Chapter 7
Capital Gains and
Other Sales of
Property
“If a client asks in any but an extreme
case whether, in your opinion, his sale
will result in capital gain, your answer
should probably be, ‘I don’t know, and
no one else in town can tell you.’”
-- James L. Wood
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
McGraw-Hill/Irwin
©The McGraw-Hill Companies, Inc. 2008
LO #1 Terms & Tax Forms
• Basis of property purchased is the cost
of the asset including cash, debt
obligations, and other property or
services included in acquiring the asset.
• Basis of assets transferred by
inheritance are valued at the FMV of the
property at the date of death or FMV on
the alternate valuation date if an estate
return is being filed and the estate
income is reduced by the valuation.
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LO #1 Terms & Tax Forms
• Basis of property transferred to a
taxpayer from a spouse or former
spouse incident to a divorce
settlement, is the same as the
spouse’s or former spouse’s adjusted
basis before the transfer.
• Assets transferred by gift can be
valued at FMV or basis of the donor
depending if the FMV is < or = >
basis.
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LO #1 Terms & Tax Forms
• Adjusted basis is the cost of the asset
less any accumulated depreciation.
• The difference between the amount
realized from the sale and the adjusted
basis of the asset;
– Amount realized > adjusted basis = gain
– Amount realized < adjusted basis=(loss)
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LO #1 Terms & Tax Forms
• The nature of tax reporting for gains and
losses on the sale of property depends
primarily on the “use” of the asset rather
than on the asset “form.”
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LO #1 Terms & Tax Forms
• Form 4797 – Sales of Business Property
– Use to report any and all gains or losses
from sale or liquidation of business
property.
– The form has four parts to it and is very
detailed to include all possible situations
involving property used in a business
• Schedule D – Capital Gains and Losses
– Use to report any and all gains or losses
from sale of property held for investment.
• Form 8949 – Record transactions
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LO # 2 Classifying Assets
• Ordinary Asset
– Ordinary income property is any
asset that is “not” a capital asset.
• Capital Asset (§1221)
– Any asset used for personal
purposes or investment.
• Eight exceptions to this definition
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LO # 2 Classifying Assets
• § 1231 Business Asset
– Depreciable or nondepreciable property
used in a trade or business
– Held for more than one year
• Any business asset disposed of within
one year of acquisition is an ordinary
income asset and is taxed to the
taxpayer at ordinary tax rates.
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LO # 3 Ordinary Assets
• Inventory and accounts receivable are
not ordinary income assets unless they
are sold outside the normal course of
business.
• Sale of business property held less than
one year.
• Gains are taxed at the taxpayer’s regular
rate
– There is no preferential tax treatment
• Losses are fully deductible
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LO #4 Capital Assets
• Tax treatment depends on holding
period of the asset. Assets must be
held for more than one year for
preferential tax treatment.
– Exceptions:
• Property received through a gift or
nontaxable exchange generally has same
holding period as the transferor.
• Property acquired through inheritance is
always considered long-term property.
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LO #4 Capital Assets
• Long term capital gain rates:
– 0%,15%, or 20% for most capital assets
– 25% rate for depreciable real property
used in a trade or business (§ 1250)
– 28% rate for “collectibles” and gains on
§1202 (Qualified Small Business Stock)
property.
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LO #4 Capital Assets
• All short-term gains and losses are
netted.
• All long-term gains and losses are
netted.
• The resultant gain or loss determines
the deductibility of a loss and the tax
rate used for gain.
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LO #5 §1231 Business Assets
• Recall that §1231 assets are those
used in a trade or business that are
held for > 1 year.
• Gains and losses from the sale of
§1231 assets are netted before tax
rates are applied.
• A net §1231 gain is taxed as a longterm capital gain subject to recapture
provisions
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LO #5 §1231 Business Assets
• Recapture provisions apply to
depreciation taken as a deduction in
prior years.
• Depreciation recapture rules are
designed to “transform” some or all of
the §1231 gain into an ordinary gain.
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LO #5 §1231 Business Assets
• Net §1231 gains receive preferential
tax rate treatment
• Net §1231 losses are treated as
ordinary losses not subject to
deductibility limit provisions of $3,000
per year.
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LO #5 §1231 Business Assets
• §1245 applies to personal trade or
business property and is a subset of
§1231 property
– Tax rate to “recapture” the depreciation
portion of a gain is taxed at ordinary rates
– Remaining gain, if any, is taxed at
preferential rates.
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LO #5 §1231 Business Assets
• § 1250 applies to buildings –
residential or nonresidential
(commercial) and is a subset of §1231
property
– The amount of capital gain
attributable to depreciation
previously taken is taxed at the 25%
rate up to the depreciation amount
considered “unrecaptured”.
– Remaining gain, if any, is taxed at
preferential rates
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LO # 6 Special Types of Sales
• Sales of stock purchased as blocks
of stock at different prices and/or
dates are valued either using
specific identification or the first-in,
first-out method for determining
basis.
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LO # 6 Special Types of Sales
• A mutual fund pools resources from various
investors and purchases shares of stock in a
portfolio
• Form 1099-DIV is the form sent annually to
individual investors in the mutual fund to
record dividends, capital gains, and
distributions from the fund for the year.
• Capital gains distributions from mutual funds
are reported on Schedule D (or directly on
Form 1040 if Schedule D is not required to be
filed).
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LO # 6 Special Types of Sales
• Three methods to calculate the “basis” of
shares in a mutual fund purchased
throughout a period
– First-In, First-Out – assumes first shares
purchased are the first shares sold.
– Specific Identification – assumes that the shares
sold can be identified with a specific purchase.
– Average Basis – Calculate the average of shares
purchased for a period and use an average to
determine the cost basis of shares sold.
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LO # 6 Special Types of Sales
• Worthless securities are treated as
losses from a sale or exchange of a
capital asset on the last day of the
taxable year.
– Declaration of bankruptcy is not
sufficient to indicate worthlessness.
– Often difficult to pinpoint exactly when a
security becomes worthless to determine
a “sale date” for long-term versus shortterm treatment.
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LO # 6 Special Types of Sales
• Sales of assets given as gifts:
– FMV<donor’s adjusted basis at time of
gift
• Use donor’s adjusted basis for a gain
• Use FMV for a loss
• Special provision, if the sell price is between
the adjusted basis and the FMV, there is no
gain or loss on the sale.
– FMV=>donor’s adjusted basis at time of
gift
• Use donor’s adjusted basis for a gain or
loss
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LO # 6 Special Types of Sales
• Basis to beneficiaries is the FMV at the date
of death or alternate valuation date (AVD
applies only if valuing the asset reduces the
overall estate amount).
• The holding period is always considered
long-term
– Example: Property inherited with a basis
of $3,000 is sold six months later for
$4,000. The $1,000 gain is considered
long-term and qualifies for preferential tax
treatment.
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