Ch 14

Question 1

Alternative tax

Answer 1

An option that is allowed in computing the tax on net capital gain. For the corporate taxpayer, the rate is 35 percent (the same as the highest regular corporate tax rate). Thus, for corporate taxpayers, the alternative tax does not produce a beneficial result. For noncorporate taxpayers, the rate is usually 15 percent (but is 25 percent for unrecaptured ? 1250 gain and 28 percent for collectibles and ? 1202 gain). However, if the noncorporate taxpayer is in either the 10 percent or the 15 percent tax bracket, the alternative tax rate is 0 percent (rather than 15 percent). Certain high-income taxpayers (i.e., in the 39.6 percent tax bracket) have an alternative tax rate of 20 percent. ?? 1(h) and 1201.

Question 2

Capital asset

Answer 2

Broadly speaking, all assets are capital except those specifically excluded from that definition by the Code. Major categories of noncapital assets include property held for resale in the normal course of business (inventory), trade accounts and notes receivable, and depreciable property and real estate used in a trade or business (? 1231 assets). ? 1221.

Question 3

Capital gain

Answer 3

The gain from the sale or exchange of a capital asset.

Question 4

Capital loss

Answer 4

The loss from the sale or exchange of a capital asset.

Question 5

Collectibles

Answer 5

A special type of capital asset, the gain from which is taxed at a maximum rate of 28 percent if the holding period is more than one year. Examples include art, rugs, antiques, gems, metals, stamps, some coins and bullion, and alcoholic beverages held for investment.

Question 6

Franchise

Answer 6

An agreement that gives the transferee the right to distribute, sell, or provide goods, services, or facilities within a specified area. The cost of obtaining a franchise may be amortized over a statutory period of 15 years. In general, the franchisor’s gain on the sale of franchise rights is an ordinary gain because the franchisor retains a significant power, right, or continuing interest in the subject of the franchise. ?? 197 and 1253.

Question 7

Holding period

Answer 7

The period of time during which property has been held for income tax purposes. The holding period is significant in determining whether gain or loss from the sale or exchange of a capital asset is long-term or short-term. ? 1223.

Question 8

Intangible drilling and development costs (IDC)

Answer 8

Taxpayers may elect to expense or capitalize (subject to amortization) intangible drilling and development costs. However, ordinary income recapture provisions apply to oil and gas properties on a sale or other disposition if the expense method is elected. ?? 263(c) and 1254(a).

Question 9

Lessee

Answer 9

One who rents property from another. In the case of real estate, the lessee is also known as the tenant.

Question 10

Lessor

Answer 10

One who rents property to another. In the case of real estate, the lessor is also known as the landlord.

Question 11

Long-term nonpersonal use capital assets

Answer 11

Includes investment property with a long-term holding period. Such property disposed of by casualty or theft may receive ? 1231 treatment.

Question 12

Net capital gain (NCG)

Answer 12

The excess of the net long-term capital gain for the tax year over the net short-term capital loss. The net capital gain of an individual taxpayer is eligible for the alternative tax. ? 1222(11).

Question 13

Net capital loss (NCL)

Answer 13

The excess of the losses from sales or exchanges of capital assets over the gains from sales or exchanges of such assets. Up to $3,000 per year of the net capital loss may be deductible by noncorporate taxpayers against ordinary income. The excess net capital loss carries over to future tax years. For corporate taxpayers, the net capital loss cannot be offset against ordinary income, but it can be carried back three years and forward five years to offset net capital gains. ?? 1211, 1212, and 1221(10).

Question 14

Options

Answer 14

The sale or exchange of an option to buy or sell property results in capital gain or loss if the property is a capital asset. Generally, the closing of an option transaction results in short-term capital gain or loss to the writer of the call and the purchaser of the call option. ? 1234.

Question 15

Original issue discount

Answer 15

The difference between the issue price of a debt obligation (e.g., a corporate bond) and the maturity value of the obligation when the issue price is less than the maturity value. OID represents interest and must be amortized over the life of the debt obligation using the effective interest method. The difference is not considered to be original issue discount for tax purposes when it is less than one-fourth of 1 percent of the redemption price at maturity multiplied by the number of years to maturity. ?? 1272 and 1273(a)(3).

Question 16

Patent

Answer 16

An intangible asset that may be amortized over a statutory 15-year period as a ? 197 intangible. The sale of a patent usually results in favorable long-term capital gain treatment. ?? 197 and 1235.

Question 17

Qualified dividend income

Answer 17

Distributions made by domestic (and certain non-U.S.) corporations to noncorporate shareholders that are subject to tax at the same rates as those applicable to net long-term capital gains (i.e., 0 percent, 15 percent, or 20 percent). The 20 percent rate applies to certain high-income taxpayers (i.e., whose tax bracket is 39.6 percent), beginning in 2013. The dividend must be paid out of earnings and profits, and the shareholders must meet certain holding period requirements as to the stock. ?? 1(h)(1) and (11).

Question 18

Related-party transactions

Answer 18

The tax law places restrictions upon the recognition of gains and losses between related parties because of the potential for abuse. For example, restrictions are placed on the deduction of losses from the sale or exchange of property between related parties. In addition, under certain circumstances, related-party gains that would otherwise be classified as capital gain are classified as ordinary income. ?? 267, 707(b), and 1239.

Question 19

Sale or exchange

Answer 19

A requirement for the recognition of capital gain or loss. Generally, the seller of property must receive money or relief from debt to have sold the property. An exchange involves the transfer of property for other property. Thus, collection of a debt is neither a sale nor an exchange. The term sale or exchange is not defined by the Code.

Question 20

Section 1231 gains and losses

Answer 20

If the combined gains and losses from the taxable dispositions of ? 1231 assets plus the net gain from business involuntary conversions (of both ? 1231 assets and long-term capital assets) is a gain, the gains and losses are treated as long-term capital gains and losses. In arriving at ? 1231 gains, however, the depreciation recapture provisions (e.g., ? 1245) are applied first to produce ordinary income. If the net result of the combination is a loss, the gains and losses from ? 1231 assets are treated as ordinary gains and losses. ? 1231(a).

Question 21

Section 1231 lookback

Answer 21

For gain to be classified as ? 1231 gain, the gain must survive the ? 1231 lookback. To the extent of nonrecaptured ? 1231 losses for the five prior tax years, the gain is classified as ordinary income. ? 1231(c).

Question 22

Section 1231 property

Answer 22

Depreciable assets and real estate used in trade or business and held for the required long-term holding period. ? 1231(b).

Question 23

Section 1245 property

Answer 23

Property that is subject to the recapture of depreciation under ? 1245. For a definition of ? 1245 property, see ? 1245(a)(3).

Question 24

Section 1245 recapture

Answer 24

Upon a taxable disposition of ? 1245 property, all depreciation claimed on the property is recaptured as ordinary income (but not to exceed any recognized gain from the disposition).

Question 25

Section 1250 property

Answer 25

Real estate that is subject to the recapture of depreciation under ? 1250. For a definition of ? 1250 property, see ? 1250(c).

Question 26

Section 1250 recapture

Answer 26

Upon a taxable disposition of ? 1250 property, accelerated depreciation or cost recovery claimed on the property may be recaptured as ordinary income.

Question 27

Short sale

Answer 27

A sale that occurs when a taxpayer sells borrowed property (usually stock) and repays the lender with substantially identical property either held on the date of the short sale or purchased after the sale. No gain or loss is recognized until the short sale is closed, and such gain or loss is generally short-term. ? 1233.

Question 28

Unrecaptured ? 1250 gain (25 percent gain)

Answer 28

Gain from the sale of depreciable real estate held more than one year. The gain is equal to or less than the depreciation taken on such property and is reduced by ? 1245 and ? 1250 gain.