Capital Gains Taxation Flashcards
What is the main tax consideration with the disposition of property?
Whether the property is transferred at a gain or loss
This gain or loss can be capital or ordinary (e.g. selling a personal-use item), though capital gains and losses (i.e. involving capital assets) are most relevant to taxation
As regards property disposition, how do taxable exchanges and nontaxable exchanges differ?
Taxable exchanges require a gain or loss to be recognized – usually as the difference between the value received for the item and the item’s adjusted basis with the transferor
Nontaxable exchanges do not require a gain or loss to be recognized either because they permanently exclude all taxable gain or loss, or (more commonly) because they realize the gain or loss but defer its recognition until a taxable transaction occurs
What kind of property does not count as a capital asset?
(1) inventory
(2) receivables
(3) property used in the course of business
(4) copyrights or other properties whose basis is determined from the creator (e.g. art)
(5) U.S. gov’t publications received for free
When does a holding period count as long-term or short-term?
Long-term = longer than twelve months Short-term = twelve months or shorter
Short-term capital gains and losses are taxed with the rest of ordinary income, while long-term ones receive a special tax rate
If property is transferred in some tax-free exchange (e.g. as a gift), how is the holding period affected?
If the donor’s basis becomes the donee’s basis, then the holding period extends from the donor’s holding period, but if its basis is FMV, then a new holding period begins
If property is transferred from a decedent, how is the holding period affected?
All property transferred this way is automatically considered to have a long-term holding period for the recipients
How do capital losses affect one’s tax liability?
They offset capital gains
If a taxpayer has a net capital loss, he can only deduct it to the lesser of $3,000 or his taxable income – any remaining capital losses can be carried forward indefinitely (but not carried back)
What is the tax rate for net long-term capital gains?
For 2013, taxpayers in the bottom two tax brackets (10% and 15%) pay no tax on capital gains, the very highest bracket (39.6%) pays 20%, and everyone else pays 15%
Does the reduced capital gains tax rate apply to all gains?
No, it does not apply to collectibles (e.g. artwork, metals), which have a maximum rate of 28%
How do capital gains and losses differ for corporations?
Corporations cannot deduct net capital losses past capital gains, yet they can carry capital losses back three years, though forward only five years
Moreover, capital gains rates for corporations are the same as for income
What is Section 1231 property?
Depreciable property or land utilized for business purposes which receives a special tax treatment
What is the special tax treatment for Section 1231 property?
Net capital losses on such property are treated as ordinary losses, while net capital gains are treated as capital gains
Under what circumstances would the disposal of Section 1231 property result in a recapture of previous deductions?
Since Section 1231 property is depreciable and depreciation expense reduces ordinary taxable income, then some of a capital gain (upon disposal) will have to be recaptured as ordinary income in order to offset the higher taxes avoided with the previous depreciation
What other property can have recaptured capital gains?
Section 1245 property – mostly personal property
Section 1250 property – mostly real property
How do related-party transactions affect capital gains and losses?
Such transactions cannot give rise to capital losses
Related parties can involve family, >50% owned entities, commonly controlled corporations, and trusts
What is a like-kind exchange, and what are the tax implications related to it?
A transaction involving property of the same nature
These exchanges, if they involve property used for business or investment purposes, can avoid recognizing any gain or loss – not if they involve personal-use property
Does an exchange count as a like-kind exchange if one item is business-use and the other is investment-use?
Yes
Related to like-kind exchanges, what property counts as personal-use property?
(1) securities (e.g. stocks and bonds)
(2) certificates of trust
(3) partnership interests
(4) beneficial interests
In a like-kind exchange where no gain is recognized, how is the basis determined?
The adjusted basis of the property disposed of is the new basis for the property received
What is boot?
Any money or non-like-kind property given in a like-kind exchange (usually doesn’t constitute the majority of the transaction)
A liability assumed by one party would count as boot given by that party to the other
How does boot affect the recognition of a capital gain or loss?
If boot is given, a loss cannot be recognized, and a gain must be either (a) the gain realized or (b) the boot received, whichever is lesser
How does boot affect the basis of received property?
Basis of property given
+ basis of boot given
- FMV of boot received
= basis of property received
For boot transactions, what is the difference between a realized gain and a recognized gain?
The realized gain is simply the FMV of property received less the basis of property given up
The recognized gain is the lesser of the realized gain and the boot received – in which case someone who receives no boot has a recognized gain of $0
This affects the final calculation, since the basis in the asset is the FMV received less the UNRECOGNIZED gain – that is, the realized gain less the recognized gain
What is an example of a like-kind exchange with boot?
Frank gives a piece of equipment with a FMV of $2,500 and a basis of $1,800 to Joe in exchange for equipment with a FMV of $2,000 and a basis of $1,100. Joe also gives Frank $700 in cash.
Frank’s realized gain is the FMV received ($2,000 + $700) less the basis of property given up ($1,800) = $900. Joe’s realized gain = $2,500 - ($1,100 + $700) = $700. The recognized gain is the lesser of realized gain and boot received, so Frank’s recognized gain is $700 and Joe’s is $0. Unrecognized gain = (realized gain) - (recognized gain), so Frank’s unrecognized gain = $900 - $700 = $200. Joe’s = $700 - 0 = $700.
The basis in the new property = (FMV of property received) - (unrecognized gain), so Frank’s new basis = $2,000 - $200 = $1,800. Joe’s new basis = $2,500 - $700 = $1,800.
How does the sale of a taxpayer’s home affect his capital gains?
So long as the home has been his principal residence for two of the five years before the sale, he can exclude a gain of $250,000 (or $500,000 if married filing jointly) for 2013
For the sale of a home, what can a taxpayer deduct if he has not lived within the home for two of the last five years?
A pro rata portion of the deduction
This applies only if he does not meet the two-year requirement due to relocation for work, health problems, or some other type of unforeseen events
How does the deduction for a gain on a home sale apply if the married couple did not live there together for two full years?
For 2013, only $250,000 can then be deducted, rather than $500,000
How does the deduction for a gain on a home sale apply if one of the spouses died?
So long as the home was sold within two years of the death, the full marital deduction ($500k for 2013) can still be used
Besides a failure to live in the home for two of the last five years, how else might a gain from a home sale not receive a full deduction?
Any use of the home for vacations or rentals in 2009 or later counts as a “non-qualifying use” which then lowers the deduction from the capital gain
The 2009 date is because of the Housing Assistance Tax Act of 2008 (HATA), which allowed rental/vacation use to be qualifying only up until Dec. 31, 2008
For a home sale, how does a non-qualifying use of the home decrease the deduction of a capital gain?
The percentage of time attributable to a non-qualifying use causes that same percentage of the home’s capital gain to be included in taxable income
E.g. if a home was sold after being owned for 10 years, and it was used as a rental house for 3 of those years, then a capital gain of $50,000 would cause the taxpayer to pay taxes on $15,000 (30% x $50k) of those, the rest being deductible
What are involuntary conversions?
Events where property is involuntarily disposed of (e.g. because destroyed or stolen), to be replaced by some other property (e.g. insurance proceeds)
How is a gain or loss on an involuntary conversion recognized?
It is recognized as normal unless the lost property is one’s home
There are some exceptions to this, however
Under what circumstances could someone not deduct a capital loss resulting from an involuntary conversion?
If there is a capital loss on personal-use property, that cannot be deducted except if it was caused by casualty or theft
Under what circumstances would someone not need to recognize a capital gain from an involuntary conversion?
If similar-use property (which has a narrower meaning than “like-kind”) is acquired in exchange for the disposed property, then no gain is recognized, and the basis of the new property is the same as the basis of the old (disposed) property
Likewise, if non-similar-use property is acquired from the involuntary conversion (usually cash), then if that property is used to attain replacement similar-use property, the gain is not recognized (but deferred)
How quickly must proceeds from an involuntary conversion be used to purchase a replacement item for the capital gain to be avoided?
This “replacement period” begins when either the property was stolen/destroyed or (if applicable) a condemnation was threatened or made imminent
This period ends two years (three years for real property) from the end of the first tax year in which any amount of gain was realized
How are the tax consequences of involuntary conversions affected by special disasters (i.e. with a declaration from the president)?
They receive various special breaks, e.g. extending the replacement period to four years’ duration
What is a wash sale?
The selling of a financial asset right before or after purchasing one of the same kind – done to gain a deduction based on an unrealized loss
Consequently these transactions are required to have 30 days between them
How do stock dividends affect capital gains and losses?
Stock dividends are not taxable – the original basis is distributed among the total stock after the dividend according to their relative FMV
If stockholders have an option to receive cash in lieu of stock dividends, do they still avoid taxation?
No, it then becomes a taxable transaction even if the stockholder opts for the stock dividends rather than the cash
How do stock splits affect capital gains and losses?
They only affect the par value and quantity of stocks, not the total dollar investment in stock, so they have no effect
What occurs if stock becomes entirely worthless?
The loss for such stock becomes deductible in the year that it becomes worthless
This is generally a capital loss, though it can be an ordinary loss in some circumstances
Under what circumstances can worthless stock lead to an ordinary (rather than a capital) loss?
With Section 1244 stock – original investors in the first million stocks for a small business company can deduct an ordinary rather than capital loss
This maxes out at $50,000, however, or $100,000 for married filing jointly taxpayers
How does qualified small-business stock (QSBS) relate to capital gains and losses?
Non-corporate investors who hold such stocks from their issuance for at least five years can deduct 50% of any gain they receive from disposing of such stock
This has a max deduction of either (a) 10 times the stock’s basis or (2) $10 million, whichever is greater
Which businesses qualify to issue qualified small-business stock (QSBS)?
C corporations with under $50 million in capital when the stock was issued, and with at least 80% of its assets employed for business use
These corporations cannot be involved in personal services (e.g. accounting or healthcare), or be in finance, real estate, farming, or similar industries
