Chapter 10 Flashcards
Taxpayers can dispose of assets in what ways?
sell, trade, scrap, casualty, donation
To calculate gain or loss must know …
amount realized and adjusted basis of each asset
Every asset disposition triggers a…
realization event for tax purposes
For every asset disposition what must be calculated?
a gain or loss
What is amount realized by a taxpayer from the sale or other disposition of an asset?
lis everything of value received from the buyer less any selling costs
Taxpayers typically receive _____ when they sell property
Cash
Besides cash, taxpayers may accept what other things in exchange for property?
marketable securities, notes receivable, similar assets, or any combination of these items as payment.
Amount realized =
Cash received + Fair market value of other property + Buyer’s assumption of liabilities - Seller’s expenses
Scrap-Happy Inc., a scrapbooking retail chain, owns a warehouse which is subject to a $50,000 mortgage. A manufacturing company offers to purchase the warehouse for $15,000 cash and a $30,000 note receivable, as well as assume the mortgage. If Scraphappy accepts this offer, and pays $1,500 in selling expenses, what is the amount realized?
50,000 liability assumed
+ 15,000 cash
+ 30,000 note receivable
_ – 1,500 selling expenses_
$ 93,500 Amount Realized
Adjusted Basis
Original basis reduced by depreciation or other types of cost recovery deductions taken against the property.
Adjusted basis =
Cost basis - Cost recovery deductions
Scrap-Happy owns a computer (5 yr MACRS recovery period ) which they purchased 2 years ago for $1,200. For financial statement purposes, they depreciate the computer over 3 years using the half-year convention and straight line method, with no salvage value. What is their adjusted book and tax bases for the computer (after 2 years of depreciation)?
Book Tax
Cost Basis: $1,200 $1,200
Yr 1 Dep. (HY): (200) (240)
Yr 2 Dep.: _(400)_ _(384)_
Adjusted Basis: $600 $576
The amount of gain or loss taxpayers realize on a sale or other disposition of assets is…
the amount they realize minus their adjusted basis in the disposed assets
Gain or (loss) realized =
Amount realized - Adjusted basis
Scrap-Happy sells the computer in the previous example (adjusted tax basis = $576) for $400. What is their realized gain or (loss) on the sale?
$400 Amount realized
(576) Adjusted basis
($176) (Loss) realized
Gain (loss) realized =
Amount realized - Adjusted basis
Amount realized =
Cash received + Fair market value of other property + Buyer’s assumption of seller’s liabilities - Seller’s expenses
Adjusted basis =
Cost basis - Cost recovery deductions
Recognizing gains (losses) do what to gross income?
increase taxpayers’ (decrease) gross income
When must taxpayers recognize the vast majority of realized gains and losses?
Immediately
T/F Taxpayers are not allowed to permanently exclude the gains from taxable income?
False: They may be allowed to permanently exclude the gains from taxable income.
How does the trade or business of an asset depend on it’s holding period?
If the holding period is short-term (one year or less), it’s ordinary.
If the holding period is long-term (more than one year), it’s section 1231
A short-term asset is also known as what kind of investment or personal-use asset?
Short-term Capital
Ordinary Assets
- Assets created or used in a taxpayer’s trade or business.
- Business assets held for less than a year
Examples of ordinary assets
- Inventory
- Accounts receivable
- Machinery
- Equipment
If taxpayers sell ordinary assets at a gain, how do they recognize it?
They recognize an ordinary gain that is taxed at ordinary rates.
If taxpayers sell ordinary assets at a loss, how do they recognize it?
They deduct the loss against other ordinary income.
Capital assets
Assets held for investment, for the production of income, or for personal use
Qualification as capital asset depends on what?
The purpose for which taxpayers use the asset
Both individuals and corporate taxpayers prefer capital gains or ordinary income?
Capital gains
If the taxpayer type are idividuals, what are the preferential rates?
Preferential Rates
- Most capital gains taxed at 15 percent (0 percent to the extent the gain would have been taxed at a 15 percent or lower rate if it were ordinary income).
- Unrecaptured Sec. 1250 gains taxed at a maximum rate of 25 percent.
- Gains on collectibles held for more than a year taxed at a maximum rate of 28 percent.
If the taxpayer type are corporations, what are the preferential tax rates?
No preferential rates, taxed at ordinary income
If the taxpayer type are individuals, what are the loss limitations?
- Individuals may annually deduct up to $3,000 of net capital losses against ordinary income.
- Losses carried forward indefinitely but not carried back.
If the taxpayer type are corporations, what are the loss limitations?
- No offset against ordinary income.
- Net capital losses can generally be carried back three years and forward five years to offset gains in those years.
§1231 Assets
Depreciable assets and land used in a trade or business (including rental property) held for more than one year.
If the taxpayer recognizes a nes Sec. 1231 gain, the net gain is treated as …
a long-term capital gain.
If the taxpayer recognizes a net Sec. 1231 loss, the net loss is treated as…
an ordinary loss.
Sec 1231 gains on individual depreciable assets may be recharacterized as…
ordinary income under the depreciation recaptue rules.
Depreciation recapture potentially applies to…
gains (not losses) on the sale of depreciable or amortizable business property.
When depreciation recapture is applied, it recharachterizes the gain on the sale of a…
Sec. 1231 asset.
Depreciation recapture does not affect…
Sec. 1231 losses.
Computation depends on the type of…
Sec. 1231 assets the taxpayer is selling (personal or real property).
Depreciation recapture changes only the character but not the…
amount of gain that taxpayers recognize when they sell a depreciable asset.
What are the three types of Sec. 1231 assets?
- Pure Sec. 1231
- Sec. 1245
- Sec. 1250
Pure Sec. 1231 consists of…
land.
Sec. 1245 consists of…
Personal property and intangibles.
Sec. 1250 consists of…
Depreciable real property.
Personal property and amortizable intangible assets are ______ assets.
Sec. 1245
For depreciation recapture concerning Sec. 1245, you will take the lesser of…
- gain recognized or
- accumulated depreciation is recaptured (characterized) as ordinary income under Sec. 1245.
Any remaining gain from Sec. 1245 property for recapture is…
Sec. 1231 gain.
For Sec. 1245 property, there is no depreciation recapture on…
assets sold at a loss.
When taxpayers sell or dispose of §1245 property, they encounter one of the following three scenarios of gain or loss:
- recognize a gain created solely through depreciation deductions
- recognize a gain created through both depreciation deductions and actual asset appreciation
- recognize a loss
Scrap-Happy sells a machine with an adjusted basis of $6,000 for $10,000. Depreciation taken on the machine amounts to $2,500. What amount of gain is recaptured as ordinary and what amount is §1231 gain?
$10,000 Selling price
_– 6,000_ Adjusted basis
$4,000 Gain realized
Depreciation recapture = Lesser of:
- Depreciation taken: $2,500
- Gain realized: $4,000
Depreciation recapture (ordinary income) = $2,500 §1231 gain (capital gain) = $4,000 Gain realized
_– 2,500_ Depr recapture
$1,500 §1231 gain
Depreciable real property (an office building or a warehouse), sold at a gain is subject to…
recapture called §1250 depreciation recapture
A modified version of the recapture rules called §291 depreciation recapture applies to…
corporations but not to other types of taxpayers
§291, corporations selling depreciable real property recapture as what as ordinary income?
20% of the lesser of the recognized gain or the accumulated depreciation.
Depreciable real property sold at a gain is §1250 property, but is no longer subject to…
§1250 recapture
The gain that would be §1245 recapture if the asset were §1245 property is called what?
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%
All gain recognized from selling property i.e., a depreciable asset to a related-party buyer is…
ordinary income.
T/F: Seller is required to recognize ordinary income for depreciation deductions the buyer will receive in the future
True
The tax laws are designed to provide symmetry between the character of deductions an asset generates and the character of income the asset generates when…
it is sold
What are other provisions affecting the rate at which gains are taxed concerning relatives?
Includes family relationships including siblings, spouses, ancestors, and lineal descendants
What’s a provision affecting the rate at which gains are taxed concerning individuals and a corporation?
Also includes an individual and a corporation if the individual owns more than 50 percent of the stock of the corporation, a partnership and any of its partners, and an S corporation and any of its shareholders
What are 3 ways taxpayers could benefit from Calculating Net §1231 Gains or Losses?
- accelerating losses into year 1
- deferring gains until year 2
- characterizing the gains and losses due to the §1231 netting process
§1231 Look-Back Rule
- A nondepreciation recapture rule
- Affects the character but not the amount of gains on which a taxpayer is taxed
T/F: Gains and losses from individual asset dispositions are annually netted together?
True
Net §1231 gains may be recharacterized as ordinary income under the…
§1231 look-back rule
Illustrate the Sec. 1231 netting process.
See picture:
For an exchange to qualify as a like-kind exchange for tax purposes, the transaction must meet the following three criteria
- The property is exchanged “solely for like-kind” property.
- Both the property given up and the property received in the exchange by the taxpayer are either “used in a trade or business” or are “held for investment,” by the taxpayer
- The “exchange” must meet certain time restrictions
Definition for like-kind property for Real Property
Used in a trade or business or held for investment is considered “like- kind” with other real property used in a trade or business or held for investment
Definition of like-kind property for personal property
Considered “like-kind” if it has the same general use and is used in a business or held for investment
Property Ineligible for Like-Kind Treatment includes:
Includes inventory, most financial instruments, partnerships interests, domestic property exchanged for property used in a foreign country and all property used in a foreign country
What are the property use and timing requirements for a like-kind exchange?
- Like-kind property exchanges may involve intermediaries
- Taxpayers must identify replacement “like-kind” property within 45 days of giving up their property
“Like-kind” property must be received within ___ days of when the taxpayer transfers property in a “like-kind” exchange
180
Make a diagram of deferred or starker exchange.
See picture:
Non-like-kind property is known as ____
boot
What happens when boot is given as part of a like-kind transaction?
The asset received is recorded in two parts: property received in exchange for like-kind property and property received in a sale (bought by the boot)
What happens when a boot is received?
- Boot received usually creates recognized gain
- Gain recognized is lesser of gain realized or boot received
The basis of the boot received is the ____ ______ _____ of the boot.
fair market value
Basis in like-kind property =
Fair market value of like-kind property received - deferred gain + deffered loss
Gain is deferred when 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, or Amount of reimbursement the taxpayer does not reinvested in qualified property
Qualified replacement property must be of a similar or related use to the…
original property
Installment Sales
Sale of property where the seller receives the sale proceeds in more than one period
T/F: Concerning installment sales, you must recognize a portion of gain on each installment payment received.
True
Gross profit percentage =
Gain realized/Amount realized
Inventory, marketable securities, and depreciation recapture cannot be accounted for under…
installment sale rules.
Installment sale rules do not apply to…
losses.
