CH. 11 - Property Dispositions Flashcards
To calculate the amount of gain or loss taxpayers realize when they dispose of assets, they must determine ___________
the amount realized on the sale and the adjusted basis for each asset they are selling
What is the amount realized by a taxpayer from the sale or other disposition of an asset?
the value of everything received by the seller in a transaction (cash, FMV of other property, and relief of liabilities) less selling costs.
What is the amount realized computation?
Amount realized = cash received + FMV of other property + buyers assumptions of liability’s – seller’s expenses
How is a gift defined?
as a transfer of property proceeding from a detached and disinterested generosity or out of affection, respect, admiration, charity, or like impulses.
If the donor’s basis is greater than the FMV value of a gifted asset on the date of the gift, then __________ rules apply
special dual basis rules
A dual basis means that the gifted property has one basis to the donee if the donee sells the property at a price above the donor’s basis and a different basis if the donee sells the property at a price below the fair market value oat the date of the gift.
For inherited property, the general ruse is that the heir’s basis in property passing from a descendent to their heir is the ___________ on the date of the decedent’s death
FMV
True or false: the basis for determining the gain or loss on the sale of converted property (from personal use to business use) does not depend on whether the property appreciated or declined in value during the time the property was used personally.
False; it does
For property converted from personal use to business use that has appreciated, the taxpayer will use ____________ to calculate depreciation and gain or loss at disposition
their basis
The basis of gifted property that has declined in value depends on _____________
the sale price of the asset subsequent to the gift
For a donee to calculate basis of an asset on sale day, they use the ____________ if the asset is sold for a gain and ____________ if the asset is sold for a loss
carryover basis (aka the sale price is more than the donor’s basis)
FMV (sales price is less than FMV at the date of the sale)
If an asset sells at a price between the donor’s basis and the FMV at the date of the gift, the the donee’s basis at the time of the sale is _______________
equal to the selling price and the donee does not recognize a gain or loss in the sale
For gifted property (if the FMV value of the gift is of equal or greater value than the donor’s basis at the time of the gift) the general rule is that _________
the donor’s basis for the gifted property is carried over to the donee. The basis is increased by the amount of gift tax paid by the donor that is attributable to the increase in the property’s value.
In general, what will the donee’s basis be when the FMV of the gift at the time of the gift is less than the donor’s basis, and what is the name of the special rules that apply?
The donee’s basis depends on the future selling price of the property, and on whether the sale transaction results in a gain or a loss to the donee.
dual basis rules
(Circumstances: what will the donee’s basis be when the FMV of the gift at the time of the gift is less than the donor’s basis?)
-If the property is sold by the donee at a price lower than the property’s FMV at the time of the gift, the donee uses _________ as their basis
the FMV
(Circumstances: what will the donee’s basis be when the FMV of the gift at the time of the gift is less than the donor’s basis?)
-If the property is sold by the donee at a price higher than the donor’s basis, the donee uses the ______________ as their basis
the donee’s basis
True or false: the holding period of inherited property is deemed to be long term regardless of how long the heir owns the property
True!
For property converted from business use to personal use with a basis greater than value, ____________ apply
The dual basis
Adjusted basis
an asset’s carrying value for tax purposes at a given point in time, measured as the initial basis (for example, cost) plus capital improvements less depreciation or amortization. Also called adjusted tax basis.
What is the basic equation for adjusted basis?
Adjusted basis = initial basis - cost recovery allowed/allowable (aka deductions)
True or false: because businesses generally use more highly accelerated depreciation methods for tax purposes than they do for book purposes, the adjusted tax basis of a particular asset is likely to be higher than the adjusted book basis.
False; it is likely to be lower
What is the basic equation for realizing a gain or loss?
Gain/loss realized = amount realized - adjusted basis
A recognized gain or loss is
a realized gain or loss reported on the taxpayer’s current year return
Recognized gains or losses
gains or losses are gains or losses that increase or decrease a taxpayers gross income
Every gain or loss is characterized as either ______ or ________
ordinary or capital
Why is it important to define the character of a gain or loss for tax purposes?
Because gains or losses of different characters are treated differently for tax purposes
What are the key facts of characters of assets?
Ordinary assets:
-Assets created or used in a taxpayers trade or business
-Business assets held for one year or less
Capital Assets:
-Assets held for investment purposes
-Assets held for personal-use purposes
1231 Assets
-Depreciable assets and land used in a trade or business held for more than one year
Business assets held for one year or less are _________ assets; depreciable assets and land used in a trade or business held for more than one year are __________ assets
ordinary assets; 1231 assets
Ordinary asset
an asset created or used in a taxpayer’s trade or business (e.g., accounts receivable, machinery used for a year or less, inventory) that generates ordinary income (or loss) on disposition.
Capital asset
in general, an asset other than an asset used in a trade or business or an asset such as an account or note receivable acquired in a business from the sale of services or property.
Generally an asset held for investment for the production of income or for personal use.
Production of income
a for-profit activity that doesn’t rise to the level of a trade or business.
True or false: the same asset may be considered a capital asset to one taxpayer and an ordinary asset to another.
True! Whether the asset qualifies as a capital asset or as an ordinary asset depends on the purpose for which the taxpayer uses the asset.
Individual taxpayers generally prefer __________ (ordinary income/capital gains)
Capital gains, because certain capital gains are taxed at lower rates and capital gains may offset capital losses that cannot be deducted against ordinary income.
Individual taxpayers prefer __________ (ordinary losses/capital losses)
ordinary losses because they are deductible without limit, while individuals may only deduct $3,000 of net capital losses against ordinary income each year
Individuals may only deduct ______ of net capital losses against ordinary income each year
$3,000
Corporate taxpayers may prefer _________ (ordinary income/capital gains)
Capital gains because may offset capital losses that they would not be aallowed to offset otherwise.
True or false: C corporatations are allowed to deduct net capital losses
False – they are not
§1231 assets
depreciable or real property used in a taxpayer’s trade or business owned for more than one year.
Depreciation recapture
the conversion of §1231 gain into ordinary income on a sale (or exchange) based on the amount of accumulated depreciation on the property at the time of sale or exchange.
What are the three types of assets that 1231 assets consist of?
Pure 1231 assets:
-Land
1245 Assets:
-Personal Property & Intangibles
1250 Assets:
-Depreciable Real Property
True or false: depreciation recapture rules changes the character and the amount realized
false–it DOES change the character (from 1231 assets to ordinary income), but not the amount realized
What are the key facts of 1245 Assets?
-Personal property and amortizable intangible assets are 1245 assets
-The lesser of (1) gain recognized or (2) accumulated depreciation is recaptured (charactered) as ordinary income under 1245
-Any remaining gain is 1231 gain
There is no depreciation recapture on assets sold at a loss
True or false: recapture rules don’t apply to losses
True!
True or false: depreciable real property (such as an office building or a warehouse) sold at a gain is subject to 1245 depreciation recapture.
False–it is not
True or false: depreciable real property (such as an office building or a warehouse) sold at a gain is subject to 1250 depreciation recapture.
True!
§1250 property
real property subject to cost recovery deductions.
Under 1250, when depreciable real property is sold at a gain, the amount of gain recaptured as ordinary income is limited to additional depreciation, defined as the excess of accelerated depreciation deductions on the property over the amount that would have been deducted if the taxpayer had used the straight-line method of depreciation to depreciate the asset.
Under current law, real property is depreciated using the ___________ method
straight-line
§291 depreciation recapture
the portion of a corporate taxpayer’s gain on real property that is converted from §1231 gain to ordinary income.
What are the key facts of Unrecaptured 1250 Gains?
-Depreciable real property sold at a gain is 1250 property but it is not subject to 1250 recapture unless it is held 12 months or less and bought and sold in different years
-The lesser of (1) recognized gain or (2) accumulated depreciation on the asset is called unrecaptured 1250 gain
-Unrecaptured 1250 gain is 1231 gain that, if ultimately characterized as a long-term capital gain, is taxed at a maximum rate of 25%
Unrecaptured §1250 gain
a type of §1231 gain derived from the sale of real estate held by a noncorporate taxpayer for more than one year in a trade or business or as rental property attributable to tax depreciation deducted at ordinary tax rates. This gain is taxable at a maximum 25 percent capital gains rate.
What are the key facts regarding netting and look-back rules?
-1231 gains and losses from individual asset dispositions are annually netted together
-Net 1231 gains may be recharacterized as ordinary under the 1231 look-back rule
Nonrecaptured net §1231 loss
a net §1231 loss that is deducted as an ordinary loss in one year and has not caused subsequent §1231 gain to be taxed as ordinary income.
What does the 1231 look-back rule specify?
It states that when a taxpayer recognizes a net 1231 gain for a year, the taxpayer must “look back” to the five year period preceding the current tax year to determine whether, during that period, the taxpayer recognized any non-recaptured net 1231 losses.
Tax-deferred transactions
transactions where at least a portion of the realized gain or loss is not currently recognized.
What are some common examples of tax deferred transactions?
-Like-kind exchanges
-involuntary conversions
-installment sales
-business formations and reorganizations
Like-kind exchange
a nontaxable (or partially taxable) trade or exchange of assets that are similar or related in use.
What is another name for a like-kind exchange?
a 1031 exchange
For an exchange to qualify as a like-kind exchange for tax purposes, the transaction must meet what criteria?
- Real property is exchanged for “solely for like-kind” property
- Both the real property given up and the real property received in the exchange by the taxpayer are and will be either “used in a trade or business” or “held for investment” by the taxpayer
- The exchange must meet certain time restrictions
What are the key facts of Like-Kind Property?
Real Property
-all real property used in a trade or business or held for investment is considerd “like-kind” with other real property used in a trade or business or held for investment
Ineligible property
-personal property
-domestic property exchanged for property used in a foreign country and all property used in a foreign country
-real property held for sale
Is personal property eligible for like-kind treatment?
No
What are the timing requirements for a like-kind exchange?
-Like-kind property exchanges may involve intermediaries
-Taxpayers must identity replacement like-kind property within 45 days of giving up their real property
-LIke-kind property must be received within 180 days of when the taxpayers transfers real property in a like-kind exchange
Third-party intermediaries
people or organizations that facilitate the transfer of property between taxpayers in a like-kind exchange. Typically, the intermediary receives the cash from selling the property received from the taxpayer and uses it to acquire like-kind property identified by the taxpayer.
Deferred like-kind exchange
a like-kind exchange where the taxpayer transfers like-kind property before receiving the like-kind property in exchange. The property to be received must be identified within 45 days and received within 180 days of the transfer of the property given up.
Substituted basis
the transfer of the tax basis of stock or other property given up in an exchange to stock or other property received in return.
What are the key facts of like-kind exchanges involving boot?
-Non like-kind property is known as boot
-When boot is given as part of a like-kind transaction:
-The asset received is recorded in two parts: (1) property received in exchange for like-kind property and (2) property received in a sale (bought by the boot)
When boot is received:
-Boot received usually creates recognized gain
-Gain recognized is lesser of gain realized or boot received
Boot
property given or received in an otherwise nontaxable transaction such as a like-kind exchange that may trigger gain to a party to the transaction. The term boot derives from a trading expression describing additional property a party to an exchange might throw in “to boot” to equalize the exchange.
What are the key facts of exchanged basis?
-The basis of like-kind property received is the FMV of the new asset minus deferred gain or plus deferred loss on the exchange (unless boot is given).
-When no gain is recognized on the exchange, the basis of the new property is the same as the taxpayers basis in the old like-kind property
-The basis of boot received is the FMV of the boot
Involuntary conversions
direct or indirect conversions of property through natural disaster, government condemnation, or accident that allows a taxpayer to defer realized gain if certain requirements are met.
What are the key facts on involuntary conversions?
-Gain is deferred when the appreciated property is involuntarily converted in an accident or natural disaster
-Basis of property directly converted is carried over from the old property to the new property
-In an indirect conversion, gain recognized is the lesser of:
-gain realized
-amount of reimbursement the taxpayer does not reinvest in qualified property
-Qualified replacement property must be of a similar or related use to the original property.
Direct conversions
when a taxpayer receives noncash property rather than a cash payment as a replacement for property damaged or destroyed in an involuntary conversion.
Indirect conversions
receipt of money or other property as a replacement for property that was destroyed or damaged in an involuntary conversion.
Qualified replacement property
property acquired to replace property damaged or destroyed in an involuntary conversion. It must be of a similar or related use to the original property even if the replacement property is real property (e.g., rental real estate for rental real estate).
What is the basic equation for a taxpayer to recognized gain on an involuntary conversion?
Recognized gain on an involuntary conversion is equal to the lesser of (1) the gain realized on the conversion or (2) the amount of reimbursement the taxpayer does not reinvest in qualified property
What are two important differences between like-kind exchanges and involuntary conversions?
- involuntary conversion rules allow taxpayers to defer gains on bother personal and real property (business, investment, or personal-use property), whereas the like-kind exchange rules limit the deferral treatment to only real property (business or investment use)
- Taxpayers experiencing a loss from involuntary conversion may immediately deduct the loss as a casualty loss, either as a business loss or as a personal loss, if incurred in a federally declared disaster area, depending on the nature of the loss.
What are the key facts of installment sales?
-Sale of property where the seller receives at least one payment in a taxable year subsequent to the year of disposition of the property
-Must recognize a portion of gain on each installment payment received
-Gains from installment sales are calculated as follows:
-Gross profit percentage = gross profit/contract price
-Gain recognized = gross profit percentage x principal payment received in the year
-Inventory, marketable securities, and depreciation recapture cannot be account for under installment sale rules
-Installment sale rules do not apply to losses
Installment sales
sales for which taxpayers receive payment in more than one period.
What is the formula for the gross profit percentage (related to installment sales)?
Gross profit percentage = gross profit/contract price
What is the purpose of the gross profit percentage/what does it tell you?
It indicated the percentage of the contract price that will ultimately be recognized as a gain
What is the formula for determining the basis on an installment note receivable?
(1-gross profit percentage) x remaining principal payments on note
True or false: taxpayers selling marketable securities or iventory on an installment basis may not use the installment method to report gain on the sales
True
True or false: depreciation recapture (including 1245, 1250, and 291 depreciation recapture) is eligible for installment reporting
False; it is not eligible and must be recognized in the year of sale.
True or false: the 1231 gain remaining after the depreciation recapture can be recognized using the installment method
True
True or false: when a business changes it’s form/organization, they are able to defer the realized gain(s) for tax purposes
True!
What are the key facts to related person losses?
-Related persons are defined in 267 and include certain family members, related corporations, and other entities
-Losses on sales to related persons are not deductible by the seller
-The related-person buyer may subsequently deduct the previously disallowed loss to the extent of the gain on the sale of an unrelated third party
True or false: taxpayers selling business or investment property at a loss to an unrelated persons are generally able to deduct the loss
True!
True or false: a related-person buyer cannot deduct the loss by by selling the property to an unrealted third party at a gain
False; they CAN deduct the loss
The ________________ gain or loss on a property disposition is the amount that increases or decreases the taxpayers gross income
recognized gain or loss
Why is the treatment of Section 1231 gains and losses for individual taxpayers more advantageous than the treatment of gains and losses from other assets?
Because the gains receive preferential tax rates, while the losses are fully deductible rather than restricted
Assets that are created or used in a taxpayer’s trade or business or that have been in service for one year or less are referred to as ________
ordinary assets
The __________ of depreciation changes the character of the gain on the sale of a Section 1231 asset from a Section 1231 gain into ordinary income.
recapture
How is the amount realized on an asset disposition calculated? (Check all that apply.)
Minus seller’s expenses
Plus cash received
Plus FMV of other property received
Plus buyer’s assumption of liabilities
The amount of Section 1245 depreciation recapture that will be taxed as ordinary income is the lesser of (1) ___________ gain on the sale or __________ ______________ on the asset
recognized;
accumulated depreciation
True or false: Net Section 1231 losses are fully deductible against all types of income.
True
True or false: Depreciation recapture changes the character of the gain or loss on a Section 1231 asset from capital to ordinary.
False
Reason: Depreciation recapture applies to gains, but does not apply to losses.
The amount of Section 1245 depreciation recapture that will be taxed as ordinary income is the ____ of (1) the recognized gain on the sale or (2) total accumulated depreciation on the asset. The remainder of any gain is characterized as Section __________ gain, which may be taxed at capital gain rates.
lesser; 1231
Section 291 depreciation recapture for corporations provides that what portion of the gain on depreciable real property will be recognized as ordinary income?
Twenty percent of the lesser of the recognized gain or the accumulated depreciation
When an individual taxpayer sells depreciable real property at a gain, the lesser of the accumulated depreciation or the recognized gain is taxed at a maximum rate of _____% If the recognized gain is higher than the accumulated depreciation, the remaining gain is taxed at a maximum of __________%
25%
20%
Why is the treatment of Section 1231 gains and losses for individual taxpayers more advantageous than the treatment of gains and losses from other assets?
Because the gains receive preferential tax rates, while the losses are fully deductible rather than restricted
The recapture of depreciation changes the character of the gain on a Section 1231 asset from a(n) __________ gain to _________ income
1231; ordinary
The Section 1231 look-back rule indicates that when a taxpayer recognizes a net Section 1231 gain for a year, the taxpayer must look-back to the _______ -year period preceding the current year to determine if there are any unrecaptured Section 1231 losses. If there are losses, the Section 1231 gain in the current year must be recharacterized as __________ _________ to the extent of the unrecaptured loss.
5 years
ordinary income
When a taxpayer sells property to a related party and the property is depreciable property to the buyer, the gain on the sale is characterized as _________ ____________
ordinary income
Mindy’s Marble Shop has a net Section 1231 gain in the current year of $18,000. In the previous five years, there are $13,000 in unrecaptured Section 1231 losses. How will Mindy’s gain be taxed in the current year?
Due to the unrecaptured losses, $13,000 will be recharacterized as ordinary income, and $5,000 will be characterized as long-term capital gain.
How does the reporting of gains and losses differ between (1) selling property for cash and (2) exchanging property for like-kind property?
In a like-kind exchange, the gain/loss is deferred. In a cash transaction, the gain/loss is recognized immediately.
Section 291 depreciation recapture for corporations provides that what portion of the gain on depreciable real property will be recognized as ordinary income?
Twenty percent of the lesser of the recognized gain or the accumulated depreciation
When an individual taxpayer sells depreciable real property used in a business for an amount that exceeds its original cost/original basis, how is the gain taxed?
The gain due to accumulated depreciation is taxed at a max rate of 25%. The remaining gain is taxed at 0/15/20%, depending on the taxpayer’s income.
True or false: Inventory held for resale and most financial instruments, such as stocks and bonds, are ineligible for like-kind treatment.
True
Reason: These assets are not eligible for like-kind treatment even if they are similar assets.
Huey sold a warehouse with an original cost of $150,000 for $230,000 to an S corp where he owns a 51% interest. The S corp will use the warehouse in the business. The warehouse had accumulated depreciation of $40,000. Assuming no other asset sales during the year, how will the gain be taxed to Huey?
$120,000 - ordinary income
Because Huey and and the S corp are related parties because the building will be used in business, the entire realized gain is taxed as ordinary income.
True or false: The exchange of personal use real estate property will qualify as a like-kind exchange if the property received will be used in a similar manner as the property transferred.
False
Reason: The property transferred and received must be used in a trade or business or held for investment. Personal use property does not qualify.
Which of the following types of property are INELIGIBLE for like-kind treatment?
Partnership interests
Land held outside the U.S.
Equipment used in a trade or business
Inventory held for resale
Stocks and bonds held for investment
In a direct conversion, if a taxpayer defers the recognized gain on the exchange of property, the adjusted basis in the property received is equal to the
taxpayer’s basis in the property involuntarily converted.
True or false: Inventory held for resale and most financial instruments, such as stocks and bonds, are ineligible for like-kind treatment.
True
Reason: These assets are not eligible for like-kind treatment even if they are similar assets.
True or false: The exchange of personal use real estate property will qualify as a like-kind exchange if the property received will be used in a similar manner as the property transferred.
False
Reason: The property transferred and received must be used in a trade in business or held for investment. Personal use property does not qualify.
An indirect involuntary conversion occurs when a taxpayer Blank______.
receives a cash settlement to use toward replacing involuntarily converted property
The amount of gain on an installment sale recognized each year is calculated by multiplying the ___________ ___________ ____________ by the installment payment received.
gross profit percentage
