EA Individuals Review - Part 2 Flashcards
Capital Gains and Losses
Items a taxpayer owns and uses for personal or investment purposes are capital assets, the net gains that result may be subject to tax at favorable capital gains tax rates. Losses from the sale of personal use property are not deductible. A gain on sale of personal use property may be taxable
Non-capital Assets
Assets held for business-use or created to earn revenue .
- Inventory
- Depreciable property used in a business
- Real property used in a business
- Self-produced copyrights, manuscripts, drawings, photographs, or artistic compositions
- Accts receivable or notes receivable acquired by a business
- Stocks and bonds held by professional securities dealers
- Business supplies
- Commodities and derivative financial instruments
Holding Period (Short term or Long term)
Affects tax treatment of capital gain or loss. Long term capital gains taxed lower than short term gains.
- Holding period for a gift is treated differently than purchased property
- Holding period for gift includes donor’s holding period (tacking on holding period)
- Inherited property is considered to have held it longer than 1 year regardless of how long property is actually held
Determining Capital Gain or Loss
Determined by comparing amount realized with the adjusted basis of property. Can deduct up to 3K (1500 for MFS) of net capital losses against ordinary income in a tax year. Unused losses in excess of the limit are carried over to later years. Amounts carried over retain their character as either long term or short term. A loss can be carried over indefinitely.
Worthless Securities
May choose to “abandon” a security that has lost entire value in order to take advantage of loss for tax purposes. Treated as though they were sold for zero dollars on last day of tax year. Unlike other losses, a taxpayer is allowed to amend a tax return for up to 7 yrs in order to claim a loss from worthless securities. More than double the usual 3 yr statue of limitations for amending returns.
Capital Gains from Mutual Funds
Regulated investment company created by pooling funds of investors to allow them to take advantage of a diversity of investments and professional management.
- Profits made are reported to its won shareholders as capital gain distributions on 1099 DIV
- Taxed at long term capital gains rates**
- If taxpayer disposes of shares that represent all or a portion of his investment in mutual fund itself Form 1099 B is issued
- Taxable gains or loss that result from sale or exchange of shares is reported in 1040, Sch D
Qualified Small Business Stock (QSBS)
- Loss is considered an ordinary loss, but any gain is a capital gain.
- Amounts that can be deducted as an ordinary loss against ordinary gross income are 50K for S, and 100K for MFJ
- Can exclude up to 50% of the gain from the sale or exchange of qualified small business stock held for more than 5 yrs.
Wash Sales
When an investor sells a security to claim a capital loss, only to repurchase again soon thereafter. Can’t deduct a loss on the sale of an investment if an identical investment was purchased 30 days before or after the sale.
- Buys identical security
- Acquires a substantially identical security in a taxable trade
- Acquires a contract or option to buy the identical security
Rules for wash sales don’t apply to Trades of Commodity, future contracts, and foreign currencies.
Home Sale Gain or Loss
Selling Price: Total amount received for home
Amt Realized: Selling price - Selling expenses
Basis: How taxpayer obtained home
Adjusted Basis: Taxpayer’s basis in home increased or decreased by certain amounts
Basis + Increases-Decreases = Adjusted Basis
IF amt is less than adjusted basis, difference is a loss. Loss on primary residence can never be deducted
Related Party Transactions
Rules to prevent related persons and entities from shuffling assets back and and forth to take improper losses
- 50% Control Rule: If a taxpayer controls more than 50% of a corp or partnership, any property transactions between taxpayer and business are subject to related party transaction rules.
Related Party Transactions Cont.
Loss is not deductible is the transaction is between taxpayer and following related parties:
- Members of immediate family
- Partnership or corporation that taxpayer controls
- Tax exempt or charitable organization controlled by taxpayer or member of family
- Losses on sales between certain closely relatted trusts or business entities controlled by same owners
Installment Sales
*** Refer to Unit 7, pg 118
Sale of property in which at least one payment is expected to be received after tax yr in which sale occurs.
Installment method can’t be used for stocks and bonds. If property is sold within 2 yrs of original sale, taxpayer will lose benefit of installment sale reporting.
Depreciation recapture
When a taxpayer disposes of certain types of property that have been depreciated, recapture requires that a taxpayer report all or a portion of the prior depreciation deductions as ordinary income in the yr of the sale.
Reporting Asset Sales
Capital gains and losses are reported using two forms
- Sch D (Reports gains or losses on sales and other capital gain distributions)
- Form 8949
Nonrecognition Property Transactions
Sale of Main Home
Like-kind exchanges
Involuntary Conversions
Sale of Main Home
May exclude the fain from the sale of main home
250K S
500K MFJ
Gain from sale of home that is not main home must be reported as income.
121 Exclusion
- Sold main home
- Meet ownership and use tests (during 5 yr period ending on date of the sale, taxpayer must have owned and lived in home for 2 yrs (24 mo or 730 days)
- Not have excluded gain in the 2 yrs prior to current sale of home
Different Rules for Married Homeowners (Sale of Main Home)
500K excluded if:
- MFJ
- Either spouse meets ownership test
- Both meet use test
- Neither excluded gain in 2 yrs prior to current sale of home
Unrelated Individuals (Sale of Main Home)
Unmarried couples/taxpayers who own a home together may take 250K exclusion individually if ownership tests are met
Deceased Spouse (Sale of Main Home)
Taxpayer is considered to have owned and lived in a home during any period of time that the spouse owned and lived in it as a main home (but can’t remarry at date of sale) Holding period tacked on - surviving spouse my exclude up to 500K even if home is old within 2 yrs. Also applies to a home that is transferred by a spouse in a divorce. Receiving spouse is considered to have owned home during any period of time transferor owned it.
Military Personnel Exceptions (Sale of Main Home)
5 Yr period can be suspended up to 10 yrs
Disability Exception (Sale of Main Home)
During 5 yr period before sale of home, if a taxpayer becomes physically or mentally unable to care for himself, he must have lived in home for 1 yr to qualify. Considered still to have lived in home even if forced to move to licensed facility
Reduced Exclusions
Taxpayers who do not meet ownership and use tests within prior two yr period may be able to claim a reduced exclusion if
Death/Divorce/Legal Separation
Health Reasons related to care
Unemployment/job exchange (50 Miles for new job)
Multiple births from same pregnancy
Damage to residence from disaster
Involuntary conversion of the property
Reduced Exclusions Cont.
Reduced exclusion amount equals full 250K or 500K(MFJ) multiplied by a fraction. Numerator is the shorter of:
- Period owned and used the home as a principal residence during 5 yr period ending on sale date
- Period b/t last sale for which taxpayer claimed exclusion and sale date for the home currently being sold
Denominator is 2 yrs or equivalents in months or days
(Full Exclusion amount x number of days (or months))/730 days or 24 months
Land Sales
Can’t exclude gain if only land is sold but not house, sale of vacant land does not qualify for 121 day exclusions. Gain from sale of vacant land that was used in connection with principal residence (land adjacent) may be excluded if the land sale occurs within 2 yrs or after sale of home.
Like-Kind Exchanges (Section 1031 Exchange)
Occurs when a taxpayer exchanges business or investment property for similar property. Does not pay tax on resulting gain and can’t deduct a loss until property is disposed.
- Must be held fr investment or for productive use in a business
- Must not be “held primarily for sale: aka inventory
- Must be an actual exchange of two or more assets or properties
- Must be received within 45 days after date of transfer
If to be received later:
- 180th day
- Due date including extensions of the tax return for the yr in which transfer occurs
Must be a trade of real property to real property or personal property to personal property
Non-qualifying Exchanges
Exchanges of equipment or business assets that are used within the US for similar items outside US are not considered an exchange of qualifying like-kind property. Applies to real estate outside US too - does not apply as well as the following:
- Livestock
- Securities
- Currency
- Partnership Interests
Taxable Exchanges
If property is received in exchange for other property not similar or related in use to property exchanged, taxpayer may need to recognize gain if FMV of property received is greater than adjusted basis of property exchanged.
Boot
Used to describe cash or other property added to an exchange in order to compensate for difference in values of properties traded. If liability is transferrered, its treated as if transfer was cash and considered boot by party relieved of liability
Related Party Transactions
Like-kind exchanges are allowed between related parties, including family members. if property is disposed within 2 years after exchange, then exchange is disqualified
Does not apply if:
- One of the involved parties dies
- Property is subsequently converted in an involuntary exchange (fire/flood)
- Can be established to satisfactions of IRS that the exchange and disposition were not done mainly for tax avoidance purposes.
Involuntary Conversions (1033)
Occurs when a taxpayers’s property is lost, damaged, or destroyed and the taxpayer receives an award, insurance money or some other type of payments, as a result of
Casualty or theft
Disaster
Condemnation
Threat of Condemnation
A taxpayer can’t deduct a loss form an involuntary conversion of personal-use property unless loss resulted from casualty or theft
Replacement Period
Replacement period for an involuntary conversion generally ends two years after the end of the first tax year in which any part of the gain is realized.
Most property - 2 yrs
Real Property held for investment or business use, such as residential rentals and office buildings - 3 yrs
Sale of livestock due to weather-related conditions - 4 yrs
Main home in federally-declared disaster area - 4 to 5 yrs
Replacement Period Cont.
IF a taxpayer reinvests in replacement property similar to the converted property, the replacement property’s basis is the same as the converted property’s basis on the date of the conversion, subject to the following adjustments:
The basis is decreased by the following:
- Any loss a taxpayer recognizes on the involuntary conversion
Any money a taxpayer receives that he does not spend on similar property
Basis is increased by:
Any gain a taxpayer recognizes on the involuntary conversion
Any additional costs of acquiring the replacement property
Condemnations
Type of involuntary conversion. Condemnation is the process by which private property is taken from its owner for public use. The property may be taken by the gov’t or by a private organization that has the legal power to seize it. Owner generally receives a condemnation award in exchange for the property that is taken. Like a forced sale, with the owner being the seller and the gov’t being the buyer.
