Module 20
Capital Assets
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1. Capital assets
2. Capital gains and losses
3. §1231
4. Depreciation recapture
Capital Assets
Key Learning Objectives
In general
 Definition of a capital asset
 Special issues

All Assets Are Capital Assets
Except
Inventory
 Accounts/notes receivable from sale of
goods or services
 Depreciable or real property used in a trade
or business (§1231 property)
 Copyrights and creative works
 Certain U.S. government publications

Special Issues

Additional clarifications provided by
Congress include:
Sales or exchanges by dealers in
securities
Sales of subdivided real estate
Nonbusiness bad debts
Capital Gains and Losses
Key Learning Objectives
Sale or exchange
 Holding period
 Corporate taxpayers
 Individual taxpayers

Sale or Exchange
The recognition of a capital gain or loss
 Usually requires the sale or exchange
 Code doesn't define the terms "sale" and
"exchange."
 The Supreme Court, however, says that the
terms are to be given their ordinary meaning

Holding Period

Holding period runs from
 Day
after acquisition date to trade date
Long vs. short controlled by code in effect
on date of sale
 Code states more than for holding period

Two Holding Periods
for Capital Gains

Short term
<

12 months
Long term
>
12 months
Four Tax Rates
for Capital Gains for Individuals

Net short term gains
 taxed

as ordinary income
Net long term gains
 taxed
at 20%/10%
 taxed at 28% if “collectable”

Some gain from real property taxed at 25%
 am’t
related to unrecaptured depreciation
deductions
25% Rate on
Gains From Real Property

Applies to noncorporate taxpayers

"unrecaptured Sec. 1250 gain,”
Building original cost = $100,000
 Depreciation taken $30,000 (straight line)
 Selling price $110,000
 Gain = $40,000 ($110,000 - $70,000)

 $30,000
limited to 25% preference rate
 $10,000 could be taxed at 20%/10% rates
In Class Exercise:
Preference Rate on Capital Gains
Single taxpayer’s taxable income for 2000
is $102,000
 If this is all ordinary income, what is her
regular tax liability?
 Note: use excerpt from 2000 tax rate
schedules on next slide
 Solution = $26,301

 Note
same answer if income included short
term capital gains
Excerpt from 2000 Tax Table
If taxable income is
At least
63,550
90,800
But less The Tax is Filing
than
Status
132,600 14,381.5
Single
147,050 20,854.5
Head of
House
+ 31%
of excess of taxable
income over column 1
In Class Exercise:
Preference Rate on Capital Gains
Single taxpayer’s taxable income for 2000
is $102,000
 If $20,000 of this is a net long term gain,
what is her regular tax liability?
 Note: use excerpt from 2000 tax rate
schedules on previous slide
 Solution = $24,101

 [102,000-20,000-63,550]*.31
20,000 *.20
+ 14,381.5 +
In Class Exercise:
Preference Rate on Capital Gains
Single taxpayer’s T. I. for 2000 is $102,000
 If $20,000 is from the sale of a collectible
held more than 12 months, what is her
regular tax liability?
 Note: use excerpt from 2000 tax rate
schedules on earlier slide
 Solution = $25,701

 [102,000-20,000-63,550]*.31
20,000 *.28
+ 14,381.5 +
Preference Rate for
Filers in 15% Tax Bracket
Prior to 1997, filers had to have MTR> 28%
before net capital gains had preference
treatment
 Long term capital gains now give all filers
preferential rates
 If filer is in 15% MTR, these gains are
taxed at 10%

In Class Exercise:
Preference Rate on Capital Gains
Single taxpayer’s TI for 2000 is $22,000
 If ordinary income, what is regular tax liability?

 In
2000 all ordinary income under $26,250 is taxed
at 15% for single filers

Solution = $3,300
 $22,000

* .15
The same answer applies if income includes
short term capital gains or long-term gains from
collectibles
In Class Exercise:
Preference Rate on Capital Gains
Single taxpayer’s taxable income for 2000
is $22,000
 If $10,000 of this is a net long term gain,
what is his regular tax liability?

 In
2000 all ordinary income under $26,250 is
taxed at 15% for single filers

Solution = $2,800
 [22,000-10,000]*.15
+ 10,000 *.10
Netting Process
Net by holding period first
 Net across holding periods if they carry
opposite signs

 Negative
and positive
In Class Exercise 1:
Netting Capital Gains and Losses

J&J have $100,000 of taxable income
before capital gains transactions
5,000 ST Capital gain
 30,000 LT Capital Gain


What is J&Js net capital gain/loss position?
Solution: In Class Exercise 1:
Netting Capital Gains and Losses
LT ST
NET
Gain
30,000 5,000
Loss
-0-0Net
30,000 5,000
N/A*
 *Don’t net if both have same sign
 Only the 30,000 is a net capital gain entitled
to maximum 20% tax rate
In Class Exercise 2:
Netting Capital Gains and Losses
Crumb had the following transactions for
the year 2000
 $25,000 long-term capital gain
 $12,000 long-term capital loss
 $8,000 short-term capital gain
 $15,000 short-term capital loss
 What is Crumb’s net capital gain/loss
position?

Solution--In Class Exercise 2:
Netting Capital Gains and Losses
LT ST
NET
 Gain
25,000
8,000
 Loss
12,000
15,000
 Net
13,000
- 7,000
6,000*
 * Net again if long and short term have
different signs
 Only 6,000 is a net capital gain entitled to
maximum 20% (10%) tax rate

In Class Exercise 3:
Netting Capital Gains and Losses
Crumb had the following transactions for
the year 2000
 $5,000 long-term capital gain
 $12,000 long-term capital loss
 $8,000 short-term capital gain
 $5,000 short-term capital loss
 What is Crumb’s net capital gain/loss
position?

Solution--In Class Exercise 3:
Netting Capital Gains and Losses

Gain
 Loss
 Net

LT ST
NET
5,000
8,000
12,000
5,000
-7,000
3,000
-4,000 LTCL
Corporate Taxpayer
Net capital loss not deducted
 Applies to net aggregate loss, not individual
transactions
 Excess losses carry back (3 years) then
forward (five years)
 No preference rate on net LTCG

In Class Exercise:
Net Capital Loss
Assume Crumb is a corporation
 Crumb's taxable income is $50,000 before
the $4,000 net capital loss
 What is Crumb’s taxable income after the
net capital loss is considered?

Solution: In Class Exercise:
Net Capital Loss
Crumb’s taxable income is still $50,000
after the net capital loss is considered
 Corporations may not deduct any net capital
losses
 However, the loss can be carried back and
used against capital gains of earlier years

Individual Taxpayer
Capital losses allowed to extent of capital
gains + $3,000.
 Capital loss carry forward only
 No time limit to c/o
 Short/long term character retained
 Short-term losses are deducted first

In Class Exercise:
Net Capital Loss
Assume Crumb is an individual taxpayer
 Crumb's taxable income is $50,000 before
the $4,000 net capital loss
 What is Crumb’s taxable income after the
net capital loss is considered?

Solution: In Class Exercise:
Net Capital Loss
Crumb’s taxable income is $47,000 after the
net capital loss is considered
 Individuals can deduct up to $3,000 of net
capital losses each year

The excess $1,000 loss CANNOT be
carried back to earlier years
 $1,000 capital loss is carried forward as a
long-term capital loss to be used in future

§1231
Key Learning Objectives (1)
In general
 §1231 property
 §1231 loss
 §1231 gain

§1231 Property

Depreciable or real property
 Used
in a trade or business AND
 Held for more than one year
Other industry-specific property also
qualifies as §1231 property
 Ordinary gain/loss treatment for assets held
one year or less

§1231 Netting
§1231 gain per transaction is amount left
after depreciation recapture
 Net all §1231 gains/losses for year
 Net §1231 loss treated as ordinary loss

§1231 Property
if Net §1231 Gain
Lookback to determine if must recapture
 Prior years' §1231 ordinary losses
 Look back period is last 5 tax years
 Net §1231 gain is recharacterized as
ordinary income to extent of net §1231
losses in look back period not already
recaptured
 Remainder is LTCG

§1231
Key Learning Objectives (2)
Gains in excess of losses
 Recapture net §1231 losses
 Gains and losses from casualty or theft
 §1231 netting procedure summary

In Class Exercise:
Recapture Net §1231 Losses
Jan has $22,650 in net §1231 gains for 2000
 Apply the lookback rule to determine how
much of this is

 Ordinary
income?
 LTCG?

See next slide for Jan’s net §1231 gains and
losses for the five-year look back period
In Class Exercise:
Recapture Net §1231 Losses
 Jan's
history of § 231 net gains
(losses) prior to 2000 (none before 1995)
 1999
9,000
 1998
(15,000)
 1997
20,000
 1996
(17,000)
 1995
5,000
Solution--In Class Exercise:
Recapture Net §1231 Losses
Start with 1995 to calculate un-recaptured
net §1231 losses outstanding at 1-1-00
 1995
$5,000
$5,000 net §1231 gain treated as LTCG
 1996
($17,000)

No un-recaptured §1231 losses at 1-1-96
$17,000 net §1231 loss treated as ordinary
Solution--In Class Exercise:
Recapture Net §1231 Losses

1997
$20,000
$17,000 un-recaptured §1231 losses at 1-1-97
$17,000 of 20,000 treated as ordinary
$3,000 treated as LTCG

1998
($15,000)
No un-recaptured §1231 losses at 1-1-98
$15,000 net §1231 loss treated as ordinary
Solution--In Class Exercise:
Recapture Net §1231 Losses

1999
$9,000
$15,000 un-recaptured §1231 losses at 1-1-99
$ 9,000 is treated as ordinary income

2000
$22,650
$6,000 un-recaptured §1231 losses at 1-1-00
$ 6,000 of $22,650 treated as ordinary
$16,650 treated as LTCG
§1231 Property

Net §1231 gain or loss determination
involves a complex 3-step netting process
discussed in the text
§1231 Netting Process
Step 1
 Net current year casualty gains and losses
 Net loss is ordinary loss
 Net gain is §1231 gain and goes to Step 2
§1231 Netting Process
Step 2
 Net current year §1231 gains and losses
 Net loss is ordinary loss
 Net gain goes to Step 3
§1231 Netting Process
Step 3
 Apply 5-year lookback
 Recharacterize gain as ordinary to extent of
un-recaptured §1231 losses in look back
period
 Remainder of gain is long-term capital gain
and goes to capital gain and loss netting
pool
Depreciation Recapture
Key Learning Objectives (1)
In general
 Recovery property
 Application to losses
 §1245 Recapture

§1245 Depreciation Recapture
Applies to gains only, not losses
 Applies generally to non-real estate

 i.e.
3,5,7 year MACRS property
§1245 recapture potential = total
depreciation taken
 Ordinary gain is recognized to the lesser of
§1245 recapture potential or realized gain
 Gain not subject to recapture is §1231 gain

In Class Exercise:
§1245 Recapture
T bought a machine in 1998 for $120,000
 T sold the machine in 2000 for $140,000
 Total MACRS depreciation taken as of the
date of the sale was $75,000
 How much should T report

 As
ordinary income under §1245?
 As §1231 gain?
Solution: In Class Exercise:
§1245 Recapture

T should report
 $75,000 of ordinary income under §1245
 $20,000 §1231 gain

Amount realized
Cost
120,000
Depreciation
75,000
Basis
Gain
§1245 recapture





140,000
45,000
95,000
75,000
Depreciation Recapture
Key Learning Objectives (2)
§1250 Property
 Additional issues §1245 and §1250
 Differences between §1245 and §1250
 §291--Additional recapture for corporations

§1250 Recapture
Applies to gains only, not losses
 Applies to real estate
 Never applies if straight-line method used
 Thus, no recapture for MACRS

 Post-1986
realty
Residential Realty
§1250 Recapture Potential
§1250 recapture potential
 Excess of accelerated depreciation over
straight-line
 MACRS--S/L only so no recapture

In Class Exercise:
§1250 Recapture--Residential
T purchased residential property for
$300,000 in 1982
 T sold the property in 2000 for $260,000
 Total ACRS depreciation was $175,000
 Straight-line depreciation would be
$155,000
 How much should T report

 As
ordinary income under §1250?
 As §1231 gain?
Solution: In Class Exercise:
§1250 Recapture Residential

T should report
 $20,000
of ordinary income under §1250
 $115,000 of §1231 gain.
Amount realized
 Cost
 Depreciation
 Basis
 Gain
260,000

300,000
175,000
125,000
135,000
Solution: In Class Exercise:
§1250 Recapture Residential
Accelerated depreciation
 Straight-line depreciation
 §1250 recapture
 §1231 gain
 Total gain

175,000
155,000
20,000
115,000
135,000
Nonresidential Realty
§1250 Recapture Potential

Pre-1981
Excess of accelerated depreciation
over straight-line subject to recapture
 Same
rule as residential realty
ACRS (1981-1986)
All depreciation subject to recapture
 MACRS--S/L only so no recapture

In Class Exercise:
§1250 Recapture Non-Residential

T purchased nonresidential real property for
$600,000 in 1986
T sold the property in 2000 for $460,000
Total ACRS depreciation was $345,000

Straight-line depreciation would be $315,000.

How much should T report


 As
ordinary income under §1250?
 As §1231 gain?
Solution: In Class Exercise:
§1250 Recapture Non-Residential
T should treat this as §1245 property AND
 Recognize the entire $205,000 gain as
ordinary
 Amount Realized
460,000
 Cost
600,000
 Depreciation
345,000
 Basis
255,000
 Gain
205,000

§291--Additional
Recapture for Corporations
Applies to §1250 property
 Additional recapture is based on §1245
rules

§291--Additional
Recapture for Corporations
The additional recapture amount is
20 % of the amount by which
§1245 recapture amount exceeds
§1250 recapture amount
 Total recapture is sum of
§1250 recapture AND
§291 amount
