Bryant - Course 4. Tax Planning. 7. Tax Consequences on Sale of Assets Flashcards
Describe Section 1231 of the IRC as it relates to property transactions.
Section 1231 of the Internal Revenue Code is an important consideration for property transactions. It defines business-use property and the possible capital gain treatment of business-use property sold at a gain
What does Sections 1245 and 1250 identify?
Sections 1245 and 1250 identify categories of property that are subject to depreciation recapture provisions.
What are Capital Assets?
Almost everybody owns property of some sort. When property is disposed of, special tax rules come into play that provide different treatment to capital gains and losses than apply to ordinary gain or loss. These rules are the capital gain provisions of the tax code. The tax on capital gain is taxed at fixed rates equal to or lower than ordinary income tax rates. There is a limitation on the use of capital losses to reduce ordinary income. Capital gain rules apply to capital assets, a vaguely defined term that generally includes all property, including personal use property, that is not inventory nor used in a trade or business. Capital gain rules also apply to other property not included in the classification of capital assets.
What is the Definition of a Capital Asset?
A capital asset is any property owned by a taxpayer other than the types of property specified in the Internal Revenue Code (IRC).
This means that the IRC describes capital assets by defining what is not a capital asset. Since the Code defines capital assets in the negative, it is difficult to accurately understand what a capital asset is, but IRC Section 1221 helps us to distinguish between capital assets and other assets.
Property that is not classified as a capital asset includes the following:
* Inventory or property held primarily for sale to customers in the ordinary course of a trade or business.
* Property used in the trade or business and subject to the allowance for depreciation provided in Section 167 or real property used in a trade or business. (These assets are referred to as Section 1231 assets if held by the taxpayer for more than one year. Gains on Section 1231 assets can be taxed as capital gains in certain circumstances.)
* Accounts or notes receivable acquired in the ordinary course of a trade or business for services rendered or from the sale of property described in the item.
* Other assets include:
* A letter, memorandum, or similar property held by a taxpayer for whom such property was prepared or produced.
* Copyrights; a literary, musical, or artistic composition; a letter or memorandum; or similar property held by a taxpayer whose personal efforts created such property or whose basis in the property for determining a gain is determined by reference to the basis of such property in the hands of one who created the property or one for whom such property was prepared or produced.
* A U.S. government publication held by a taxpayer who receives the publication by any means other than a purchase at the price at which the publication is offered for sale to the public.
* A U.S. government publication held by a taxpayer whose basis in the property for determining a gain is determined by reference to the basis of such property in the hands of a taxpayer in item 4c (for example, certain property received by gift).
Give examples of Capital Assets
Eric owns an automobile that is held for personal use and copyright for a book he has written. Because the copyright is held by the taxpayer whose personal efforts created the property, it is not a capital asset. The automobile held for personal use is a capital asset. One can conclude that the classification of an asset is often determined by its use. Still, it is easy to be confused. An automobile used in a trade or business is not a capital asset (it is Section 1231 property) but is considered a capital asset when it is held for personal use.
Examples of assets that qualify as capital assets include a personal residence, land held for personal use, and investments in stocks or bonds. In addition, certain types of assets are specifically given capital asset status, such as patents & franchises.
What landmark decision did the Supreme Court rendered in Corn Products Refining Co. v. CIR?
In Corn Products Refining Co. v. CIR, the Supreme Court rendered a landmark decision when it determined that the sale of futures contracts related to the purchase of raw materials resulted in ordinary rather than capital gains and losses.
The Corn Products Company, a manufacturer of products made from grain corn, purchased futures contracts for corn to ensure an adequate supply of raw materials. While delivery of the corn was accepted when needed for manufacturing operations, unneeded contracts were later sold. Corn Products contended that any gains or losses on the sale of the unneeded contracts should be capital gains and losses because futures contracts are customarily viewed as security investments, which qualify as capital assets. The Supreme Court held that these transactions represented an integral part of the business for the purpose of protecting the company’s manufacturing operations and that the gains and losses should, therefore, be ordinary in nature.
What did the Supreme Court rule in the Arkansas Best Corp. v. CIR (1988)?
Although the Corn Products doctrine has been interpreted as creating a non-statutory exception to the definition of a capital asset when the asset is purchased for business purposes, the Supreme Court ruled in the Arkansas Best Corp. v. CIR (1988) case that the motivation for acquiring assets is irrelevant to the question of whether assets are capital assets. Arkansas Best, a bank holding company, sold shares of a bank’s stock that had been acquired for the purpose of protecting its business reputation. Relying on the Corn Products doctrine, the company deducted the loss as ordinary. The Supreme Court ruled that the loss was a capital loss because the stock is within the broad definition of the term capital asset in Section 1221 and is outside the classes of property that are excluded from capital asset status. Arkansas Best apparently limits the application of Corn Products to hedging transactions that are an integral part of a taxpayer’s system of acquiring inventory.
Choose the landmark decision rendered by the Supreme Court that determined that the sale of futures contracts related to the purchase od raw materials resulted in ordinary gains, not capital gains and losses
* Corn Products Refining Co. v. CIR
* Arkansas Best Corp. v. CIR (1988)
Corn Products Refining Co. v. CIR
In Corn Products Refining Co. v. CIR, the Supreme Court rendered a landmark decision when it determined that the sale of futures contracts related to the purchase of raw materials resulted in ordinary rather than capital gains and losses.
Other IRC Provisions Relevant to Capital Gains and Losses - Describe what section 1244 does
A number of IRC sections provide special treatment for certain types of assets and transactions. For example, loss on the sale or exchange of certain small business stock that qualifies as Section 1244 stock is treated as an ordinary loss rather than a capital loss to the extent of $50,000 per year ($100,000 if the taxpayer is married and files a joint return).
How does IRC Section 1236 define security?
IRC Section 1236 defines security as any share of stock in any corporation, note, bond, debenture, or indebtedness. It is any evidence of an interest in, or right to subscribe to, or purchase, any of the above.
What is special about Dealers in Securities?
Securities held by dealers in securities are not capital assets and are considered inventory. Section 1236 provides an exception for dealers in securities if the dealer clearly identifies that the property is held for investment. This act of identification must occur before the close of the day on which the security is acquired. The security must not be held primarily for sale to customers in the ordinary course of the dealer’s trade or business at any time after the close of the day of purchase.
Once a dealer clearly identifies a security as being held for investment, any loss on the sale or exchange of the security is treated as a capital loss.
Identification of Investment Property Example:
Allyson, a dealer in securities, purchases Cook Corporation stock on April 8 and identifies the stock as being held for investment on that date. Four months later, Allyson sells the stock. Any gain or loss recognized due to the sale is capital gain or loss.
What method must securities dealers use for their inventory of securities?
For tax years ending on or after December 31, 1993, securities dealers must use the mark-to-market method for their inventory of securities.
Describe the Mark-to-Market Method of Securities Inventory - in Valuing Securities, Recognized Gains and Losses, Treatment of Gains and Losses, and Adjustments
- Valuing Securities - Securities must be valued at fair market value (FMV) at the end of each taxable year.
- Recognized Gain or Loss - Dealers in securities recognize gain or loss each year as if the security is sold on the last day of the tax year.
- Treatment of Gains and Losses - Gains and losses are generally treated as ordinary rather than capital.
- Adjustments - Gains or losses due to adjustments in subsequent years or resulting from the sale of the security must be adjusted to reflect gains and losses already taken into account when determining taxable income.
What happens when Real Property is Subdivided for Sale?
A taxpayer who engages in regular sales of real estate is considered to be a dealer, and, as a result, any gain or loss recognized is ordinary gain or loss rather than capital gain or loss. A special relief provision is provided in IRC Section 1237 for non-dealer, non-corporate taxpayers who subdivide a tract of real property into lots (two or more pieces of real property are considered to be a tract if they are contiguous).
Part or all of the gain on the sale of the lots may be treated as a capital gain if the following provisions of Section 1237 are satisfied:
* During the year of the sale, the non-corporate taxpayer must not hold any other real property primarily for sale in the ordinary course of business.
* Unless the property is acquired by inheritance or devise (i.e., a gift of real estate left at death), the lots sold must be held by the taxpayer for a period of at least five years.
* No substantial improvement may be made by the taxpayer while holding the lots if the improvement substantially enhances the value of the lot.
* The tract or any lot may not have been previously held primarily for sale to customers in the ordinary course of the taxpayer’s trade or business unless such tract at that time was covered by Section 1237.
How does Section 1237 treat losses?
What is the advantage?
How is it computed?
Section 1237 does not apply to losses. Such losses are capital losses if the property is held for investment purposes, or ordinary losses if the taxpayer is a dealer.
The primary advantage of Section 1237 is that potential controversy with the IRS is avoided as to whether a taxpayer who subdivides investment property is a dealer. This allows a person who owns a large tract of land to sell that land in the most economically advantageous way, even if that means selling the land lot by lot.
If the Section 1237 requirements are satisfied, all gain on the sale of the first five lots may be capital gain. Starting in the tax year during which the sixth lot is sold, 5% of the selling price for all lots sold in that year and succeeding years is ordinary income.
IRC Section 1237 Example:
Jean subdivides a tract of land held as an investment into seven lots and all requirements of Section 1237 are satisfied. Each lot has a FMV of $10,000 and a basis of $4,000. Jean incurs no selling expenses and sells four lots in 2021 and three lots in 2022.
What are the gains in 2021?
What are the gains in 2022? How much is ordinary income?
In 2021, all of the $24,000 [4 lots x ($10,000 - $4,000)] gain is capital gain.
In 2022, the year in which the sixth lot is sold, $1,500 of the gain is ordinary income [0.05 x ($10,000 x 3 lots)], and the remaining $16,500 {[3 lots x ($10,000 - $4,000)] - $1,500} gain is capital gain.
How are non-business bad debts treated?
Non-business bad debts are deductible only as short-term capital losses (STCLs). Such debt is deductible only in the year in which the debt becomes totally worthless.
Non-business bad debt losses are __ ____??____ __.
* not deductible
* deductible as a short-term capital loss
* deductible as an ordinary loss
* a deduction for AGI
deductible as a short-term capital loss
Bad debt losses from non-business debts are deductible only as short-term capital losses. It is only deductible in the year in which the debt becomes totally worthless.
What is the Tax Treatment of Non-corporate Taxpayers?
To recognize capital gain or loss, it is necessary to have a sale or exchange of a capital asset. In addition, it is also necessary to classify the gains and losses as short-term and long-term. The following list describes the different gains and losses:
* Short-Term Capital Gain (STCG): The asset is held for one year or less with a gain.
* Short-Term Capital Loss (STCL): The asset is held for one year or less with a loss.
* Long-Term Capital Gain (LTCG): The asset is held for more than one year with a gain.
* Long-Term Capital Loss (LTCL): The asset is held for more than one year with a loss.
Describe Net capital gain (NCG) and it’s tax treatment.
What IRC Section addresses Net capital gain (NCG)?
Net capital gain (NCG), which may receive favorable tax treatment, is defined as the excess of net long-term capital gain over the net short-term capital loss. According to IRC Section 1222(11), net long-term capital gains may be taxed at 0%, 15%, or 20%. Part or all of NCG may be adjusted net capital gain (ANCG).
To compute net capital gain, first, determine all short-term capital gains (STCGs), short-term capital losses (STCLs), long-term capital gains (LTCGs), long-term capital losses (LTCLs), and then net gains and losses as described below.
If total STCGs for the tax year exceed total STCLs for that year, the excess is defined as net short-term capital gain (NSTCG). As discussed later, NSTCG may be offset by net long-term capital loss (NLTCL).
If the total LTCGs for the tax year exceed the total LTCLs for that year, the excess is defined as net long-term capital gain (NLTCG). As indicated earlier, a NCG exists when NLTCG exceeds net short-term capital loss (NSTCL).
NSTCG Example:
Hal has two transactions involving the sale of capital assets during the year. As a result of those transactions, he has a STCG of $4,000 and a STCL of $3,000.
- What is Hal’s NSTCG?
- How is his AGI affected?
Hal’s NSTCG is $1,000 ($4,000 - $3,000), and his AGI increases by $1,000.
NLTCG Examples:
Linda has four transactions involving the sale of capital assets during the year. As a result of the transactions, she has a STCG of $5,000, a STCL of $7,000, a LTCG of $10,000 and a LTCL of $2,000.
* What is Linda’s NSTCL and NLTCG?
* What is the NCG?
After the initial netting of short-term and long-term gains and losses, Linda has a NSTCL of $2,000 ($7,000 - $5,000) and a NLTCG of $8,000 ($10,000 - $2,000).
Because the NLTCG exceeds the NSTCL by $6,000 ($8,000 - $2,000), her NCG is $6,000.
NLTCG Examples:
Clay has two transactions involving the sale of capital assets during the year. As a result of the transactions, he has a LTCG of $4,000 and a LTCL of $3,000.
* What is Clasy’s NLTCG?
* What is Clay’s net capital gain?
* How is his AGI affected?
Clay has a NLTCG and a net capital gain of $1,000.
His AGI increases by $1,000.
What are the tax rates for Adjusted Net Capital Gains?
The rates of 20%, 15%, and 0% apply to adjusted net capital gain (ANCG) recognized, and the rate to use depends upon the taxpayer’s taxable income.
Filing Status:
Single
0% Rate, Up to $44,625,
15% Rate, $44,676 - $492,300
20% Rate, Over $492,300
Head of Household
0% Rate, Up to $59,750
15% Rate, $59,751 - $523,050
20% Rate, Over $523,050
Married Filing Jointly
0% Rate, Up to $89,250
15% Rate, $89,251 - $553,850
20% Rate, Over $553,850
Married Filing Separately
0% Rate, Up to $44,625
15% Rate, $44,676 - $276,900
20% Rate, Over $276,900
What is the rate gain for collectibles and the rate for unrecaptured Section 1250 gain (i.e., gain from real estate used in a trade or business)?
ANCG is net capital gain (NCG) without regard to the 28% rate gain (for collectibles) and the 25% unrecaptured Section 1250 gain (i.e., gain from real estate used in a trade or business). The 28% rate gain is the sum of collectibles gain and IRC Section 1202 gain over the sum of collectibles loss, NSTCL, and LTCL carried forward from a preceding year.
As a general rule, gains resulting from the sale of collectibles such as artwork, rugs, antiques, stamps, and most coins are not taxed at the lower tax rates of 0%, 15%, or 20% but may be taxed at a maximum rate of 28%. Newly minted gold and silver coins issued by the U.S. government qualify for the 0%/15%/20% rates.
Recall that NCG is reduced by collectibles gains to determine ANCG.
How is NCG affected by collectibles gains?
Recall that NCG is reduced by collectibles gains to determine ANCG.
Capital Gain Calculation Example:
Sandy is single with taxable income of $100,000 without considering the sale of a capital asset, Merck stock, during 2023 for $15,000. The stock was purchased four years earlier for $3,000. Sandy has $12,000 of NLTCG, which is ANCG taxed at 15%.
* How do you compute her total tax for 2023?
To compute her total tax for 2023, ordinary rates would be applied to the $100,000, and then the tax on ANCG (15% X $12,000) is added.
Adjusted Net Capital Gain Example:
Danny, a single taxpayer whose marginal tax rate is 32%, purchased Bowling common stock and antique chairs for investment on March 10, 2022. He sold the assets in April of 2023 and has a gain of $8,000 on the stock sale and $10,000 on the sale of the antique chairs.
- What is Danny’s NLTCG?
- What is Danny’s NCG?
- What is his ANCG?
- What is his tax on the capital gains?
Danny’s NLTCG is $18,000, and his NCG is $18,000. His ANCG is $8,000 since $10,000 of the NCG is a collectibles gain.
His tax on the capital gains is $4,000 [(15% x $8,000) + (28% x $10,000)].
How are Qualified Small Business Stock (QSBS) gains treated?
IRC Section 1202 provides that** non-corporate taxpayers may exclude 50% of the gain resulting from the sale or exchange of qualified small business stock (QSBS) issued after August 10, 1993, if the stock is held for more than five years**. A corporation may have QSBS only if it is a C corporation, and at least 80% of the value of its assets must be used in the active conduct of one or more qualified trades or businesses.
Normally, the excluded gain is 50% of any gain resulting from the sale or exchange of qualified small business stock held for more than five years, and the remaining half of the gain is taxed at a maximum rate of 28%. However, the excluded gain may be less than 50% of the gain, because the amount of gain that a taxpayer for one corporation may exclude is 50% of the greater of $10,000,000 or ten times the aggregate basis of the qualified stock. If the gain on the sale of qualified small business stock is $11.4 million and $5 million of the gain is excluded, $5 million is taxed at 28%, and the remaining $1.4 million gain is taxed at 15%.
How did QSBS Exclusion change over the years?
The exclusion for QSBS had been 50% for many years, but pursuant to several tax bills in recent years, the exclusion percentage increased to 75%, then to 100% as follows:
Acquisition Date Exclusion Percentage
* Before February 18, 2009 50%
* February 18, 2009 – September 27, 2010 75%
* September 28, 2010 – December 31, 2011 100%
* After December 31, 2011 100%
QSBS Tax Treatment Example:
Roger purchased $200,000 of newly issued Monona common stock on October 1, 2009. On December 15, 2023, he sells the stock for $4 million (a gain of $3.8 million).
- How much of the gain can he exclude?
- How is the remaining gain taxed?
- If Rodger purchased the stock on July 11, 2017, and sold it in 2023, how much of the gain could he exclude?
He excludes $2.85 million of the gain (i.e., 75%), and the remaining $1.150 million of gain is Section 1202 gain taxed at 28%.
Alternatively, if Rodger purchased the stock on July 11, 2017, and sold it in 2023, he could exclude 100% of the gain.
What is the tax treatment of short term capital losses?
To have a capital loss, one must sell or exchange the capital asset for an amount less than its adjusted basis. As in the case of capital gains, the one-year period is used to determine whether the capital loss is short-term or long-term.
If total short-term capital losses (STCLs) for the tax year exceed total short-term capital gains (STCGs) for that year, the excess is defined as a net short-term capital loss (NSTCL). If the NSTCL exceeds the NLTCG, the capital loss may be offset, in part, against other income. The NSTCL may be deducted in full (i.e., on a dollar-for-dollar basis) against a non-corporate taxpayer’s ordinary income for amounts up to $3,000 in any one year ($1,500 for MFS).
Capital Loss Tax Treatment Example:
Bob has gross income of $60,000 before considering capital gains and losses. If Bob has a NLTCG of $10,000 and a NSTCL of $15,000, he has $5,000 of NSTCL over NLTCG and may deduct $3,000 of the losses from gross income.
* Assuming no other deductions for AGI, what is Bob’s AGI?
* What happens to any loss not used?
* What happens if a taxpayer dies with unused capital loss carryover?
Bob has gross income of $60,000 before considering capital gains and losses. If Bob has a NLTCG of $10,000 and a NSTCL of $15,000, he has $5,000 of NSTCL over NLTCG and may deduct $3,000 of the losses from gross income. Assuming no other deductions for AGI, Bob’s AGI is $57,000 ($60,000 - $3,000).
In Bob’s case, $10,000 of the NSTCL is used to offset the $10,000 of NLTCG, and $3,000 of the NSTCL is used to reduce ordinary income. However, $2,000 of the loss is not used. This net capital loss is carried forward for an indefinite number of years. The loss retains its original character and will be treated as a STCL occurring in a subsequent year.
If a taxpayer dies with an unused capital loss carryover, it expires.
What is the tax treatment of long term capital losses?
If total long-term capital losses (LTCLs) for the tax year exceed total long-term capital gains (LTCGs) for the year, the excess is defined as net long-term capital loss (NLTCL). If there is both a NSTCG and a NLTCL, the NLTCL is initially offset against the NSTCG on a dollar-for-dollar basis. If the NLTCL exceeds the NSTCG, the excess is offset against ordinary income on a dollar-for-dollar basis up to $3,000 per year.
What happens if an individual has both NSTCL and NLTCL?
If an individual has both NSTCL and NLTCL, the NSTCL is offset against ordinary income first, regardless of when the transactions occur during the year.
Capital Loss Carryforward Example:
In the current year, Gordon has a NLTCL of $9,000 and a NSTCG of $2,000.
* How does he use the loss?
* What is the carryforward of NLTCL?
In the current year, Gordon has a NLTCL of $9,000 and a NSTCG of $2,000.
He must use $2,000 of the NLTCL to offset the $2,000 NSTCG, and then use $3,000 of the $7,000 ($9,000 - $2,000) NLTCL to offset $3,000 of ordinary income.
Gordon’s carryforward of NLTCL is $4,000 [$9,000 - ($2,000 + $3,000)]. This amount is treated as a LTCL in subsequent years.
What are the three tax rate groups that taxpayers separate their long-term capital gains (LTCGs) and long-term capital losses (LTCLs) into?
Taxpayers separate their long-term capital gains (LTCGs) and long-term capital losses (LTCLs) into three tax rate groups:
* 28% group: This group includes capital gains and losses when the capital asset is a collectible held for more than one year and, if applicable, either half or a quarter of the gain from the sale of qualified small business stock (Section 1202) held for more than 5 years.
* 25% group: This group consists of unrecaptured Section 1250 gain and there are no losses for this group.
* 0/15/20% group: This group, depends upon the taxpayer’s taxable income, includes capital gains and losses when the holding period is more than one year and the capital asset is not a collectible or Section 1202 small business stock.
When a taxpayer has NSTCL & NLTCG, how is the NSTCL used to offset gains?
When a taxpayer has NSTCL and NLTCG, the NSTCL is first offset against NLTCG from the 28% group, then the 25% group, and, finally, the 0/15/20% group. This treatment of NSTCL is favorable for taxpayers because the NSTCL offsets the higher-taxed NLTCG first. Note that a taxpayer could have NLTCLs in one group, except the 25% group, and NLTCGs in another group. A net loss from the 28% group is first offset against gains in the 25% group and then net gains in the 15% (or 20% or 0%) group. A net loss from the 15% group is first offset against net gains in the 28% group then gains in the 25% group.
How does the net investment income tax rules affect LTCG rate?
In addition, the 20% LTCG rate could increase to 23.8% based on the net investment income tax rules. The NII tax on individuals is calculated using a 3.8% tax rate and is imposed on the lesser of “net investment income” for such taxable year, or
* (i) the excess (if any) of the individual’s modified adjusted gross income for such taxable year, over
* (ii) a threshold amount ($250,000 for a married taxpayer filing a joint return, $125,000 for a married taxpayer filing separately, and $200,000 in all other cases).
Capital Losses Applied to Capital Gains Example:
Leroy, whose tax rate is 32%, has NSTCL of $20,000, a $25,000 LTCG from the sale of a rare stamp held for 16 months, and a $18,000 LTCG from the sale of stock held for three years.
* How are the Capital Losses Applied to Capital Gains?
* What is Leroy’s tax liability for his capital gain?
The $20,000 NSTCL is offset against $20,000 of the collectibles gain in the 28% group.
Leroy’s tax liability for his capital gain is $4,100 [($5,000 x 28%) + ($18,000 x 15%)].
What is the tax treatment of mutual funds?
Taxpayers who own mutual funds must recognize their share of capital gains even if no distributions are received. Many mutual fund shareholders reinvest their distributions instead of withdrawing assets from the mutual fund. Mutual funds must classify the gains as short-term or long-term, and long-term gains will need to be separated by rate groups.
When shareholders of a mutual fund recognize their share of capital gains (and are thus liable for the income tax on the gains) when no distribution is actually received, the basis for their shares is increased by the amount of the gain they recognized but did not receive.
Mutual Fund Capital Gains Example:
Eunice, whose tax rate is 32%, is a shareholder of Canyon Mutual Fund. The basis for her shares is $23,000. At the end of the current year, she received a statement from Canyon indicating her share of the following:
Dividend Income = $200
STCG = $300
28% rate gain = $1,000
ANCG = $1,500
* What is the increase in her taxes as a result of her ownership of the mutual shares?
* How is the basis for her shares increased?
The increase in her taxes as a result of her ownership of the mutual shares is $631 [($200 x 15%) + ($300 x 32%) + ($1,000 x 28%) + ($1,500 x 15%)].
The basis for her shares is increased by the amount of the gain recognized, but not received, or, $26,000 ($23,000 + $200 + $300 + $1,000 + $1,500).
Identify the maximum tax rate applied to gains on the sale of collectibles.
* 20%
* 25%
* 28%
* 37%
28%
The 28% rate is in force for certain types of capital gain such as collectibles.
How is Section 1244 Stock (Small Business Stock Election) treated?
Taxpayers generally recognize a capital gain or loss on the sale of stock or securities. The tax law provided an exception for losses from the worthlessness of small business corporation (IRC Section 1244) stock.
Taxpayers may deduct these losses as ordinary losses up to a maximum of $50,000 per tax year ($100,000 for married taxpayers filing a joint return).
Any remaining loss for the year is a capital loss.
What requirements must be met under Section 1244?
To qualify as ordinary under Section 1244, the following requirements must be met:
* The stock must be owned by an individual or a partnership.
* The stock must have been originally issued by the corporation to the individual or to a partnership in which an individual is a partner.
* The stock must be stock in a domestic (U.S.) corporation.
* The stock must have been issued for cash or property other than stock or securities. Stock issued for services rendered is not eligible for Section 1244 treatment.
* The corporation must not have derived over 50% of its gross receipts from passive income sources during the five tax years immediately preceding the year of the sale or worthlessness.
* The amount of money and property contributed to both capital and paid-in surplus may not exceed $1 million at the time that the stock is issued.
How should a couple filing jointly address a 1244 loss of $200,000?
The 1244 loss limits ($50k/$100k) are annual limits. For instance, a couple filing jointly with a 1244 loss of $200,000 would most likely be better off selling half of their stock in two tax years.
Selling the entire amount in one tax year would cause $100,000 of the loss to be treated as a capital loss.
At a limit of $3,000 capital loss per year, it could take years or even decades to use the capital loss in full.
How is the Tax Treatment of Corporate Taxpayers different from non-corporate tax payers?
Tax treatment for both corporate and non-corporate taxpayers is the same in the case of rules for capital gains and losses, determining holding periods, and the procedure for offsetting capital losses against capital gains. However, a major difference is that the lower tax rates of 0%, 15%, and 20% on net capital gain for non-corporate taxpayers do not apply to corporations.
A second significant difference relates to the treatment of capital losses. Unlike the non-corporate taxpayer, who may offset capital losses against ordinary income up to $3,000, corporations may offset capital losses only against capital gains.
Corporate taxpayers may carry capital losses back to each of the three preceding tax years (the earliest of the three tax years first and then to the next two years) and forward for five years to offset capital gains in such years. When a corporate taxpayer carries a loss back to a preceding year or forward to a subsequent year, the loss is treated as a short-term capital loss.
Corporate Capital Losses Example:
The Peach Corporation has income from operations of $200,000, a net short-term capital gain (NSTCG) of $40,000, and a net short-term capital loss (NLTCL) of $56,000 during the current year. The $40,000 NSTCG is offset by $40,000 NLTCL.
* How is the remaining $16,000 of NSTCL used?
* What happens if Peach Co. has NLTCG and/or NSTCG in the previous three years?
The remaining $16,000 of NSTCL may not be offset against the $200,000 of other income but may be carried back three years and then forward five years to offset capital gains arising in these years.
If Peach Co. has NLTCG and/or NSTCG in the previous three years, a refund of taxes paid during those years will be received during the current year.
What did The Tax Cuts and Jobs Act (TCJA) set the corporate income tax rate at?
The Tax Cuts and Jobs Act (TCJA) set the corporate income tax rate at a flat 21%. Corporations do not receive the same favorable tax rates on capital gains as non-corporate taxpayers.
How much can non-corporate taxpayers and corporate taxpayers offset of net capital losses against ordinary income?
non-corporate taxpayers - up to $3000
corporate taxpayers - none
How is Holding Period calculated?
The length of time that an asset is held before it is disposed of is called the holding period and is an important factor in determining whether any gain or loss resulting from the disposition of a capital asset is treated as long-term or short-term. To be classified as a long-term capital gain or loss, the capital asset must be held for more than one year.
To determine the holding period:
* the day of acquisition is excluded
* the disposal date is included
If the date of disposition is the same date as the date of acquisition, but a year later, the asset is considered to have been held for only one year. If the property is held for an additional day, the holding period is more than one year.
Holding Period Example:
Arnie purchased a capital asset on April 20, 2022, and sells the asset at a gain on April 21, 2023. The gain is classified as a long-term capital gain (LTCG). If the asset is sold on or before April 20, 2023, the gain is a short-term capital gain (STCG).
How is basis & holding period affected when property is received as a gift?
If a person receives property as a gift and uses the donor’s basis to determine the gain or loss from a sale or exchange, the donor’s holding period is added to the donee’s holding period. In other words, the donee’s holding period includes the donor’s holding period.
If the donee’s basis is the fair market value (FMV) of the property on the date of the gift, the donee’s holding period starts on the date of the gift. This situation occurs when the FMV is less than the donor’s basis on the date of the gift, and the property is sold at a loss.
Gift Property Holding Period Example:
Cindy received a capital asset as a gift from Marc on July 4, 2022, when the asset has a $4,000 FMV. Marc acquired the property on April 12, 2021, for $3,400. If Cindy sells the asset on or after April 13, 2023, any gain or loss is LTCG or LTCL.
* What is Cindy’s basis and holding period?
Cindy’s basis is the donor’s cost because the FMV of the property is higher than the donor’s basis on the date of the gift. Because Cindy takes Marc’s basis, Marc’s holding period is tacked on.
How is the basis determined in a nontaxable exchange?
In a nontaxable exchange, the basis of the property received is determined by taking into account the basis of the property given in the exchange.
If the properties are capital assets or Section 1231 assets, the holding period of the property received includes the holding period of the surrendered property.
In essence, the holding period of the property given up in a tax-free exchange is tacked on to the holding period of the property received in the exchange.
How is the holding period determined in nontaxable stock dividends or stock rights?
What if stock rights are exercised?
If a shareholder receives nontaxable stock dividends or stock rights, the holding period of the stock received as a dividend or the stock rights received includes the holding period for the stock owned by the shareholder.
However, if the stock rights are exercised, the holding period for the stock purchased begins with the date of exercise.
Holding Period on Nontaxable Stock Dividends or Rights Example:
As a result of owning Circle Corporation stock acquired three years ago, Paula receives nontaxable stock rights on June 5, 20XX.
* Why is any gain or loss on the sale of the rights long-term?
* If Paula exercises the stock rights and receives shares of Circle Corporation stock, what is her holding period?
Any gain or loss on the sale of the rights is long-term, regardless of whether any basis is allocated to the rights, because the holding period of the rights includes the holding period of the stock.
If Paula exercises the stock rights and receives shares of Circle Corporation stock, her holding period for the stock begins with the day she exercised the stock rights.
List 3 Other IRC Provisions Relevant To Capital Gains And Losses
Other IRC Provisions Relevant To Capital Gains And Losses include:
* Provisions for dealers dealing in securities
* Real property subdivided for sale
* Non-business bad debts
When is an asset is considered long-term?
When the holding period is more than one year, when a property is received as a gift, when a property is received from a decedent, or in the case of nontaxable exchanges, the asset is considered long-term.
John buys a property on December 31, 2022, and sells it on December 31, 2023. Is the property long-term or short-term?
* Short-Term
* Long-Term
Short-Term
To determine the holding period, the day of acquisition is excluded and the disposal date is included.
John held the property for exactly one year, not more than one year, therefore it will be classified as short-term.
Which of the following is NOT considered a capital asset?
* Corporate stock held for investment
* Automobile used in a trade or business
* A Rembrandt painting held in a private collection
* Personal residence
Automobile used in a trade or business
Property used in a trade or business and subject to allowances for depreciation under Section 167 or real property used in a trade or business is not a capital asset. (i.e., automobile used in a trade or business)
Net long-term capital gains receive preferential tax treatment if they exceed net short-term capital losses.
* False
* True
True
Net capital gain (NCG), which may receive favorable tax treatment, is defined as the excess of net long-term capital gain over net short-term capital loss.
Lynn has two transactions involving the sale of capital assets during the year resulting in a short-term capital loss of $1,500 and a long-term capital loss of $5,000. What can Lynn offset?
* $1,500 of ordinary income and have a LTCL carryforward of $5,000
* $3,000 of ordinary income and have a $3,500 LTCL carryforward
* $3,000 of ordinary income and have a STCL carryforward of $3,500
* $6,500 of ordinary income
$3,000 of ordinary income and have a $3,500 LTCL carryforward
Short-term losses are deducted first. The NSTCL may be deducted in full (i.e., on a dollar-for-dollar basis) against any non-corporate taxpayer’s ordinary income for amounts up to $3,000 in any one year.
When you own a residence and are ready to sell, it is important to understand the tax consequences. What are specific things to be aware of?
Specifically, you need to determine when a gain resulting from the sale of a principal residence is excluded. You will need to determine what is your adjusted basis for your residence and what will happen if you have an excess amount over the property’s adjusted basis.
List 3 ways Congress uses the tax law to encourage homeownership.
Congress uses the tax law to encourage homeownership in many ways:
* Real estate taxes and interest on a mortgage used to acquire a principal or second residence are deductible,
* Part or all of the interest on home equity debt may be deductible, and
* Taxpayers may elect to exclude up to $250,000 ($500,000 on a joint return) of gain from the sale of a principal residence.
How much may an individual may exclude up to on the sale of their personal residence?
How is any gain not excluded treated?
How is any loss treated?
Individuals who sell or exchange their personal residence after May 6, 1997, may exclude up to $250,000 of gain if it was owned and occupied as a principal residence for at least two years of the five-year period before the sale or exchange. A married couple may exclude up to $500,000 when filing jointly if both meet the use test, at least one meets the ownership test and neither spouse is ineligible for the exclusion because he or she sold or exchanged a residence within the last two years.
Any gain not excluded is capital gain because a personal residence is a capital asset.
A loss on the sale or exchange of a personal residence is not deductible because the residence is personal-use property.
Who should maintain financial records on their homes?
Taxpayers who expect to sell their homes for more than $250,000, or $500,000 if a joint return is filed, still need to maintain records.
Also, taxpayers who convert their personal residence to business property or rental property will need to know the property’s correct adjusted basis to compute depreciation.
How do you determine the Realized Gain?
The amount of gain on the sale of the property is called realized gain. Gain realized is the excess of the amount over the property’s adjusted basis. The amount realized on the sale of the property is equal to the selling price less selling expenses. Selling expenses include commissions, advertising, deed preparation costs, and legal expenses incurred in connection with the sale.
