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16: Disposals of Assets
Examine types of GLDs in more detail
Capital GLDs
Do not commonly occur in engineering projects
Section 1231, 1245, and 1250 GLDs
Commonly occur in engineering projects
Sometimes treated as a capital GLD
16.1 Capital Gains and Losses
Compute tax effects of any disposal after computing taxes on OI
Establish terminology and compute tax flows assuming only one disposal
Next section considers multiple disposals
Terminology
Capital asset is any property except for depreciable property, real property used in a trade or business, inventory held for sale, and a few other
items
Examples include stocks, bonds, or person's home
Assets that are not capital assets include equipment that is depreciated,
real property used for rental purposes, office buildings, structures housing equipment
Equipment and machines frequently associated with projects are not
capital assets, but can be taxed under capital gain or loss provisions in
some circumstances
Need to understand capital assets before considering project equipment
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Capital gain or loss occurs when amount realized from disposal of a capital asset does not equal its book value
Capital Gain or Loss = Amount Realized – Book Value
Gain if positive, loss if negative
Short-term CGLs have holding periods of a year or less. Long-term
CGLs occur after more than one year.
Same brackets (e.g., 10%, 15%, 27%, …) used for OI apply when TI includes CGLs, but sometimes lower rates can be used for the CGL
component
Laws on CGLs change periodically depending upon political and economic conditions
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Individuals
CGL Taxes for Individuals
G / L Term
Gain
Gain
Loss
Treatment
Short
Long
Taxed as OI.
First, any portion of the gain in the OI 15% bracket is
taxed at 10%. Any remainder above the OI 15% bracket is
taxed at 20%, with a few exceptions such as collectibles
(28%) and gains on real property due to SL depreciation
(25%).
Either Up to $3,000 may be deducted from OI in the current year,
and the remainder may be carried forward indefinitely. A
loss remains a SCL or LCL when it is carried forward.
Example 16.1 CGL Taxes for Individuals
Only CGL is sale of stock having book value of $10,000
Not depreciated, so BV = price paid plus costs of purchase
Different scenarios
1. Holding period ≤ 1 year, Sales price = $11,000 ⇒
SCG = $1,000 taxed as OI. If in OI 31% bracket ⇒
Fed tax = $310 = 0.31 × 1,000
2. Holding period > 1 year, Sales price = $11,000 ⇒ LCG = $1,000
Single, TI of update $26,650 before sale ⇒
First $400 in OI 15% bracket, next $600 in OI 27% bracket ⇒
Fed tax = $160 = 400(0.10) + 600(0.20)
Single, TI before sale in 27% or higher bracket ⇒
Fed tax = $200 = 1,000(0.20)
3. Holding period ≤ 1 year, Sales price = $3,000 ⇒ SCL = $7,000
Deduct $3,000 from OI this year. Carry forward $4,000 of SCL.
4. Holding period > 1 year, Sales price = $3,000 ⇒ LCL = $7,000
Deduct $3,000 from OI this year. Carry forward $4000 of LCL.
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CGL Taxes for Corporations
G/L
Term
Treatment
Gain
Gain
Short
Long
Loss
Either
Taxed as OI.
Taxed as OI, or the corporation may elect to use a 35%
rate.
No deduction may be made from OI. Carry a loss back
for up to 3 years to claim refunds on any CG taxes in
those years, or carry it forward up to 5 years to reduce a
future CG. Any amount carried back or forward always
is classified as a SCL, even if it was originally a LCL.
This is different from an individual's CL.
Corporations
Example 16.2 CGL Taxes for Corporations
Different scenarios on sale of stock with book value of $10,000
1. Holding period ≤ 1 year, Sales price = $11,000 ⇒
SCG = $1,000 taxed as OI. If in OI 34% bracket ⇒
Fed tax = $340 = 0.34 × 1,000
2. Holding period > 1 year, Sales price = $11,000 ⇒ LCG = $1,000
If in OI 34% bracket, Fed tax = $340 = 0.34 × 1,000
If in OI 39% bracket, elect 35% LCG rate so
Fed tax = $350 = 0.35 × 1,000
3. Holding period ≤ 1 year, Sales price = $6,000 ⇒ SCL = $4,000
Carry back then forward as SCL to reduce gains in other years
4. Holding period > 1 year, Sales price = $6,000 ⇒ LCL = $4,000
Carry back then forward as SCL to reduce gains in other years
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16.2 Consolidation
If either an individual or a corporation has several CGLs during a year,
consolidate them using following procedure prior to computing tax
1. Sum the individual short-term gains and losses, to obtain a net shortterm capital gain (NSCG) or a net short-term capital loss (NSCL).
2. Sum the individual long-term gains and losses, to obtain a net longterm capital gain (NLCG) or a net long-term capital loss (NLCL).
3. Consolidated values equal the net values unless one is a gain and the
other a loss. In this case, reduce or offset the gain by the loss and let
the term (short/long) of the result be that of whichever is larger.
Consolidation of Net Gains and Losses
Short
Term
Long Term
NSCL
NSCL
CLCL = NLCL
CSCL = NSCL
$0
CLCL = NLCL
$0
NLCG
If NLCG ≥ NSCL, then
CLCG = NLCG − NSCL
CSCL = NSCL
If NSCL > NLCG, then
CSCL = NSCL − NLCG
---
CLCG = NLCG
If NSCG ≥ NLCL, then
CSCG = NSCG − NLCL
CLCG = NLCG
CSCG = NSCG
NLCG
CSCG = NSCG
If NLCL > NSCG, then
CLCL = NLCL − NSCG
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Example 16.3 Consolidating Capital Gains and Losses
Example of Consolidation
Net
Short
-100
0
100
Net Long
-100
-25
0
25
CSCL: 100 CSCL: 100
CLCL: 100 CLCL: 25
CSCL: 100
CSCL: 75
CLCL: 100 CLCL: 25
All: $0
CLCG: 25
All: $0
CSCG: 100
CSCG: 100 CSCG: 100
CLCG: 25 CLCG: 100
CSCG: 75
100
All : $0
CLCG: 100
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Effect of Consolidation on Economic Analyses
Taxpayer's net gain and loss situation prior to project can affect a project's ATCF
Suppose taxpayer has a net capital loss in year of disposal before project
Project CL might not produce tax savings in year of disposal since
it might have to be carried forward
Project CG might cause tax payment in year of disposal or reduce
loss carried forward
If analyst has knowledge of net gain and loss situation prior to project,
should use it
If several projects being analyzed for large corporation, then analyst
might not know net gain and loss situation
Scenarios one possibility
Sometimes assume gains cause taxes and losses reduce taxes
Measure potential of project, but accurate only if taxpayer is in net
gain situation
Errors will be from shifts in the timing of the cash flow for disposal taxes or possibly the tax rate
Effect of errors on PW small since many other cash flows are larger and occur earlier
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16.3 Types of Project Disposals
Section 1231 disposals include depreciable assets and real property used
in a trade or business
Holding period of more than a year
Regulations prevent converting accelerated depreciation into CG
Consider an individual in 30% OI bracket with an early depreciation
charge of $100
Create tax savings of $30 at OI rates in early years
Make tax payment of $20 at LCG rates later if AR − BVd = 100
Gains due to accelerated depreciation are recaptured at OI rates
Investor still benefits from saving $30 early and paying back $30 later
Recaptures covered by Sections 1245 and 1250 of Internal Revenue Code
Can be considered as categories of Section 1231 properties
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Section 1245 Disposals
Section 1245 properties include personal property and some real properties
Non-residential real properties, such as office or factory buildings, acquired from 1980 through 1986, are Section 1245 properties. Their
use of accelerated depreciation makes them subject to Section 1245
recapture just like project equipment.
Section 1231 gain
BV 0
Section 1245 recapture
BV d
Section 1231 loss
Section 1245 Recapture
Example where BV0 equals $800 and BVd is $600
Section 1245 Disposal
Amount
Realized
$900
750
350
1231
Gain
$100
0
0
1245
Recap.
1231
Loss
$200
150
0
$0
0
250
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Section 1250 Disposals
Section 1250 covers most real properties of interest to project economics
Section 1250 includes non-Section 1245 real properties, so most nonresidential real properties acquired outside of the 1980-86 window are
Section 1250 properties, as well as residential real assets.
Any real property built from 1987 on (no accelerated component)
Section 1231 gain
BV0
SL
Section 1231 gain
(unrecaptured depreciation)
Acc
Section 1250 recapture
BVd
Section 1231 loss
Section 1250 Recapture
Example of Section 1250 disposal
BV0 equals $80,000 and BVd is $60,000
BVd would have been $65,000 if SL
Acc = 5,000
Amount
Realized
$53,000
62,000
71,000
87,000
Section 1250 Disposal
1231 Unrecap. 1250
Deprec. Recapt.
Gain
$0
0
6,000
22,000
$0
0
6,000
15,000
$0
2,000
5,000
5,000
1231
Loss
$7,000
0
0
0
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16.4 Taxes on Project Disposals
Use Section 1245 and Section 1250 to determine amounts of recapture
and Section 1231 gains and losses
Procedure for Computing Taxes
Apply Section 1231 rules to net GLDs and determine how to tax them
1. Sum the individual gains and losses to obtain a net Section 1231 gain
or loss.
2. Deduct a net loss from OI. It will be subject to recapture for five
years.
3. If there is a net gain and net losses were reported in the last five years,
then recapture the prior net losses. For example, suppose that the current net gain is $100,000 and prior losses were $20,000. Then $20,000
of the $100,000 is treated as OI, leaving the remaining $80,000 as the
net Section 1231 gain for the current year.
4. Treat a net gain as a LCG, where it becomes part of the capital gains
consolidation process.
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Capital
Asset
Type?
Section 1245
or 1250
Compute CGL
on project
Compute Section 1245 or
1250 recapture. Tax as OI.
Compute Section 1231 gain
or loss on project.
Net all CGLs
Net Section 1231 gains and
losses. Recapture any prior
1231 losses.
Consolidate
CGLs
Treat net 1231
gain as LCG
Gain
Net gain or
loss?
Loss
CSCG: Taxed at OI rate
CLCG: Indiv - Taxed at CG rate
Corp - Taxed at OI or 35% rate
Deduct net
Section 1231
loss from OI
CSCL: Indiv - Deduct up to $3,000 and then carry as SCL
Corp - Carry as SCL
CLCL: Indiv - Deduct up to $3,000 and then carry as LCL
Corp - Carry as SCL
Disposal Logic
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ATCFs for Section 1231 Asset (with Rounding to Fit Table in Display)
Yr
BTCF Dep / BV
0 -90,000
1 37,000
2 27,750
2-a 95,000
2-b 50,000
2-c 10,000
2-d 10,000
OI
LCGL OI Tax LCG Tax ATCF
47,998 -10,998
0 -4,625
14,002 13,748
0 5,781
28,000 62,000 5,000 26,071
28,000 22,000
0 9,251
28,000 -18,000
0 -7,569
28,000
0 -18,000
0
0
0
1,847
0
0
-6,651
-90,000
41,625
21,969
67,082
40,749
17,569
16,651
Example 16.4 ATCFs With Recapture and Section 1231 GLDs
Personal property with 3 year MACRS recovery period
BV0 is $90,000 for MACRS 3 year property with disposal in year 2
Year 1 depreciation at 53.33310% and year 2 is one-half of depreciation at 31.1150%
BV2 = $28,000 = 90,000 − 47,998 − 14,002
Corporation has OI rates of 39% for fed, 5% for state for combined OI
marginal rate of 42.05%
CG rates of 35% for fed, 3% for state for combined CG marginal rate
of 36.95%
Four scenarios for disposal of project
a) AR = $95,000, net Section 1231 gain, CLCG before disposal
Recapture = $62,000 = 90,000 − 28,000
Immediately tax as OI: $26,071 = 0.4205 × 62,000
Project Section 1231 gain = $5,000 = 95,000 − 90,000
Increase net Section 1231 gain and hence CLCG
Tax as LCG: $1,847 = 0.3695 × 5,000
Total disposal tax = $27,918 = 26,071 + 1,847
Disposal ATCF = 67,082 = 95,000 − 27,918
Total ATCF = 89,051 = 67,082 + 21,969
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b) AR = $50,000, any Section 1231 or CLG situation elsewhere
Recapture = $22,000 = 50,000 − 28,000
Immediately tax as OI: $9,251 = 0.4205 × 22,000
No Section 1231 gain or loss
Total disposal tax = $9,251
Do not need net Section 1231 or CGL position
c) AR = $10,000, net Section 1231 loss of $300,000 before disposal
No project recapture or project Section 1231 gain
Project Section 1231 loss = $18,000 = 28,000 − 10,000
Net Section 1231 loss = $318,000 = 300,000 + 18,000
Increase Section 1231 loss that is deducted from OI
OI tax saving: $7,569 = 0.4205 × 18,000
Total disposal tax saving = $7,569
d) AR = $10,000, net Section 1231 gain of $200,000 and CLCG of
$300,000 before disposal
No project recapture or project Section 1231 gain
Project Section 1231 loss = $18,000 = 28,000 − 10,000
Net Section 1231 gain = $282,000 = 300,000 − 18,000
Decrease Section 1231 gain that becomes part of a CLCG
CG tax saving: $6,651 = 0.3695 × 18,000
Total disposal tax saving = $6,651
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Implementation Difficulty
Taxpayer's net gain and loss situation prior to project can affect a project's ATCF
If position known, use it
If position not known
Examine scenarios and if one alternative is dominant, choose it; otherwise, make subjective choice
Chance of dominance occurring if disposal tax flows are comparatively small, late flows and there are many other flows
Corporations also can use simplified Section 1231 GLD procedure
and possibly incur small error
Following scenarios allow Section 1231 GLDs to be treated as OI
1. A taxpayer has net Section 1231 losses before and after the new project. This is a very likely scenario since most spending is on
equipment that is salvaged for less than its original book value, causing either recapture or a Section 1231 loss.
2. A corporation in a bracket of 35% or less has a consolidated LCG before and after the project.
3. A corporation in a bracket of 35% or less has no capital gains or
losses and only Section 1231 losses and gains.
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16.5 Corporate Procedure
Foregoing material allows examining accuracy of simplified corporate
procedure that treats any Section 1231 GLDs as OI
One of the following must occur for any Section 1231 GLD
If the GLD is a recapture, then treating it as OI is correct
If the GLD is not a recapture
If it becomes part of a net Section 1231 loss, then treating it as
OI is correct
If it becomes part of a net Section 1231 gain, then treating it as
OI might create an error
Likelihood of a Section 1231 net gain position seems small, but possible
Section 1245 properties are equipment, and they are not likely to be
sold for more than they cost
If AR is between BVd and BV0 , then recapture is treated as OI
and removed from further consideration
If AR is less than BVd , project level losses increase probability
of a net Section 1231 loss
If most investment is in equipment, then net loss position becomes very likely
Section 1250 consists of real property where gains are possible but
chances are lessened by long recovery periods and SL
If a net Section 1231 gain does occur, then it can still be recaptured as OI if there were net Section 1231 losses in prior years
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If net Section 1231 gain does occur
If it becomes part of a CLCG
For corporations, using OI rates causes no error for CG rates of
35% or less and little error thereafter
For individuals, using OI rates can cause a larger error
If it becomes part of a consolidated CL
If carried by a corporation, then might cause no error (in amount of
taxes) for CG rates of 35% or less and at most little error thereafter, but timing of tax flow can be affected. Worse case occurs if CL
can never be used.
Errors for individuals can be either smaller or larger than corporations
Conclusions
For corporations, probable events of recapture or net Section 1231
loss result in no error. A small error is possible in the less likely event
of a net Section 1231 gain.
If error should occur, but it is late and comparatively small relative
to other flows, then little effect on PW
For individuals, probable events of recapture or net Section 1231 loss
result in no error. Errors are possible in the less likely event of a net
Section 1231 gain.
Errors can be larger than in corporate analyses, so their potential
for affecting PW should be examined