Chapter 11 Property Dispositions Howard Godfrey, Ph.D., CPA UNC Charlotte Copyright © 2013, Dr. Howard Godfrey Edited October 27, 2013 T13F-Chp-11-1-Property-Dispositions-2013

Chapter 11 Property Dispositions

Howard Godfrey, Ph.D., CPAUNC Charlotte

Copyright © 2013, Dr. Howard GodfreyEdited October 27, 2013

T13F-Chp-11-1-Property-Dispositions-2013

Introduction Section 1231 Realized Gain-Loss Sec. 1231 Prop.

Amount Realized Sec. 1231 Netting

Debt Assumptions Recapture Character-Gain-Loss Sec. 1245 Recapture

Capital Gains & Losses Sec. 1250 Recapture

Capital Asset Definition Sec. 1245 Property

L.Term vs Short-Term Sec. 1250 Property

Netting gains & losses Unrecap. 1250 Gain

Strategies Summary

11. Property Dispositions

Introduction

Realized Gain-Loss

Amount Realized

Debt Assumptions

Sale to Related Party• Losses on sales to related parties are

disallowed– Related parties include brothers, sisters,

spouse, ancestors and lineal descendents, as well as a more-than 50% owned corporation

• If related buyer later sells property at a gain, this gain can be reduced (not below zero) by the seller’s previously disallowed loss

Loss on Sale to Relative - 1In April 2013, Pam sold stock with a cost basis of $17,000, to Lisa, her sister, for $10,000. In September 2013, Lisa sold the same shares of stock to her neighbor, Niki, for $20,000. What is Lisa's gain for 2013?a. $0 b. $3,000 c. $7,000 d. $10,000

Price received by Pam $10,000

Pam's basis in stock 17,000

Loss realized by Pam

Loss Disallowed

on sale by Pam

Loss recognized by Pam

Loss on Sale to Relative - 2

Price received by Pam $10,000

Basis to Pam 17,000

Loss realized by Pam (7,000)

Loss Disallowed

on sale by Pam (7,000)

Loss recognized by Pam $0


Price received by Lisa

Basis to Lisa

Gain realized by Lisa

Less Loss Disallowed

on sale by Pam

Gain recognized by Lisa


Price received by Lisa $20,000

Basis to Lisa 10,000

Gain realized by Lisa 10,000

Less Loss Disallowed

on sale by Pam (7,000)

Gain recognized by Lisa $3,000


Amount realized from disposition

less: Adjusted basis of property

Realized gain (loss)

less: Allowed deferral

Recognized gain (loss)

Property Disposition

Amount RealizedAmount 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 seller

Effect of Debt Assumption• Assumption of debt is treated as a

realization of income similar to paying or receiving cash–Assumption 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)

Types of Dispositions • Sale – seller receives cash or cash

equivalents in return for asset• Exchange – taxpayer receives property

other than cash or cash equivalents in return for property transferred to the other party

• Involuntary conversion – complete or partial destruction due to events not under control of taxpayer (condemnations, thefts, and casualties)

• Abandonment – property is permanently withdrawn from use (loss = basis of asset)

+ Cash Received

+ FMV of property received

+ Seller’s liabilities assumed by the buyer

- Buyer’s liabilities assumed by the seller

- Selling expenses

= Amount Realized

Amount Realized

Recognized Gain or Loss • Almost all realized gains are

recognized (taxable)• Losses are usually only recognized

(deductible) if they are– Incurred in a business– Incurred in an investment activity– Casualty or theft losses

Allan’s Gains and Losses-1Allan received $5,000 cash and an auto worth $15,000 in exchange for a lot that was encumbered by a $13,000 liability that the buyer assumed. a. What is the amount realized on this sale? b. If Allan had a basis of $34,000 in the land, what is his gain or loss on the sale?

Allan’s Gains and Losses-2c. If Allen has owned the land for five years as an investment, what is the character of the gain or loss?

d. How would your answer to (c) change if the land had been used by Allan’s business as a parking lot?

Allan’s Gains and Losses-13a. $5,000 + $15,000 + $13,000 = $33,000 amount realized.b. $33,000 - $34,000 = $1,000 lossc. Long-term capital loss.

d. If the property had been used in a business, it would be Section 1231 property and it would be a Section 1231 loss.

Cash received 5,000$ Other Prop. Received- Auto 15,000 Mortgage assumed by buyer 13,000 Total Consideration Received 33,000 Expenses of sale

Sales commission - Other selling expenses -

Total expenses of sale - Amount Realized 33,000 Cost (basis) of property (34,000)Gain (Loss) (1,000)$

Allan's Transactions

Capital Gains & Losses

Capital Asset Definition

Long-Term vs Short-Term

Gain-and-Loss Netting

Planning Strategies

Concept ReviewUnder 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.

Character of Gain or LossCharacter of Gain or LossAmount 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 LossesA 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 Losse Holding PeriodThe 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 Losses Netting 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

Capital Gains and LossesNetting Procedures

Long-term gains netted againstLong-term losses

Net Long-termGain or Loss

Short-term gains netted againstShort-term losses

Net Short-termGain or Loss

=

=

Capital Gains and LossesNetting Procedures

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=

Four One Buckets Bucket

Net Net NetShort-T. Long-T. Gain (Loss) Return

Yr 1 STCG $4,000

Yr 1 STCL ($2,400)

Yr 1 LTCG $4,000

Yr 1 LTCL ($3,500)

Net Gain

Gain taxed at ordinary rates

Gain taxed at capital gains rates

Stock Trans.

Barb-1 TwoBuckets



Yr 1 STCG $4,000

Yr 1 STCL ($2,400) $1,600

Yr 1 LTCG $4,000

Yr 1 LTCL ($3,500) $500

$2,100

$2,100

$1,600

$500

Net Gain

Gain taxed at ordinary rates

Gain taxed at capital gains rates

Stock Trans.

Barb-2 TwoBuckets

Tax Treatment for Net Long-term GainIndividual 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)Are taxed at the 15% or 5% rates.ANCG = NLTG - [Net Collectible Gain + Small Business Gain - NSTCL - LTL carryovers]* - unrecaptured Sec. 1250 gain + Eligible Dividend Income

* called: “28% rate gain”

Tax Treatment for Net Long-term GainIndividual Taxpayers

–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%.

Short-term capital loss ($2,000)

Long-term capital gain $12,000

Long-term capital

loss carryover ($5,000)

Collectibles gain $10,000

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

Example Short-term:S.T. capital loss ($2,000)

Long-term:Collectibles gain $10,000L.T. capital gain $12,000L.T. capital loss c/o ($5,000)

L.T. capital gain $17,000Net L.T. capital gain $15,000

ExampleResults:

“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

Individual Taxpayers •Net short-term capital gain is taxed as ordinary income (i.e., taxpayer’s marginal tax rate).

Gain Treatment for Corporations

•Corporations do not receive special treatment for capital gains.

Tax Treatment for Net Loss•Net Capital Loss

– Individuals 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

$100,000

Big had the following:

$3,000

($9,000)

Taxable income?

Big Corp's taxable income before

Long-term capital gain

Short-term capital loss

capital gains & losses

$100,000

Big had the following:

$3,000

($9,000)

$100,000 Taxable income?

Big Corp's taxable income before



capital gains & losses

O'Donnell Corp. had these capital gains & (losses):

2009 2010 2011 2012 2013

$30,000 ($20,000) $15,000 ($30,000) $60,000

($20,000) $20,000

$10,000

Corporate Capital Loss Carryover

2009 2010 2011 2012 2013

$30,000 ($20,000) $15,000 ($30,000) $60,000

($20,000) $20,000

$10,000 ($10,000) ($15,000) $25,000

($5,000)$5,000 ($5,000)

$0

Net capital gain for 2013 is: $55,000

Corporate Capital Loss Carryover



Yr 1 STCG $0

Yr 1 STCL ($2,400)

Yr 1 LTCG $400

Yr 1 LTCL ($3,500)

Deduct STCL

Deduct LTCL

Carry over to next year

Deduction limit this year

Bob-1

TwoBuckets



Yr 1 STCG $0

Yr 1 STCL ($2,400) ($2,400)

Yr 1 LTCG $400

Yr 1 LTCL ($3,500) ($3,100)

($5,500)

($2,400)

($600)

($3,000)

($2,500)

Deduct STCL

Deduct LTCL

Carry over to next year

Deduction limit this year

Bob-2

TwoBuckets

Sharon’s Capital Asset Sales-1Sharon has salary income of $68,000, a net short-term capital gain of $15,000, and a net long-term capital loss of $24,000. What is Sharon’s adjusted gross income if she has no other income items?

Sharon-Cap. Asset Sale Details Capital Ordinary Return

Salary Income (Other AGI) $68,000 $68,000

Net L.T. capital gain or loss 15,000

Net S.T. capital loss or loss (24,000)

Gain (loss) non-cap. asset:

Gain (Loss)-bus. use asset

Sec. 1231 gain (Cap. Gain.)

Net capital gain or loss

Cap. Loss limited to $3,000 3,000

Net capital gain or loss in AGI

Adjusted Gross Income

Carryforward

Sharon-Cap. Asset Sale Details Capital Ordinary Return

Salary Income (Other AGI) $68,000 $68,000

Net L.T. capital gain or loss $15,000

Net S.T. capital loss or loss (24,000) (9,000)

Gain (loss) non-cap. asset:

Gain (Loss)-bus. use asset

Sec. 1231 gain (Cap. Gain.)

Net capital gain or loss (9,000)

Cap. Loss limited to $3,000 (3,000)

Net capital gain or loss in AGI (3,000)

Adjusted Gross Income $65,000

Carryforward ($6,000)

Qualified Small Business Stock• Qualified stock

– Held for more than 5 years– Purchased directly from corporation

• Corporation with gross assets < $50 million– Purchased after 8/10/93

• Up to 50% of gain may be excluded– Limited to the greater of

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

– Exclusion is based on a 28% rate

Qualified Small Business Stock Rollover Provision• Individual taxpayers may rollover gain on

Qualified Small Business Stock–Held more than 6 months–Replaced 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 Strategies• Net Capital Gain position

– Sell assets with unrealized losses• Net Capital Loss position

– Sell assets with unrealized gains – Optimize at $3,000 (deduct $3,000 from Ord. Inc.)

• Worthless Securities– Worthlessness deemed to occur on the last day of

the year– Realized loss = basis in the worthless security

• Basis determination– FIFO– Specific identification

Section 1231

1231 Property

1231 Netting

Section 1231 Asset Definition• Asset used in a trade or

business –not for investment

• Held long term

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

$2,000

($8,000)

($4,000)auto (owned 2 years)

Adjusted gross income?

Jill had AGI of $100,000, before these transactions.



Loss on sale of business

$2,000

($8,000)

($4,000)

$93,000

auto (owned 2 years)


Jill had AGI of $100,000, before these transactions.



Loss on sale of business

$2,000

($8,000)

$4,000 land (owned 2 years)


Jack had AGI of $100,000, before these transactions.



Gain on sale of business

$2,000

($8,000)

$4,000

$98,000

land (owned 2 years)


Jack had AGI of $100,000, before these transactions.



Gain on sale of business

Section 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 NettingGains 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 Results•Net Section 1231 gain is classified as long-term capital gain

–Lookback 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

• 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

Deprec. Recapture

Section 1245 Recapture

Section 1250 Recapture

Section 1245 Property

Section 1250 Property

Unrecaptured 1250 Gain

Depreciation RecapturePrevents taxpayers from receiving

the dual benefits of a depreciation deduction and special Section 1231 gain treatment.

Applies to Sec. 1231 gain property onlyRequires gains to be treated as ordinary

to the extent of prior depreciation deductions

Depreciation Recapture-Section 1245• Requires full recapture of all

depreciation–Gains are treated as ordinary

income to the extent of any depreciation taken

• Any gain in excess of depreciation is netted under Section 1231

Depreciation Recapture-Section 1245

• Applies to –Depreciable personal property

and–Nonresidential real estate placed

in service between 1981 and 1986 and depreciated under ACRS

Depreciation Recapture• Depreciation recapture converts part or

all of the gain on the sale of depreciable assets to ordinary income to the extent of the reduction in basis attributable to depreciation expense previously claimed

• The amount of income recaptured as ordinary income can never exceed either the realized gain or prior depreciation deductions

• Recapture rules cannot apply to assets on which there is a realized loss

Section 1245 Full Recapture• Applies to machinery, equipment,

furniture, and fixtures (but not to buildings or structural components)

• Any gain on the sale of section 1245 property is ordinary income to the extent of all depreciation allowed or allowable for the property– Any amount expensed under section 179 is

included in the depreciation allowed– The income recaptured is the lesser of all

depreciation taken or the realized gain

Asset - Section 1245 Machine

Owner Individual

Selling Price $290,000Cost 300,000Accum. Deprec. (S/L) (60,000) Additional Dep. DDB -

Adjusted Basis

Gain

Section 1245 GainSection 1231 gain (CG?)


Owner Individual

Selling Price $290,000Cost 300,000Accum. Deprec. (S/L) (60,000) Additional Dep. DDB

Adjusted Basis 240,000

Gain 50,000

Section 1245 Gain 50,000 Section 1231 gain (CG?)


Owner Individual

Selling Price $320,000Cost 300,000Accum. Deprec. (S/L) (60,000) Additional Dep. DDB

Adjusted Basis

Gain

Section 1245 GainSection 1231 gain (CG?)

Asset - Sec. 1245 Machine

Owner Individual

Selling Price 320,000$ Cost 300,000Accum. Deprec. (S/L) (60,000) Additional Dep. DDB


Gain 80,000

Section 1245 Gain 60,000 Section 1231 gain (CG?) 20,000

Asset - Section 1250 Apartment

Owner Individual

Selling Price 250,000$ Cost 300,000Accum. Deprec. (S/L) (80,000) Additional Dep. DDB


Gain 30,000

Section 1245 GainSection 1250 gain - Section 1231 gain (CG?) 30,000

Unrecaptured 1250 gain

The next slide has an illustration of how the tax law worked for accelerated depreciation on residential real estate. However, only the straight-line method has been allowed for buildings acquired in last 25 years.Buildings bought more than 25 years ago would actually already be fully depreciated by now (shorter life used then).But this shows how it worked.

Asset - Section 1250 Apartment

Owner Individual

Selling Price 250,000$ Cost 300,000Accum. Deprec. (S/L) (80,000) Additional Dep. DDB (40,000)


Gain 70,000

Section 1245 GainSection 1250 gain 40,000 Section 1231 gain (CG?) 30,000

Depreciation Recapture-Section 1250• Requires partial recapture of

depreciation–Gains are treated as ordinary income

to the extent of depreciation taken in excess of straight-line amount

• Any gain in excess of depreciation is netted under Section 1231

Depreciation Recapture-Section 1250• 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• 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 (SP in excess of original cost) is a Section 1231 gain taxed at 15%.

Owner GailAsset Apt BldgSelling Price $390,000Cost $400,000Accum. Dep. (S/L) (60,000) Extra depreciationAdjusted Basis 340,000 Gain 50,000 Section 1245 Gain OrdinarySection 1250 Gain OrdinarySection 1231 gain UnRecap.25%Section 1231 gain Cap. Gain-15%

Owner GailAsset Apt BldgSelling Price $390,000Cost $400,000Accum. Dep. (S/L) (60,000) Extra depreciationAdjusted Basis 340,000 Gain 50,000 Section 1245 Gain Ordinary - Section 1250 Gain Ordinary - Section 1231 gain UnRecap.25% 50,000 Section 1231 gain Cap. Gain-15%

Owner GusAsset Apt BldgSelling Price $410,000Cost $400,000Accum. Dep. (S/L) (60,000) Extra depreciation - Adjusted BasisGainSection 1245 Gain OrdinarySection 1250 Gain OrdinarySection 1231 gain UnRecap.25%Section 1231 gain Cap. Gain-15%

Owner GusAsset Apt BldgSelling Price $410,000Cost $400,000Accum. Dep. (S/L) (60,000) Extra depreciationAdjusted Basis 340,000 Gain 70,000 Section 1245 Gain Ordinary - Section 1250 Gain Ordinary - Section 1231 gain UnRecap.25% 60,000 Section 1231 gain Cap. Gain-15% 10,000

Section 1231 Look-Back Rules • Net Section 1231 gains are taxed as ordinary

income to the extent of any unrecaptured net Section 1231 losses in the five preceding years

– This prevents taxpayers from generating tax savings by bunching their Section 1231 gains into one year (to receive tax-favored long-term capital gains treatment) and losses into alternate years (deducting the Section 1231 losses in full against ordinary income)

Year 1 Year 2 Year 3 Year 4

$50,000 ($45,000) $20,000 $15,000

a.

b.

c.

d. $0 $15,000

(loss)Gain or

How will she treat the $15,000 gain in yr 4?

$10,000 $5,000

$15,000 $0

Section 1250 Lookback Barbara had these Sec. 1231 gains & losses:

Ordinary Income Capital Gain

$5,000 $10,000

Added Section 291 Recapture for Corporations• Section 291 applies to corporate dispositions

of realty (Section 1250 property)• Converts to ordinary income (as Section 1250

recapture) 20% of any Section 1231 gain that would have been ordinary income if Section 1245 full recapture applied– For realty acquired after 1986, Section

1245 full recapture x 20% = Section 291 recapture

– Eliminates some of the capital gains that would otherwise be available to offset corporate capital losses

Angel CorporationAsset Office Bld

Selling Price $500,000

Cost 600,000

Accum. Depreciation (S/L) (200,000)

Extra Depreciation -


Gain 100,000

Recapture-Sec. 1250 (Excess Deprec.)

Sec. 1231 gain- before considering 291

Section 291 recapture (20% rule)

Sec. 1231 gain- after considering 291

Angel CorporationAsset Office Bld

Selling Price $500,000

Cost 600,000

Accum. Depreciation (S/L) (200,000)

Extra Depreciation -


Gain 100,000

-

100,000

20,000

80,000

Recapture-Sec. 1250 (Excess Deprec.)

Sec. 1231 gain- before considering 291

Section 291 recapture (20% rule)

Sec. 1231 gain- after considering 291

Ori

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-

$400

,000

Buy, Use and Sell Business Asset

$300,000

$400,000

SL-$50,000

Extra-$50,000

Book

Val

ue

$300

,000

Gai

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elli

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Pri

ce $

400,

000

Case 1 Case 2Buy Asset Use AssetSe

lling

Pri

ce$2

00,0

00

Ori

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al C

ost

-

$400

,000

$300,000

$200,000

Book

Val

ue

$300

,000

$100,000

Sel

lin

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rice

$40

0,00

0

Documents

Chapter 11 Property Dispositions Howard Godfrey, Ph.D., CPA UNC Charlotte Copyright © 2013, Dr. Howard Godfrey Edited October 27, 2013 T13F-Chp-11-1-Property-Dispositions-2013