Capital Gain Flashcards
What are the 2 reasons that capital gain/loss matters as compared with ordinary gain/loss
1) The 1211 loss deduction limitation
2) For non corporate taxpayers, cap gains/losses are taxed at preferential rates
Describe the 1211 loss deduction limitation for individuals and for corporations.
Loss must still be allowed by some other provision. 1211 only acts as an additional limitation.
For corporations: Can only use capital losses to offset capital gains
For individuals: Can only use capital losses to offset capital gains plus $3K of ordinary income
What are the 1211 loss carryover rules for corporations?
For individuals?
Corporations can carry back losses for 3 years and can carry forward losses for 5 years.
Individuals cannot carryback losses but can carry forward losses forever
Why does 1211 cap the deductibility of capital losses?
It forces taxpayers to make the realization doctrine a two way street (at least in a rough way). Otherwise taxpayers would delay selling their gains and harvest their losses and defer a lot of taxes
What is the unfairness of the 1211 cap on the deductibility of capital losses?
If someone has a huge capital loss and never has any capital gains to offset, then they are out of luck
If you could pick, how do you want to allocate your gains and losses over capital and ordinary assets?
Individuals want all gains to be capital and losses to be ordinary (This is what Biefeldt was trying to pull off)
Same applies for corps, but Corps don’t care as much about the gains being capital because they don’t get any preferential rates
What are the two ways that aggressive taxpayers can try to make their gains capital and their losses ordinary?
1) Can try to push assets in/out of the 1221 exclusions from capital asset
2) Can try to create or eliminate the sale or exchange required by 1222
If a sale or exchange of a capital asset is not taken into account in gross income (gain) or taxable income (loss) then there is technically no capital gain or loss (see 1222)
1222 limits the definition of capital gains and losses to only those affecting gross income or taxable income
What are the 2 questions to ask when determining if there is capital gain?
1) Was there a sale or exchange necessary to trigger a gain or loss under 1222?
2) Was the asset sold or exchanged a capital asset in the hands of the TP under 1221?
Describe the scope of 1222’s sale or exchange requirement for capital gains or losses.
1222’s Sale or exchange is narrower than 1001’s sale or other disposition
Sale or exchange requires that the property given up continue to exist in the hands of the buyer
Abandonments/casualties are not sales and exchanges but ARE dispositions under 1001?
How can you manipulate the sale or exchange requirement to make something a capital gain? To eliminate capital loss?
If you abandon (or burn) the property, there is no sale or exchange so any loss would be ordinary.
If you sell or exchange property then it is eligible to be a capital gain/loss
What are two areas where Congress has specifically made a disposition a “sale or exchange”?
Redemption/retirement of a debt instrument (1271(a)1)
Amounts received by shareholders on complete corporate liquidations in exchange for canceling their shares (331a)
What was the inspiration for the carve-out doctrine?
What is the carveout doctrine?
this is Hort importing the horst definition of property where only the remainder is property.
If you carveout a term interest from a larger interest in property and then sell the carveout, you have not sold “the property” and hence cannot have capital gain
What are some examples of cases where the carveout doctrine applied?
Gillette: The forced lease/temporary taking was a carveout from the larger ownership of the property, so there was no capital gain on compensation for that term interest
Hort: a lease was a carved out interest from the term interest of the landlord, so there was no capital gain on compensation from it
What is a way around the carveout doctrine for some TPs?
If your entire interest is a term interest, then you can sell that interest and the carveout doctrine does not apply.
e.g. Tenant sells their lease back to the landlord. the tenant would have capital gain because they are selling their full interest.
What are the 3 theories justifying capital gain?
1) Bunching theory
2) Encouraging Risky Assets Theory
3) Unlocking Property Theory
What is the argument of the Bunching Theory?
Congress doesn’t want taxpayers to be forced into a higher bracket when they recognize gain that has been building over multiple years all in one year, so they provide a special lower capital gains rate
Why is the Bunching Theory not convincing?
1) Most capital gains are reported by people in the highest brackets every year
2) If we were really trying to solve a bunching problem, the tax break would be a function of how long you’ve held the asset (one year is really short)
Why is the Unlocking Property Theory not convincing?
If we really wanted to solve the lock-in problem, we would eliminate the realization doctrine
If we couldn’t kill the realization doctrine for practical reasons, it’s still not clear why a single rate of cap gain is the way to fix the problem.
What is Chirelstein’ Theory about distinguishing capital gain from ordinary gain?
He says that capital gain is from changes in market value and ordinary gain is from time value of money
Are qualified dividends capital gain?
No - they are only taxed at rates that are similar to capital gains rates
What question should you ask when determining if an asset is a capital asset?
Is this asset a capital asset IN THE HANDS OF THIS TAXPAYER.
Intentions of the person holding the property are relevant and can change
What is the bias of courts in determining if assets are capital in the hands of a taxpayer?
Courts are more likely to find a change of intentions more persuasive to move property into the 1221(a)1 inventory exclusion (making them ordinary assets) than they are to move property out of the inventory exclusion (making them capital assets)
This is generally a bias that disadvantages the taxpayer
I’ve owned the family farm for a long time and the suburbs are now approaching. I want to become a real estate developer and sell the family farm as lots with streets and sewers. How should I approach it?
Beware transforming your capital asset (farm) into inventory (ordinary asset).
You want to convey the land to a corp that you own, in exchange for the corps note at FMV. That way you only pay ordinary income on the increase in value due to your development and get capital gain on the gain that you’re sitting on because you’ve held it since it was a farm.
