Chapter 5: Property Transactions Flashcards
Realized gain or loss
Based on amount realized from sale or exchange vs adjusted basis of property sold or exchanged
Must be an identifiable event, not merely a change in value
Property transfers potentially resulting in rain or loss
Sale
Exchange
Condemnation
Casualty
Theft
Bond retirements
Corporate distribution
(NO gain or loss on gift or bequest)
Return of capital
Anything considered return of capital will reduce basis
Amount realized from disposition of propert
Sum of money received
FMV of all other property received
Any debt assumed by buyer
FMV per IRS
The price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to sell
Treatment of selling expenses
Generally reduce the amount realized
Adjusted basis
Initial basis
+ Capital additions
- capital recoveries (depreciation deduction etc .)
= Adjusted basis
Initial basis
Generally cost paid for purchase
If acquired from a decedent, basis = FMV at date of death (or six months from date of death: alternate valuation)
Capital additions
Aka capital expenditures
Expenditures that add to the value of the property, prolong the life of the property, or adapt the property to a new/different use
Increase basis
NOT ordinary or necessary business expenses (like basic repairs)
Capital recoveries
Reduce the basis
- deductions for casualty losses
- cost recovery
- depreciation/amortization/depletion
- return of basis
- compensation or awards for involuntary conversion
- insurance reimbursement
- cash rebates received by purchaser
Recovery of basis doctrine
Taxpayers are allowed to recover the basis of an asset without tax (such amount considered return of capital)
Recognized gain or loss
Amount of gain or loss recognized on the tax return
May be different from realized gain or loss depending on tax provisions
Losses that are generally deductable
- if incurred carrying out trade or business
- incurred in an activity engaged in for profit
- casualty
- theft
Realized losses on sale or exchange of property held for personal use
Not recognize (not deductible) for tax purposes
Cost of acquired property
Amount paid for property including:
- cash
- FMV of property given in exchange
- costs of acquiring the property and preparing it for use
- funds borrowed and used to pay for property
- obligations to the seller assumed by the buyer
Uniform capitalization rules
Dictate which costs taxpayers must capitalize for all property used in trade, business, and activity engaged in for profit
(Taxes are included in capitalized costs and reduce the amount reali,Ed on disposition)
Capitalization of interest
Interest on debt paid or incurred during the production period to finance the construction/installation/development/manufacture of real or tangible personal property must be capitalized if:
- property has a long useful life (20+ years)
- production period exceeding 2 years
Or
- estimated production period exceeding 1 year with cost exceeding $1M
To hold stock in “street name”
Brokerage firm holds title of stock certificates and does not make physical transfer of the actual securities
When investors want to sell they must give brokers specific instruction as to which blocks to sell. Otherwise defaults to FIFO
Identification of stock being sold
If want to sell specific blocks of stock just identify specifically. Otherwise FIFO will be used
Identification of shares of mutual funds being sold
Owners may choose specific identification, FIFO, or average cost
Average cost method is widely used
Basis of property received as a gift
generally the same as the donor’s basis
If FMV > = donor’s basis then donee’s basis = donor’s basis for all purposes
If FMV < donor’s basis then donee has dual basis in the property
Dual basis in gift property
Occurs when FMV at time of gift < donor’s basis
Basis for loss: donee’s basis is property’s FMV at time of gift
Basis for gain: donee’s basis is donor’s basis
If property is sold for more than FMV but less than donor’s basis no gain or loss is recognized
Effect of gift tax on basis
May increase donee’s basis if the FMV excess the donor’s basis on the date of the gift
Calculation of gift tax to increase donee’s basis
(for taxable gifts after 1976)
= Gift tax paid x ((FMV at time of gift - donor’s basis) / amount of the gift)
Amount of gift = FMV of property gifted less annual exclusion (15,000 in 2021)
Essentially pro rata portion of gift tax attributable to appreciation in property unrealized by doner
Gifts of property that has declined in value below original cost
Due to tax law loss will never be recognized (donee’s basis will be FMV)
Basis for property received from decedent
Either FMV at date of death or at an alternate valuation date (AVD)
Different rules for decedents who died in 2010!
Alternative valuation date option
For value of property from a decedent
AVD generally six months after date of death
Makes basis for all assets of that estate their FMV on the AVD unless property distributed to heirs/sold before AVD (in which case basis is the FMV on date of disposal)
Estate tax
2021: taxed if gross estate plus any previous taxable gifts exceeds 11.7 million
Requirements for electing AVD
For property received from a decedent
- AVD may ONLY be used if the value of the gross estate and the amount of estate tax after credits are REDUCED as a result (so only if value of assets decrease after death)
- AVD may not be used if no estate tax is required
Effect of AVF on property
AVD changes basis for purpose of estate taxes but also for purpose of income taxes for the heirs
Carryover basis rule for 2010
Estate tax eliminated for 2010 and not reinstated retroactively till Dec 2010. Estates of individuals who died in 2010 may elect to use provisions for 2010 when estate tax did not apply.
If estate elects not to have estate tax apply:
Taxpayer inheriting property will take the LESSER of the decedent’s basis or FMV at time of death
But basis may be increased if asset is appreciated
May not be increased over FMV. Total increase limited to 1.3Million + any unused built -in loss or NOL carryover
Surviving spouse may receive 3million adjustment
Basis for decedent’s community property
- half the jointly held property is included in the estate
- basis to surviving spouse is FMV
- surviving spouse’s basis ALSO adjusted to FMV
Basis for decedent’s jointly owned property in common law state
Decedent’s Half of jointly owned property is included in decedent’s estate and adjusted to FMV. Survivors share is not adjusted
Determining basis when property is converted from personal to business use
Basis is LOWER of adjusted basis or FMV
This is the basis to be used in depreciation - any subsequent loss on sale or exchange is calculated by this basis less depreciation AFTER transferred to business use
No loss recognized if business basis lower than personal basis
Gain on sale of property converted from personal to business use
Use adjusted basis less depreciation taken after transfer to business use to calculate gain
Allocation of basis in basket purchase
When multiple assets are acquired in a single transaction and later sold/disposed of separately the cost of the original transaction must be apportioned between the assets based on their relative FMV (no allocation needed if disposed of as a lot)
Allocation of common costs for basket purchases
Any common costs incurred to obtain or prepare an asset for use must be capitalized and allocated to the basis of the individual assets
Allocating basis of nontaxable stock dividends received
A portion of the basis of the stock on which the stock dividend is received must be allocated to the new shares and the cost basis of the previously acquired shares reduced
Stock dividend of the same type of stock: basis allocated equally to all shares
Stock dividend of a different type of stock: basis allocated basked on relative FMV
Stock rights
Rights to acquire shares of a specified corporation’s stock at a specific exercise price when specific conditions are met
Basis of nontaxable stock rights
If FMV of stock rights received < 15% DMV of the stock = basis is 0
Unless taxpayer elects to allocate the basis between the stock rights and the stock owned BEFORE distribution of the rights (in which case basis of original stock owned is allocate between stock and stock rights based on FMV)
If FMV > 15% of FMV of stock the basis of the stock previously owned MUST be allocated between stock and stock rights
Basis of stock purchases via exercises stock rights
Amount paid PLUS any basis allocated to the stock rights
Stock rights allows to expire
No loss recognized and full basis reverts to original shares
Property that is NOT a capital asset
Inventory/property to be sold to customers or property subject to depreciation or accounts /notes receivable or supplies used or acquired in ordinary course of business
Us government publications held by taxpayers who received it by means other than stated purchase price or received as a gift
Property held by taxpayer that was created by the taxpayer’s personal efforts
Letter, memo, or similar held by taxpayer for whom property was prepared or produced
Hedging transactions clearly identified as a hedge
Capital assets
Often determined by use
Investments in property, land, financial instruments held for personal use
Also patents, franchises, self-created musical works sold or exchanged
Sale of futures contracts related to purchase of raw materials
Results in ordinary (not capital) gains and losses
- transactions about an integral part of business not about investing
BUT limited to hedging transactions that are an integral part of a taxpayer’s system of acquiring inventory
Gain or loss on securities held by security dealer
Generally ordinary income
If property is clearly identified as held for investment by the close of the day the security is acquired loss or gain is capital loss or gain (cannot be held for sale to customers)
If removed from investment account and held as inventory gains are ordinary gains and losses are capital losses
Mark-to-marker method
Method of inventory valuation required for dealers in securities
Securities must be valued at DMV at end of each taxable year and gain or loss recognized as ordinary gains/losses for income
Subsequent gains and losses must take into account these gains and losses
Real estate sales by taxpayer who regularly engages in such sales
Gains and losses= ordinary gains and losses
Gains Real property subdivided for sale
If sold by nondealer, noncorporate taxpayers may be a capital gain if:
- noncorporate taxpayer holds no other real property primarily for sale in the normal course of business during the year
- unless acquire by inheritance (or devise) lots sold must be held for at least 5 year
- no substantial improvements made while lots are being held (improvements that substantially increase the value of the lots)
- tract or lot may not have been previously held for sale to customers in taxpayers ordinary course of business
Losses on real property subdivided for sale
Capital losses if property is held for investment purposes. Ordinary losses if taxpayer is a dealer
Sale of more than five lots of real property divided for sale
As long as previous requirements met first full gain on first five lots may be capital gain
Starting in tax year in which sixth lot is sold, 5% of the selling price for all lots sold in that and following years is ordinary income (remaining gain is capital gain)
Any selling expenses first applied against portion treated as capital gain (may result in elimination of ordinary income part of the gain)
Bad debt losses from nonbusiness debts
Deductible only as short term capital losses regardless of when debt occured
Deductible only in year in which debt becomes totally worthkess
Net capital gains
The excess of net long term capital gain over net short term capital loss
Net capital gain tax rates
0%
15%
20%
25%
28%
Net short-term capital gain
NSTCG
When total short-term capital gains (STCG) exceeds total short-term capital losses (STCL) for that year
May be offset by net long-term capital loss (NLTCL)
Increases AGI
Net long-term capital gain
NLTCG
When total long-term capital gains (LTCGs) exceed total long-term capital losses (LTCLs) for a year
When exceeds net short-term capital losses results in net capital gains
Preferential rates for adjusted net capital gain and qualified dividends
For single/MFJ/HOH in 2021
0% up to 40,400/ 80,800/ 54,100
15% >40,400 but <=445,850/ >80,800 but <=501,600/ >54,100 but <=473,750
20% >445,850/ >501,600/ >473,750
When ANCG causes income to cross from one income bracket to the next
Amount to bring income to next bracket taxes at lower rate, amount beyond that taxes at the higher rate
Types of long-term capital gains
- Collectables gain (maximum tax rate of 28%)
- Part of gain (usually 50%) resulting from the sale or exchange of qualified small business stock (maximum tax rate of 28% net losses treated as normal LTCLs)
- Unrecaptured section 1250 gain (generally when a building is sold. Maximum 25% tax rate)
- All other LTCGs (preferential tax rate)
Adjusted net capital gains
ANGC
Net capital gains (NCG) less:
- collectibles gain
- Part of gain (usually 50%) resulting from the sale or exchange of qualified small business stock
- Unrecaptured section 1250 gain
Capital losses first offset within their category and then excess loss offset against the highest rate LTCG first, working down to the lowest rate
Collectibles gain
Gain resultung from the sale of collectibles (art, antiques, stamps etc…)
Maximum tax rate of 28%
Section 1202
Provides that noncorporate taxpayers may exclude a portion of the gain resulting from the sale or exchange of qualified small business stock issued after 8/10/1993 that has been held for more than five years
Section 1202 exclusion percentage
Qualified small business stock acquired:
- before 2/18/2009 = 50%
- 2/18/2009 - 9/27/2010 =75%
- after 9/27/2010 = 100% (but still must have been held more than five years to be eligible for exclusion)
Amount of gain eligible for exclusion may not exceed the greater of $10million or 10x aggregate basis of the qualified stock
Remaining eligible gain after exclusion generally taxes at 28%
Gain over eligible amount taxed at preferential rate?
What corporations may issue qualified business stock
C corporation
At least 80% of the value of its assets must be used in active conduct of one or more qualified trades or businesses (as listed in section 1202)
Net short term capital loss
NSTCL
Excess of short-term capital losses (STCG) over short -term capital gains (STGC)
First offset against any net long term capital gain to determine bet capital gain
If net short term capital loss exceeds net long term capital gain
Capital loss may be offset against noncorporate taxpayers ordinary income for up to $3000 in any one year
Any loss beyond the 3000 can be carried forward indefinitely(expires on death)
Net long term capital loss
NLTCL
When long term capital loss (LTCL) exceeds long term capital gain (LTCG) for the year
Can be offset against Net Short term capital gain. If exceeds NSTCG can be offset against ordinary income up to $3000 per year
Can be carried forward. Remains LTCL is later years
In the case of both net long term capital loss and net short term capital loss
Short term capital loss is offset against ordinary income first. Excess carried forward
Long term capital gains and losses 28% tax group
Capital gains and losses from sale or exchange of a collectable held more than one year
Part of the gain from the sale of qualified small business stock held more than 5 years
Long term capital gains and losses 25% tax group
Unrecaptured section 1250 gains
No losses
Long term capital gains and losses 15 or 20% tax group
Capital gains and losses where the asset was held for more than a year and is not a collectable or section 1202 mall business stock
Order for offsetting net short term capital loss against Net long term capital gain
- first against the 28% group, the the 25% group, then then 15 or 20% group
Order for offsetting net long term capital loss from net long term capital gains
Always offset from highest available group first
Qualified dividends
Same preferential tax rates and income breakpoints as for net capital gains
Tax treatment of mutual fund capital gains
Taxpayer must recognize their share of capital gains from a mutual fund even if no distributions received
Increases their basis in their shares if no dividends (still owe taxes)
Mutual funds must separate capital gains into long term and short term
3.8% net investment income tax
NIIT
3.8% tax on investment income or excess of modified AGI over $200,000 individuals/ HOH or $250,000 MFJ
Investment income
interest, dividends, net short term capital gains, bet long term capital gains, rental income, royalty income
Modified AGI
AGI plus:
Net foreign income excluded
Net investment income
Gross investment income less allocable investment expenses
Tax on capital gains and losses- corporate taxpayers
No preferential tax rates
May only offset capital losses against capital gains
But may carry capital losses back to each of the three preceding tax years and forward 5 years to offset gains (carry forward or back treated as short term loss)
Abandonment of property
NOT a sale or exchange
Tax treatment of worthless securities
If a capital asset security becomes worthless it is treated as a loss from sale or exchange of a capital asset on the last day of the tax year
Taxpayer has burden of proof to show worthlessness
Worthless securities held by affiliated corporation
NOT a capital asset and any loss tested as ordinary loss
Affiliated corporation
Parent company owns at least 80% of the voting power of all classes of stock and at least 80% of each class of nonvoting stock
Subsidiary must be an active business (not a passive investment company)
Retirement of debt instrument
If debt instrument is retired (not collected) amounts received are treated as being received in an exchange
Original issue discount
OID
The excess of stated redemption price at maturity over issue price
Discount must be amortized and included in gross income for each day the debt issue is held
When is original issue discount considered 0
If the amount of the discount is less than 1/4 of 1% (.25%) of the stated redemption price at maturity, multiplied by the number of years to maturity
Constant interest rate method
Method to amortize the original issue discount over the life off the bond
Increase in adjusted issue price = (adjusted issue price at beginning of the period x effective rate for period) - interest received
Daily portion of OID for accrual period is simple proportional
Sale of a debt instrument with OID before maturity
Part of OID included in sellers income depends on number of days the debt instrument is owned by seller within the accrual period
Essentially amortize up to date of sale
Market discount bonds
Bonds with a market discount resulting from a rise in interest rates after the issuance of the bonds
Market discount
Excess of the stated redemption price of the bond at maturity over the taxpayer’s basis for the bond immediately after it is acquiredb
De minimis rule for market discount
Market discount is 0 if the discount is less than .25% (1/4 of 1%) of the stated redemption price of the bond at maturity multiplied by the number of years to maturity
Gain on disposition of market discount bonds purchased after April 30 1993
Gain on disposition = ordinary income to the extent of the accrued a market discount (determined by straight line method of accrual)
Market discount allocated on the basis of the number of days the taxpayer held the bond relative to the number of days between acquisition and maturity
Remaining gain is long term capital gains
Income from discount bonds held to maturity
All ordinary income
Options exercised
If option is exercised the amount paid for the option is added to the purchase price of the property acquired
Options sold or allowed to expire
Considered that a sale or exchange has occured and so a gain or loss is recognized
Character of underlying property determines if gain or loss is capital or ordinary
Right to call exercised
WRITER (not buyer of option) wdsa the amount received for the call to the amount realized and is long term or short term based on underlying asset
If call expires writer recognizes a short term gain (even if option held for more than one year)
Writer does not receive income until call is exercised or expires
Tax treatment of transfer of patent
- if holder transfers all substantial rights to the patent it is treated as the sale or exchange of a long term capital asset (regardless of holding period or character of asset) even if payments are periodic or contingent
Does not include copyrights
If rights are limited may not be considered transfer of all substantial right
Not available to corporate taxpayers
“Benefits may be limited by TCJA?”
Holder of a patent
- individual whose efforts created the property or
- individual who acquires patent rights from creater for valuable consideration before property covered by patent is placed into service or used
(Acquiring individual may not be relative of creator or creator’s employer)
Tax treatment of franchise, trademark or trade name
Shall not be treated as a sale or exchange of a capital asset if transferor retains abt significant power, right, or continued interest with respect to the franchise, trademark, or trade name
If not treated as exchange of capital asset then is a licensing agreement and income is ordinary income
Income from exchange of Franchise, trademark or trade name that is contingent
Treated as ordinary income by transferor and may be deducted as business expenses by transferee
Tax treatment of lease cancellation payment received by lessor
Ordinary income (substitute for rent)
Recognized in year received even if accrual method is used
Tax treatment of lease cancellation payment received by lessee
Considered amounts received in exchange for the lease so if lease is a capital asset any gain or loss is a capital loss
Rented personal residence (with no basis in lease) = capital gain
Holding period
Length of time asset is held before it is disposed of
For capital gains
Long term = holding more than one year
Day of acquisition excluded and disposal date included (so if same day a year later = short term, only a year. If next day = long term)
Based on 12 months not 365 days
Day of acquisition / day of disposal
Must be trade dates not settlement dates
Holding period of property received as a gift
If donee’s basis determined by donor’s basis: donor’s holding period added to donee’s
If donee’s basis is FMV on date of gift holding period starts on rate of gift (only if FMV at date of gift was less than donor’s basis AND gift is then sold at a loss)
Holding period for property received from a decedent
Always long term
Basis of property acquired in nontaxable exchange
If properties are capital assets or section 1231 assets the holding period of the property received includes the holding period of the surrenders property
Holding period of nontaxable stock dividends or stock rights
Includes the holding period of the original stock
Holding period of stock purchased with stock rights
Begins on date of exercise
Holding period of stock purchased with stock rights
Begins on date of exercise
Justification for preferential treatment of capital gains
- incentivises mobility of capital
- mitigates effects of inflation and progressive tax system
- lowered cost of capital
- allows Congress a method of effecting taxpayer behavior
“locked-in” effect
An unwillingness to sell or exchange assets for more attractive investments due to potential tax consequences of gain
Selecting property to gift if goal is to reduce future estate taxes
Preferable to make gifts of properties that are expected to significantly increase in value during the post gift period before the donor’s death
Gifting property with FMV less than basis
Inadvisable
Donee’s basis for loss will be FMV. Better to sell asset and give proceeds to donee
Schedule D
Attached to form 1040 to report capital gains and losses
Part I = short term
Part II = long term
Part III = summary
Schedule D
Attached to form 1040 to report capital gains and losses
Part I = short term
Part II = long term
Part III = summary
