciated under ACRS




Requires partial recapture of depreciationGains are treated as ordinary income to

the extent of depreciation taken over straight-line amount

Any gain in excess of depreciation in netted under Section 1231




Applies to depreciable real property Not covered by Section 1245 and Not depreciated using the straight-line

method Eliminates most MACRS realty


Unrecaptured Section 1250 Gain

Unrecaptured Section 1250 Gain

Requires that the portion of the gain attributable to depreciation that is not Section 1250 recapture is taxed at a rate of 25%.

Applies to depreciable real property sold after 5/7/97.

Any gain not attributable to depreciation (in excess of original cost) is a Section 1231 gain taxed at 15%.


End of Chapter 11End of Chapter 11

Documents

Chapter 11 Property Dispositions ©2006 South-Western Kevin Murphy Mark Higgins Kevin Murphy Mark Higgins