Chapter
8
Property Dispositions
Realized Gain or Loss
Amount realized on disposition
MINUS adjusted basis of property (e.g. cost accumulated tax depreciation = “NBV”)
= Realized gain or loss.
GENERALLY, realized (economic) gains and
losses on disposition are recognized (result in
taxable income or deductions) unless there is a
specific exception. See Chapter 8.
Unrealized (mere appreciation or decline in value)
gains and losses are neither realized nor
recognized.
Amount Realized
Cash received
FMV of any property received, including buyer’s
note
Relief of debt. AP3.
Reduce the amount realized by selling costs such
as sales commissions, broker fees.
No adjustment for “inflationary gains.”
Installment Sale Method
Permits deferral of gain recognition until cash is
received on the sale.
Gain recognized this year = (cash this year) x (total
gain / total sales price).
Not allowed for sales of publicly traded stock or for
inventory, or to delay recognition of depreciation
recapture.
Financial accounting uses accrual accounting, so
installment sales method for tax creates a
temporary book-tax difference.
Related Party Losses
Relative:
family = spouse, sibling, ancestors, lineal descendants
Q10
50% controlled corporations
Losses realized on sale of property between
related parties are NONdeductible.
Future gain (but NOT loss) by relative can be offset
by disallowed loss.
Character of Gain or Loss - Overview
Tax or deduct
at ordinary rates
Ordinary
Section1231
net gain
Capital
Net capital gains and
losses: Individual may
deduct $3000 net loss.
Net LT gain taxed at
lower rates.
Capital Asset (negatively) Defined
Capital assets (under Section1221) are everything
EXCEPT:
1) inventory
2) accounts receivable
3) supplies
4) real or depreciable property used in a trade or
business (this is the same as Section 1231
property)
Capital Asset (negatively) Defined
5) copyright, compositions, artistic efforts created
by taxpayer. (exception - patents by inventors are
capital assets).
6) certain U.S. government publications
7) Commodities derivative financial instruments
held by a dealer
8) Hedging transaction properties.
Capital Losses
Only deduct capital losses UP TO capital gains.
Excess of capital loss over capital gains
Individual taxpayers:
can deduct $3000 of net losses per year against ordinary
income
carryforward excess indefinitely against capital gains
Corporation
NO deduction for net loss in current year
carry back 3 years and forward 5 years against capital gains
Capital Gains
Individuals obtain preferential taxation on long-term
(> 1 year) capital gains - generally 20% tax rate
(15% as result of 2003 Tax Act). See Chapter 16.
Corporations pay tax at regular tax rates.
Section 1231 Assets
Real or depreciable property used in a trade or
business. Q1
GENERAL rule.
Net Section 1231 gains and losses
IF NET GAIN => add to capital gains and losses. Result
is possible lower tax rate on 1231 net gains.
IF NET LOSS => add to ordinary gains and losses. Can
also offset salary, interest, dividends, etc. Result is
ordinary rate benefit of 1231 net losses.
Depreciation Recapture
Gain on each separate asset may be subject to
depreciation recapture.
Depreciation recapture does NOT apply if the asset
is sold at a loss, nor can it increase the amount of
the gain.
For sales of depreciable personalty and
amortizable intangibles, the gain is characterized as
ordinary up to the amount of accumulated
depreciation.
Why? because depreciation has resulted in prior
deductions at ordinary rates.
Depreciation Recapture
REALTY:
Special rules apply to pre-1986 depreciation on
accelerated methods: most of this property is
fully depreciated, so rules seldom apply.
Corporations must recapture 20% of amount
that would have been ordinary had it been
personalty (lesser of gain or depreciation)..
Individuals treat lesser of gain or depreciation
as a capital gain subject to a special 25% tax
rate - see chapter 16.
Section 1231 Netting
After all depreciation recapture, NET the remaining
Section1231 gains with Section 1231 losses.
If a net loss, treat as an ordinary loss and combine
with other ordinary income and losses.
If a net gain, then the net gain is treated as a
capital gain UNLESS:
Section 1231 Look Back Rule
The net 1231 gain is treated as ordinary income
recapture to the extent of unrecaptured Section
1231 losses during the prior five years.
EXAMPLE: Start business in 1990. Section 1231
gains and losses.
1998 net gain $10 treated as capital.
1999 net loss ($15) treated as ordinary.
2000 net gain $23 treated as $15 ordinary
(recapture 1991) and $8 capital.
2001 net loss ($40) treated as ordinary.
2002 net gain $6 treated as ordinary. Still have
$34 unrecaptured loss from 1993.
2003 net gain $50 treated as $34 ordinary, $16
capital.