Chapter 11
Property Dispositions
Learning
Objective 1
Calculate the amount
of gain or loss
recognized on the
disposition of assets
used in a trade or
business.
Amount Realized
All dispositions of assets are realization
events for tax purposes
+ Cash
rec’d
+ FMV
prop.
rec’d
+ Debt
relief
- Seller
exp.
Initial Basis, revisited
General Rules discussed in Chapter 10
Exceptions to general rules:
Gifted Property
• If FMV > adjusted
basis, then initial basis
is adjusted basis for all
purposes
• If FMV < adjusted
basis, ‘dual’ adjusted
basis rule applies
Converted Personal
Property
• Another ‘dual’ basis
rule applies
• See Example 11-2 for
discussion of possible
scenarios
Example: Adjusted Basis
Scrap-Happy owns a computer (5-yr MACRS recovery
period), which it purchased 2 years ago for $1,200. For
financial statement purposes, the computer depreciates
over 3 years using the half-year convention and straight-line
method, with no salvage value. What is the adjusted book
and tax bases for the computer (after 2 years of
depreciation)?
Answer:
Book
Cost Basis:
$1,200
Yr 1 Dep. (HY): (200)
Yr 2 Dep.:
(400)
Adjusted Basis: $600
Tax
$1,200
(240)
(384)
$576
Adjusted Basis & Realized Gain (loss)
Initial
Basis
Cost
Recovery
Adjusted
Basis
Gain or loss realized on disposition is amount
minus adjusted basis
Realized gains and losses are generally
recognized in current year
Example
Scrap-Happy sells the computer in the
previous example (adjusted tax basis = $576)
for $400. What is the realized gain or (loss) on
the sale?
Answer: $400 Amount realized
(576) Adjusted basis
($176) (Loss) realized
Learning
Objective 2
Describe the general
character types of
gain or loss recognized
on property
dispositions.
Ordinary and Capital Assets
All gains and losses are eventually
characterized as ordinary or capital
Character of gain or loss depends on:
How asset was used by taxpayer
How long taxpayer held asset
Section 1231 Assets
Depreciable assets and land:
Used in a trade or business
Held by taxpayers longer than one year
Net §1231 gain treated as LTCG
Net §1231 loss treated as ordinary loss
Net §1231 gains may be recharacterized
as ordinary income (see LOs 3 and 4)
Learning
Objective 3
Calculate depreciation
recapture.
Depreciation Recapture –
§1245 Assets
Tangible and intangible personal property
Gain is characterized as ordinary to the
extent of cost recovery deductions
Amount recharacterized is lesser of:
Recognized gain
Accumulated cost recovery
(depreciation) on asset
Three possible scenarios
Exhibit 11-6
§1231 ASSETS:
§1245 Recapture Example
Scrap-Happy sells a
machine with an
adjusted basis of
$6,000 for $10,000.
Depreciation taken
on the machine
amounts to $2,500.
What amount of gain
is recaptured as
ordinary and what
amount is §1231
gain?
Answer:
$10,000
Selling price
− 6,000
Adjusted basis
$4,000
Gain realized
Depreciation recapture = Lesser of:
Depreciation taken: $2,500
Gain realized: $4,000
Depreciation recapture (ordinary
income) = $2,500
§1231 gain (capital gain) = $4,000
Gain realized
Depreciation recapture
$1,500
− 2,500
§1231 gain
Depreciation Recapture –
§1250 Assets (and §291)
Depreciable real property
§1250 recapture generally do not apply to
modern assets
However, §291 requires corporations to
recapture as ordinary income 20 percent of
the lesser of:
Recognized gain
Accumulated depreciation on asset
Learning
Objective 4
Describe the tax
treatment of
unrecaptured §1250
gains.
Other Rate-Impacting Items
Unrecaptured §1250 gain for individuals taxes
the gains caused by depreciation at the
lower of:
25 percent or
The ordinary rate, if lower than 25 percent
Gains on sales to related parties cause any
realized gain to be taxed at ordinary rates if
property is depreciable to buyer
Learning
Objective 5
Describe the tax
treatment of §1231
gains or losses,
including the §1231
netting process.
Net §1231 Gains (Losses)
Planning opportunity –
why sell §1231 loss
assets in one year and
§1231 gain assets in
another year?
Opportunity is limited
by nonrecaptured net
§1231 loss rule (5 year
lookback)
Like other recapture
provisions, rule affects
the character – but
not the amount – of
taxable gains
Learning
Objective 6
Explain common
deferral exceptions to
the general rule that
realized gains and
losses are recognized
currently.
1031 Exchanges Help Art Investors Avoid Taxes
What Does the Code Say?
No gain or loss shall be recognized on the
exchange of property held for productive use
in a trade or business or for investment if such
property is exchanged solely for property of
like kind which is to be held either for
productive use in a trade or business or for
investment
Code Sec. 1031(a)(1)
Refers to nature or character,
rather than grade or quality
Real property is generally like-
kind with real property
Like-Kind
Property
cont’d
Some property is ineligible
regardless of business or
investment use
Domestic property
exchanged for property used
in a foreign country and all
property used in a foreign
country
Real property held for sale
Like-Kind
Exchange
Handout
Involuntary Conversions
Gains deferred on property destroyed, stolen,
condemned, or seized – why?
Must acquire qualified replacement property
within a prescribed time limit
Basis of replacement property is FMV of new
property minus deferred gain on conversion
Installment Sales
Realized gain is recognized pro rata as installment
payments are received
Must compute gross profit percentage
Gross profit / Contract price
Taxable gain = percentage * payments received
Depreciation recapture not eligible
Report in year of sale and add to adj. basis
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