Review of Review of Property DispositionsProperty Dispositions

Dr. Richard OttDr. Richard Ott

Realized and RecognizedRealized and RecognizedGains (Losses) from Gains (Losses) from

Property Sales or ExchangesProperty Sales or Exchanges

Realized Gains (Losses)Realized Gains (Losses)

Calculation: Calculation: Amount realized [IRC §1001(b)] Amount realized [IRC §1001(b)] – Adjusted tax basis [IRC §1011]– Adjusted tax basis [IRC §1011]= Realized gain (loss) [IRC §1001(a)] = Realized gain (loss) [IRC §1001(a)]

Amount RealizedAmount Realized

Includes [IRC §1001(b)]:Includes [IRC §1001(b)]: Cash receivedCash received FMV of property receivedFMV of property received

ReceivablesReceivables ServicesServices Other propertyOther property Discharge of liabilities [Reg. §1.1001-2(a)]Discharge of liabilities [Reg. §1.1001-2(a)]

With proper adjustments for real property With proper adjustments for real property taxes, where applicabletaxes, where applicable

Adjusted Tax BasisAdjusted Tax Basis

Calculation Calculation

Initial basis [IRC Initial basis [IRC §1012 through §1015]§1012 through §1015] Adjustments to basis [IRC Adjustments to basis [IRC §1016]§1016]

= Adjusted tax basis [IRC = Adjusted tax basis [IRC §1011]§1011]

Recognized Gains (Losses)Recognized Gains (Losses)

““Except as otherwise provided in this Except as otherwise provided in this subtitle” the entire amount of any subtitle” the entire amount of any realizedrealized gains (losses) are gains (losses) are recognizedrecognized [IRC [IRC §1001(c)]§1001(c)]

Some Exceptions to IRC §1001(c) Some Exceptions to IRC §1001(c)

Corporate formations [IRC Corporate formations [IRC §351(a) and (b)]§351(a) and (b)] Related party losses [IRC §267(a)]Related party losses [IRC §267(a)] Installment sale gains [IRC §453(a)]Installment sale gains [IRC §453(a)] Wash sale losses [IRC Wash sale losses [IRC §1091(a)]§1091(a)] Tax-free reorganizations [IRC §354(a)]Tax-free reorganizations [IRC §354(a)] Partial exclusion for gain from certain Partial exclusion for gain from certain

small business stock [IRC §1202]small business stock [IRC §1202] Like-kind exchanges [IRC §1031]Like-kind exchanges [IRC §1031] Involuntary conversion [IRC §1033]Involuntary conversion [IRC §1033]

Capital versus OrdinaryCapital versus Ordinary Gains (Losses) Gains (Losses)

Capital versus Ordinary GainsCapital versus Ordinary Gains

Corporate taxpayers are taxed at the Corporate taxpayers are taxed at the same rates on net capital gains (capital same rates on net capital gains (capital gains in excess of capital losses) and gains in excess of capital losses) and ordinary gains [IRC §11]ordinary gains [IRC §11]

Individual taxpayers are taxed at more Individual taxpayers are taxed at more favorable rates on net long-term capital favorable rates on net long-term capital gains and on qualifying dividend income gains and on qualifying dividend income [IRC [IRC §1(h)§1(h)] ]

Capital versus Ordinary LossesCapital versus Ordinary Losses Corporate taxpayers can only deduct Corporate taxpayers can only deduct

capital losses against capital gains [IRC capital losses against capital gains [IRC §1211(a)] §1211(a)] Capital losses > capital gains carry back 3 Capital losses > capital gains carry back 3

years and forward 5 years to offset net capital years and forward 5 years to offset net capital gainsgains[IRC §1212(a)][IRC §1212(a)]

Individual taxpayers can only deduct Individual taxpayers can only deduct capital losses against capital gains plus capital losses against capital gains plus $3,000 per year [IRC §1211(b)] $3,000 per year [IRC §1211(b)] Capital losses not deductible in current year Capital losses not deductible in current year

carry forward indefinitely [IRC §1212(b)] carry forward indefinitely [IRC §1212(b)]

Capital versus Ordinary LossesCapital versus Ordinary Losses For both corporate and individual For both corporate and individual

taxpayers, there is no general overall taxpayers, there is no general overall limitation on the deductibility of ordinary limitation on the deductibility of ordinary losses but ordinary losses may still be losses but ordinary losses may still be subject to limitations that apply to all subject to limitations that apply to all losses such as:losses such as: Passive activity losses [IRC Passive activity losses [IRC §469]§469] Carryovers in corporate acquisitions [IRC §381]Carryovers in corporate acquisitions [IRC §381] Carryovers and certain built-in losses after Carryovers and certain built-in losses after

ownership change [IRC §382]ownership change [IRC §382]

Determining the Character of Determining the Character of Recognized Gains (Losses)Recognized Gains (Losses)

Categories of AssetsCategories of Assets

All assets fall into one of the following All assets fall into one of the following three categories:three categories: Capital assetsCapital assets IRC §1231 assetsIRC §1231 assets Ordinary assetsOrdinary assets

Capital AssetsCapital Assets

Capital assets include all assets except Capital assets include all assets except those specifically listed in IRC §1221(a) those specifically listed in IRC §1221(a) Listed assets are IRC §1231 assets or ordinary Listed assets are IRC §1231 assets or ordinary

assetsassets

IRC §1231 AssetsIRC §1231 Assets

IRC IRC §1231 assets §1231 assets include [IRC §1231(b)]:include [IRC §1231(b)]: All depreciable property and real property used All depreciable property and real property used

in a trade or business and held for more than in a trade or business and held for more than one yearone year

Includes amortizable intangible assets [IRC §197(f)Includes amortizable intangible assets [IRC §197(f)(7)] (7)]

Certain livestock, unharvested crops, timber, Certain livestock, unharvested crops, timber, coal, or domestic iron orecoal, or domestic iron ore

Ordinary AssetsOrdinary Assets Ordinary assets are those assets excluded Ordinary assets are those assets excluded

from both capital assets [IRC §1221(a)] and from both capital assets [IRC §1221(a)] and IRC IRC §1231 assets §1231 assets [IRC §1231(b)] and include:[IRC §1231(b)] and include: Inventory and/or property held primarily for sale to Inventory and/or property held primarily for sale to

customers in the ordinary course of the businesscustomers in the ordinary course of the business Accounts and notes receivable acquired in the Accounts and notes receivable acquired in the

ordinary course of the business ordinary course of the business Supplies used in the ordinary course of the Supplies used in the ordinary course of the

businessbusiness Depreciable property and/or real property used in Depreciable property and/or real property used in

a trade or business and held for 1 year or lessa trade or business and held for 1 year or less Certain copyrights, compositions, letters, or similar Certain copyrights, compositions, letters, or similar

property, government publications, commodities property, government publications, commodities derivatives, and hedging transactionsderivatives, and hedging transactions

Character of Gains (Losses)Character of Gains (Losses)

Character of recognized gains (losses) Character of recognized gains (losses) from sales or exchanges of property from sales or exchanges of property depends on the category the asset falls depends on the category the asset falls into (capital, IRC into (capital, IRC §1231 or ordinary asset)§1231 or ordinary asset) However, several provisions in the Code However, several provisions in the Code

override these categoriesoverride these categories

Overriding ProvisionsOverriding Provisions

Gains from sales or exchanges of depreciable Gains from sales or exchanges of depreciable property between certain related taxpayers are property between certain related taxpayers are ordinary gainsordinary gains[[IRC IRC §1239]§1239]

Losses on qualifying small business stock is Losses on qualifying small business stock is ordinary to up to $50,000 ($100,000 MFJ) for ordinary to up to $50,000 ($100,000 MFJ) for qualifying individuals [IRC §1244]qualifying individuals [IRC §1244]

Depreciation recapture on sales or exchanges of Depreciation recapture on sales or exchanges of depreciable property is ordinary gaindepreciable property is ordinary gain IRC IRC §1245 for tangible personal property§1245 for tangible personal property IRC §1250 for real propertyIRC §1250 for real property IRC §291(a) additional recapture on real property for IRC §291(a) additional recapture on real property for

corporationscorporations

Depreciation Recapture – In Depreciation Recapture – In GeneralGeneral All depreciable assets that are sold or All depreciable assets that are sold or

exchanged at a recognized exchanged at a recognized gaingain are subject are subject to depreciation recapture rulesto depreciation recapture rules Depreciation recapture is ordinary gain, any gain Depreciation recapture is ordinary gain, any gain

remaining may be capital or IRC remaining may be capital or IRC §1231 gain §1231 gain Depreciation recapture amount depends on the Depreciation recapture amount depends on the

type of asset and when it was placed in servicetype of asset and when it was placed in service All depreciable assets fall into one of two All depreciable assets fall into one of two

categories:categories: IRC §1245 property (tangible personal property) orIRC §1245 property (tangible personal property) or IRC §1250 property (real property)IRC §1250 property (real property)

Additional depreciation recapture under IRC Additional depreciation recapture under IRC §291(a) applies to IRC §1250 property dispositions §291(a) applies to IRC §1250 property dispositions made by corporate taxpayersmade by corporate taxpayers

Depreciation Recapture – IRC Depreciation Recapture – IRC §1245 §1245 Applies to all depreciable tangible personal Applies to all depreciable tangible personal

property and amortizable intangible assetsproperty and amortizable intangible assets Recognized gain on the disposition of IRC Recognized gain on the disposition of IRC

§1245 property is ordinary income up to §1245 property is ordinary income up to the extent of all previously recognized the extent of all previously recognized deductions for:deductions for: MACRSMACRS IRC §179IRC §179 Bonus depreciationBonus depreciation AmortizationAmortization

Depreciation Recapture – IRC Depreciation Recapture – IRC §1245§1245

See See Example 1 Example 1 and and SolutionSolution See Example 2 and SolutionSee Example 2 and Solution

Depreciation Recapture – IRC Depreciation Recapture – IRC §1250 §1250 Applies to all depreciable real propertyApplies to all depreciable real property Recognized gain on the disposition of IRC Recognized gain on the disposition of IRC

§1250 property is ordinary gain up to the §1250 property is ordinary gain up to the extent that the sum of all previously extent that the sum of all previously recognized deductions exceed the amounts recognized deductions exceed the amounts that would have been deducted using the that would have been deducted using the straight-line methodstraight-line method Since MACRS is calculated using the straight-line Since MACRS is calculated using the straight-line

method for real property placed in service after method for real property placed in service after 12/31/86, the IRC §1250 depreciation recapture 12/31/86, the IRC §1250 depreciation recapture is zero for these propertiesis zero for these properties

Depreciation Recapture – IRC Depreciation Recapture – IRC §291(a) §291(a) Applies only to IRC §1250 property held by Applies only to IRC §1250 property held by corporatecorporate taxpayers taxpayers

Additional depreciation recapture amount Additional depreciation recapture amount is ordinary gain. Additional amount is the is ordinary gain. Additional amount is the lesserlesser of: of: 20% X [Hypothetical IRC 20% X [Hypothetical IRC §1245 depreciation §1245 depreciation

recapturerecapture less actual IRC §1250 depreciation less actual IRC §1250 depreciation recapture (if any)], orrecapture (if any)], or

20% X [Recognized gain less IRC §1250 20% X [Recognized gain less IRC §1250 depreciation recapture (if any)]depreciation recapture (if any)]

Depreciation Recapture – IRC Depreciation Recapture – IRC §1250§1250

See See Example 3 Example 3 and and SolutionSolution See Example 4 and SolutionSee Example 4 and Solution

Character of Gains (Losses)Character of Gains (Losses)

General Rule: Gains (losses) from sales or General Rule: Gains (losses) from sales or exchanges of capital assets are capital exchanges of capital assets are capital gains (losses) [IRC §1222]gains (losses) [IRC §1222] If the asset was held for 1 year or less, the gain If the asset was held for 1 year or less, the gain

(loss) is short-term(loss) is short-term If the asset was held for more than 1 year, the If the asset was held for more than 1 year, the

gain (loss) is long-termgain (loss) is long-term Caveat:Caveat:

Gains are ordinary to the extent of any Gains are ordinary to the extent of any required depreciation recapturerequired depreciation recapture

Other overriding provisions may applyOther overriding provisions may apply

Character of Gains (Losses)Character of Gains (Losses)

Recognized gains on the sale or exchange Recognized gains on the sale or exchange of ordinary assets are ordinary gains [IRC of ordinary assets are ordinary gains [IRC §64] §64]

Recognized losses on the sale or exchange Recognized losses on the sale or exchange of ordinary assets are ordinary losses [IRC of ordinary assets are ordinary losses [IRC §65]§65]

Character of Gains (Losses)Character of Gains (Losses)

When the sum of all IRC When the sum of all IRC §1231 losses > §1231 losses > the sum of all IRC §1231 gains:the sum of all IRC §1231 gains: All the IRC §1231 gains (losses) are ordinary All the IRC §1231 gains (losses) are ordinary

gains (losses) [IRC §1231 (a)(2)]gains (losses) [IRC §1231 (a)(2)] When the sum of all IRC When the sum of all IRC §1231 losses < §1231 losses <

the sum of all IRC §1231 gains:the sum of all IRC §1231 gains: All the gains (losses) are capital gains (losses) All the gains (losses) are capital gains (losses)

[IRC §1231 (a)(1)] except to the extent of:[IRC §1231 (a)(1)] except to the extent of: Depreciation recapture [IRC §1245 or IRC §1250 and Depreciation recapture [IRC §1245 or IRC §1250 and

§291] §291] IRC §1231 recapture [IRC §1231(c)]IRC §1231 recapture [IRC §1231(c)]

IRC §1231 RecaptureIRC §1231 Recapture

Applies if:Applies if: Taxpayer has a Taxpayer has a netnet IRC §1231 gain (IRC §1231 IRC §1231 gain (IRC §1231

gains exceed IRC §1231 losses) in the current gains exceed IRC §1231 losses) in the current year andyear and

Taxpayer reported a Taxpayer reported a netnet IRC §1231 loss during IRC §1231 loss during any one of the previous five yearsany one of the previous five years

IRC §1231 RecaptureIRC §1231 Recapture

Current year Current year netnet IRC §1231 gain is IRC §1231 gain is ordinary to the extent of any non-ordinary to the extent of any non-recaptured recaptured netnet IRC §1231 loss over the IRC §1231 loss over the previous five years [IRC previous five years [IRC §1231(c)]§1231(c)] Non-recaptured Non-recaptured netnet IRC §1231 loss = IRC §1231 loss = netnet IRC IRC

§1231 losses over the past 5 years less §1231 losses over the past 5 years less amounts already recaptured during that time amounts already recaptured during that time period period

IRC §1231 Recapture – Example 1IRC §1231 Recapture – Example 1 A taxpayer had the following net IRC A taxpayer had the following net IRC

§1231 gains (losses) over the past five §1231 gains (losses) over the past five years (there were no IRC years (there were no IRC §1231 gains or §1231 gains or losses for years prior to 2001)losses for years prior to 2001):: 2001 $(5,000)2001 $(5,000) 2002 $ 8,0002002 $ 8,000 2003 $(4,000)2003 $(4,000) 2004 $ 2,0002004 $ 2,000 2005 $(3,000)2005 $(3,000)

For the 2006 taxable year, the non-recaptured For the 2006 taxable year, the non-recaptured IRC §1231 loss over the previous five years is IRC §1231 loss over the previous five years is $5,000 $5,000

IRC §1231 Recapture – Example 2 IRC §1231 Recapture – Example 2 A taxpayer had the following net IRC A taxpayer had the following net IRC

§1231 gains (losses) over the past five §1231 gains (losses) over the past five years (there were no IRC years (there were no IRC §1231 gains or §1231 gains or losses for years prior to 2001)losses for years prior to 2001):: 2001 $18,0002001 $18,000 2002 $ 02002 $ 0 2003 $(15,000)2003 $(15,000) 2004 $(6,000)2004 $(6,000) 2005 $(3,000)2005 $(3,000)

For the 2006 taxable year, the non-recaptured For the 2006 taxable year, the non-recaptured IRC §1231 loss over the previous five years is IRC §1231 loss over the previous five years is $24,000 $24,000

IRC §1231 Assets Netting ProcessIRC §1231 Assets Netting Process

See See Example 5 Example 5 and and SolutionSolution See Example 6 and solutionSee Example 6 and solution See Example 7 and solutionSee Example 7 and solution