Chapter 8 - Property Dispositions.

Question 1

Define Abandonment Loss

Answer 1

The unrecovered basis in an abandoned asset. Abandonment losses with respect to business assets are ordinary deductions.

Question 2

Define Affiliated Corporation

Answer 2

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.

Question 3

Define Amount Realized

Answer 3

The sum of any money plus the fair market value of any property raised by a seller on the sale or exchange of property.

Question 4

Define Capital Asset

Answer 4

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.

Question 5

Define Capital Gain or Loss

Answer 5

Gain or loss realized on the sale or exchange of a capital asset. Capital gain may be eligible for a preferential tax rate.

Question 6

Define Depreciation Recapture

Answer 6

Recapture computed with reference to depreciation or amortization deductions claimed with respect to property surrendered in a sale or exchange.

Question 7

Define Gross Profit Percentage

Answer 7

The ratio of gain realized to total contract price in an installment sale.

Question 8

Define Installment Sale Method

Answer 8

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.

Question 9

Define Net Capital Loss

Answer 9

The excess of current year capital losses over capital gains.

Question 10

Define Nonrecaptured Section 1231 Loss

Answer 10

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

Question 11

Define Nonrecourse Debt

Answer 11

A debt secured by specific collateral for which the debtor is not personally liable.

Question 12

Define Ordinary Gain or Loss

Answer 12

Any realized gain or loss that is not a capital gain or loss.

Question 13

Define Realized Gain or Loss

Answer 13

The positive or negative difference between the amount realized on the disposition of property and the adjusted basis of the property.

Question 14

Define Recapture

Answer 14

Recharacterization of Section 1231 or capital gain as ordinary income.

Question 15

Define Recognized Gain or Loss

Answer 15

Realized gain or loss taken into account for tax purposes in the current year.

Question 16

Define Recourse Debt

Answer 16

A debt for which the debtor is personally liable.

Question 17

Define Section 1231 Asset

Answer 17

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.

Question 18

Define Section 1245 Recapture

Answer 18

Full recapture of depreciation or amortization allowed for tangible personalty or purchased intangibles.

Question 19

Define Section 1250 Recapture

Answer 19

Recapture of excess accelerated depreciation over straight-line depreciation allowed for buildings placed in service before 1987.

Question 20

Define Seller-Financed Sale

Answer 20

A sale transaction in which the seller accepts the purchaser’s debt obligation as part of the sale price.

Question 21

Define 20 Percent Recapture

Answer 21

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

Question 22

How is a realized gain or loss computed?

Answer 22

Amount realized on disposition
- Adjusted tax basis of property
_____________________________
Realized gain (or loss)

Question 23

What principle of accounting is reflected in the computation of realized gains or losses?

Answer 23

Realization principle (Increases and decreases in value of assets are not account for as income)

Question 24

What are the two ways owners can dispose of property?

Answer 24

Sell

Exchange for other property.

Question 25

What part of a sale or exchange is taxable income?

Answer 25

Only the excess of amount realized over adjusted basis is taxable income. Accordingly, sellers recover their investment in the property at no tax cost.

Question 26

What happens when a seller realizes a loss on sale or exchange?

Answer 26

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.

Question 27

When a seller finances a purchase and charges interest, the gain is taxable, but how is the interest earned treated?

Answer 27

The interest is not part of the gain, so it is treated as ordinary income.

Question 28

What are two exceptions to being able to use the installment sale method?

Answer 28

• 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.

Question 29

What is the basis of a note receivable?

Answer 29

The face value (not interest)

Question 30

When are losses disallowed?

Answer 30

When the losses realized is on the sale or exchange of property between related parties. Then they are nondeductible.

Question 31

How does the IRS define related parties?

Answer 31

• 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

Question 32

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?

Answer 32

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.

Question 33

How is every gain or loss ultimately characterized?

Answer 33

Ordinary

Capital

Question 34

What are the two distinct components of a capital gain or loss definition?

Answer 34

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.

Question 35

Capital assets are everything except asset that fall under what eight categories?

Answer 35

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.

Question 36

What is the limitation on capital losses? Can they be carried? What is the exception?

Answer 36

• 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.

Question 37

How are capital gains taxed for corporations? Individuals?

Answer 37

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)

Question 38

What is the basic rule of Section 1231?

Answer 38

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.

Question 39

What are the three components of depreciation recapture?

Answer 39

Full recapture (Section 1245 Recapture)
Partial recapture (Section 1250 Recapture)
20% recapture (Section 291 Recapture)

Question 40

When does a Section 1245 capture happen and how does that interact with a Section 1231 gain?

Answer 40

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)

Question 41

When does the Section 1245 recapture rule not apply?

Answer 41

To losses.

Question 42

What is the essential concept of the partial recapture rule for realty?

Answer 42

AKA Section 1250 recapture - Only accelerated depreciation in excess of straight-line depreciation is recaptured.

Question 43

What effect does selling cost have on a transaction?

Answer 43

The selling cost directly reduces the amount realized.

Question 44

What is the formula for the gain recognized this year under the installment method?

Answer 44

Gain recognized this year = (cash this year) x (total gain / total sales price).