Chapter 8 - Property Dispositions. Flashcards
Define Abandonment Loss
The unrecovered basis in an abandoned asset. Abandonment losses with respect to business assets are ordinary deductions.
Define Affiliated Corporation
For purposes of the tax rules governing worthless securities, any 80% or more controlled domestic subsidiary that has always derived more than 90% of annual gross receipts from the conduct of an active business.
Define Amount Realized
The sum of any money plus the fair market value of any property raised by a seller on the sale or exchange of property.
Define Capital Asset
Any asset that does not fall into one of the eight statutory categories of noncapital assets. Most business assets (accounts receivable, supplies, inventories, tangible personalty, realty, and purchased intangibles) are noncapital assets.
Define Capital Gain or Loss
Gain or loss realized on the sale or exchange of a capital asset. Capital gain may be eligible for a preferential tax rate.
Define Depreciation Recapture
Recapture computed with reference to depreciation or amortization deductions claimed with respect to property surrendered in a sale or exchange.
Define Gross Profit Percentage
The ratio of gain realized to total contract price in an installment sale.
Define Installment Sale Method
A method of accounting for gains realized on the sale of property when some part of the amount realized consists of the buyer’s note. Under the installment sale method, gain recognition is linked to the seller’s receipt of cash over the life of the note. The seller calculates the gain recognized in the year of the sale and each subsequent year by multiplying the cash received during the year by a gross profit percentage.
Define Net Capital Loss
The excess of current year capital losses over capital gains.
Define Nonrecaptured Section 1231 Loss
A net Section 1231 loss recognized in any of the five preceding taxable years that has not caused recharacterization of Section 1231 gain as ordinary income
Define Nonrecourse Debt
A debt secured by specific collateral for which the debtor is not personally liable.
Define Ordinary Gain or Loss
Any realized gain or loss that is not a capital gain or loss.
Define Realized Gain or Loss
The positive or negative difference between the amount realized on the disposition of property and the adjusted basis of the property.
Define Recapture
Recharacterization of Section 1231 or capital gain as ordinary income.
Define Recognized Gain or Loss
Realized gain or loss taken into account for tax purposes in the current year.
Define Recourse Debt
A debt for which the debtor is personally liable.
Define Section 1231 Asset
Real or depreciable property used in a trade or business (including rental real estate) and intangible business assets subject to amortization held by the owner for more than one year.
Define Section 1245 Recapture
Full recapture of depreciation or amortization allowed for tangible personalty or purchased intangibles.
Define Section 1250 Recapture
Recapture of excess accelerated depreciation over straight-line depreciation allowed for buildings placed in service before 1987.
Define Seller-Financed Sale
A sale transaction in which the seller accepts the purchaser’s debt obligation as part of the sale price.
Define 20 Percent Recapture
Twenty percent of the excess of Section 1245 recapture over 1250 recapture for buildings owned by corporations.
(Section 1245 Recapture - Section 1250 Recapture) * .2 = 20% recapture.
or
In cases where §1250 recapture doesn’t apply it is just 20% of the §1245 recapture
How is a realized gain or loss computed?
Amount realized on disposition
- Adjusted tax basis of property
_____________________________
Realized gain (or loss)
What principle of accounting is reflected in the computation of realized gains or losses?
Realization principle (Increases and decreases in value of assets are not account for as income)
What are the two ways owners can dispose of property?
Sell
Exchange for other property.
What part of a sale or exchange is taxable income?
Only the excess of amount realized over adjusted basis is taxable income. Accordingly, sellers recover their investment in the property at no tax cost.
What happens when a seller realizes a loss on sale or exchange?
The entire amount realized is a tax-free recovery of the seller’s investment.
Moreover, the seller may be allowed to deduct the unrecovered investment (realized loss) in the computation of taxable income.
When a seller finances a purchase and charges interest, the gain is taxable, but how is the interest earned treated?
The interest is not part of the gain, so it is treated as ordinary income.
What are two exceptions to being able to use the installment sale method?
- Does not apply to gains realized on the sale of stocks or securities traded on an established market
- Does not apply to gains realized on the sale of inventory to customers in the ordinary course of the seller’s business.
What is the basis of a note receivable?
The face value (not interest)
When are losses disallowed?
When the losses realized is on the sale or exchange of property between related parties. Then they are nondeductible.
How does the IRS define related parties?
- People who are members of the same family,
- An individual and a corporation if the individual owns more than 50% of the value of the corporations outstanding stock, or
- Two corporations controlled by the same shareholders
What benefit does an original seller who has a disallowed loss on a transaction get when the person he sells it to, resells it for higher than the original basis?
None
-The purchaser of the product may receive some or all of the benefit. If the purchaser subsequently sells the property acquired in the related party transaction and realizes a gain, the purchaser can offset this gain (only enough to zero it out) by the previously disallowed loss.
How is every gain or loss ultimately characterized?
Ordinary
Capital
What are the two distinct components of a capital gain or loss definition?
1 - The transaction resulting in the gain or loss must be a sale or exchange (can’t abandon)
2 - The asset surrendered must be a capital asset.
Capital assets are everything except asset that fall under what eight categories?
1 - Inventory
2 - Accounts Receivable
3 - Supplies
4 - Real or depreciable property used in a trade or business (AKA, Section 1231 property)
5 - Copyright, compositions, artistic efforts created by the taxpayer (exception - patents by inventors are capital assets)
6 - Certain U.S. government publications
7 - Commodities derivative financial instruments held by a dealer.
8 - Hedging transaction properties.
What is the limitation on capital losses? Can they be carried? What is the exception?
- Capital losses can be deducted only to the extent of capital gains.
- They can carry back 3 years and forward 5 years against capital gains.
- There is an exception for individuals. They can deduct $3,000 of net looses per year against ordinary income and carryforward excess indefinitely against capital gains.
How are capital gains taxed for corporations? Individuals?
Corporations - The net gain is taxed at the same rates as ordinary income.
Individuals - The net capital gain may be taxed at preferential rates ranging from zero to 31.8 percent. (If they are long term)
What is the basic rule of Section 1231?
If the combined result of all sales and exchanges of Section 1231 assets during the year is a net loss, the loss is treated as an ordinary loss.
If the result is in a net gain, the gain is treated as a capital gain.
What are the three components of depreciation recapture?
Full recapture (Section 1245 Recapture) Partial recapture (Section 1250 Recapture) 20% recapture (Section 291 Recapture)
When does a Section 1245 capture happen and how does that interact with a Section 1231 gain?
Section 1245 recapture is the character of a gain that is just making back the amount the asset was depreciated by where a 1231 gain is the actual appreciation over the actual cost of the asset (not the adjusted basis)
When does the Section 1245 recapture rule not apply?
To losses.
What is the essential concept of the partial recapture rule for realty?
AKA Section 1250 recapture - Only accelerated depreciation in excess of straight-line depreciation is recaptured.
What effect does selling cost have on a transaction?
The selling cost directly reduces the amount realized.
What is the formula for the gain recognized this year under the installment method?
Gain recognized this year = (cash this year) x (total gain / total sales price).
