Lesson 1 Property Taxation

Question 1

What Items are not Capital Assets

Answer 1

Remember ACID
1. accounts/notes receivable
2. Copyrights and creative works (if held by creators of such work)
3. Inventory and
4. Depreciable Property used in trade or business (1231 Asset)

Question 2

What are ordinary Income Assets

Answer 2

Assets that when sold result in ordinary income to the owner of the asset. Includes inventory, accounts receivable, creations in hands of creator, and copyrights in hands of creators

Question 3

What are 1231 assets

Answer 3

Assets that are used in a trade or business in two forms:
1. Depreciable property
2. Real Property

Doesn’t income. Inventory, property held by taxpayer primarly for sale to customers in ordinary course of his trade, copyrights or creative works.

Question 4

What are some additional items included in cost basis?

Answer 4

1. Sales Tax
2. Freight
3. Installation and testing
   4.Excise taxes,
4. Legal and accounting fees (when they must be capitalized)
5. Revenue Stamps
6. Recording Fees
7. Real estate taxes (if assumed for the seller)

When property is acquired in taxable exchange, the cost is Fair Market Value (FMV) of the property given in exchange for what is received.

When property is acquired subject to a mortgage, the basis of the property is the FMV of the property
When property is acquired as a dividend in kind or as compensation for services, the taxpayer’s basis in the property is the FMV of the property at time of acquisition.

Question 5

What are items that increase your basis?

Answer 5

1. Capital improvements, such as an addition on your home, a new roof, paving your driveway, installing central air condition, or rewiring your home.
2. Assemssments for local improvements- including water connections, sidewalks and roads
3. Cost of restoring damaged property after casulaty loss
4. Legal Fees, including cost of defending and perfecting a title to the the property
5. Zoning Costs

Question 6

What are items that decrease basis?

Answer 6

1. Exclusion from income of subsidies for energy conservation measures
2. Casualty or theft loss deductions and insurance reimbursements (business only)
   3.Deduction for clean-fuel vehicles and clean-fuel vehicle refueling property.
3. Section 179 deduction
4. Credit for qualified electric vehicles
5. Depreciation
6. Nontaxable corporate distributions

Question 7

Property acquired by nontaxable exchange

Answer 7

When property is acquired in an exchange, the newly acquired property will have carryover basis if property is exchanged for property of equal value (no boot paid)
1. If exchanged for more valuable asset- boot is paid, the new basis will have a carryover basis (the cost basis of the exchanged property) plus any boot paid
2. If property is exchanged for a less valuable asset and thus boot is received, new asset will have a carryover basis reduced by any boot received that was greater than the gain.

1. Get more expensive property = Boot paid = Higher Basis
2. Get less expensive property = Boot Received = Lower basis

Question 8

Special Basis Rules for holding period for inherited property

Answer 8

Always considered long-term for inherited property

Question 9

What are the rules and exceptions in regards to basis in a gifted property?

Answer 9

The donee’s basis in the gifted property is the same as the donor’s basis in gifted property. However, there are two exceptions.
1. First exception occurs when FMV of gifted asset is less the donor’s basis (Loss property) When FMV of gifted asset is less than donor’s basis, DOUBLE BASIS RULE APPLIES
- For gains only, the basis of the donor is also the adjusted basis of the donee
-For Losses only, the basis of the donee is the FMV of the property on the date of the gift.
-If asset is later sold by the donee and the amount realized is between the fair market value at the time of the gift and the adjusted basis of the donor, no gain or loss is recognized.

2. Second exception occurs when gift tax has been paid. In event that gift tax has been paid and the asset has appreciated in the hands of the donor, then the portion of that tax which is associated with the appreciated is added to the donor’s basis to determine donee’s basis

Donor’s basis Formula
Donor’s Bais + ((Net Appreciatin in Value of Gift/Value of Taxable Gift) X Gift Tax Paid)

Question 10

What is the holding period for gifted property?

Answer 10

1. Generally the holding period in hands of the donee includes holding period of the donor
2. If double basis asset sold for a loss, then holding period for donee starts at the date of gift

Question 11

How does the basis of property transferred between spouse incident to divorce

Answer 11

This is treated same as gift. In other words the carryover basis applies. No gain or loss is recognized on a transfer between spouses, or between former spouses incident to a divorce. Treated as incident to a divorce it it occurs within on year of the date which the marriage legally ended.

Question 12

How doe the related party transactions (Section 267) Rule (sale to a related party)

Answer 12

• Only affectstransaction where there is a loss
• Transferor’s loss is forever lost, trasnferee takes asset with double basis rule (FMV for losses, transferor’s basis for gains) The holding period always beings at the date of sale.

Question 13

What taxpayers are subject to the 3.8% Medicare Contribution tax on investment income?

Answer 13

Taxpayers with AGI over $200,000 (single) or $250,000 MFJ will be subject to 3.8% Medicare contribution tax on investment income. Tax is imposed on lesser of an individual’s net investment income for the tax year or modified adjustment gross income in excess of the limits. Other exceptions include
Collectibles- taxed at 28%
Unrecaptured Section 1250 gain (which is equal to straight line depreciation) taxed at 25%
Qualifying Small Business Stock (Section 1202), for which a percentage of the gain is taxed at 28% if holding period is at least five years. If stock acquired before 2009 you can exclude:
50% of QSBS if acquired before Feb 18, 2009
75% If acquired after feb 17, 2009 and before sept 28, 2010
100% if the QSBS is acquired after Sept. 27, 2010 (Made permeant by PATH 2015)

Question 14

Realization and Recognition for Capital Gains

Answer 14

Gains on capital assets are taxed only when there has been both (1) realization event (2) recognition event. Gains must be realized before they can be recognized.
Realization usually occurs when:
- There is a disposition of property (sale or exchange)
- There is a segregation of gain.

Recognition occurs when realized gain is taxed.

Some exceptions can occur before tax is recognized. (gain is exempt from taxation, or gain is deferred for a future time)

Question 15

When is a time when it is not so obvious that a gain has been realized?

Answer 15

Natural disasters that destroy property cause a realization even to occur for income tax purposes, since the gain or loss in particular property can be calculated (permanently set aside) at the time. Loss may or may not be recognized at the time. Another event that could cause realization is the bankruptcy of company

Question 16

How is Amount realized Calculated

Answer 16

Cash Received + The FMV of property received in exchange + Liabilities Shed

Question 17

What are some recognition rules?

Answer 17

-When debt is relived
-When money is “taken out of” an investment as a loan when the individual is not personally laible for the loan
- When money “taken out of” an investment as a loan when the individual is not personally liable for the loan
-with net gifts (transfers where the donee agrees to pay the gift tax)

Question 18

What are examples in whcih gain or loss is realized but not recognized

Answer 18

• Like-kind exchanges of real property held for productive use or investment.
  -certain exchanges where cash received is quickly reinvested in similar property
  -transfer of property to controlled corpororation
  -exchange for plans of corporate reorganization
  transfer to, or distribution from, partnerships

Question 19

Are losses allowed for property used for personal purposes?

Answer 19

when asset is used for personal purposes any loss incurred during the period of personal use is considered a personal loss and is not permitted as tax deduction.

Question 20

How do wash sale rule apply and when may they be disallowed?

Answer 20

Occurs when a taxpayer disposes of securities at a loss and acquires substantially identical securities within 30 days before or after the date of the loss sale
Disallowed loss is added to the cost of the new stock or security to determine the new basis of the substantially idential securities
-index fund for index fund- was sale rule applies
-index fund for managed large cup fund- wash sale rules do not apply

Wash sale rules only apply to losses not gains

To calculate loss basis in wash sales (Add new purchase price + Disallowed Loss to get new cost basis)

Question 21

what investment securities does wash sale rule apply to and not apply to?

Answer 21

IT applies to losses from sales or trades of contracts and options to acquire or sell securities. Does not apply to losses from sales or trades of commodity futures contract and foreign currencies.
- Applies if you sell common stock at a loss and at the same time buy warrants for common stocks of the same corporation. However if you sell warrants at a loss and, at the same time, buy common stock in same corporation, the wash sale rules apply only if the warrants and stocks are considered substantially identical.

Where bonds or preferred stock are convertible into common stockof the same corporation, the realtive values, price changes, and other circumstances may make these bonds or preferred stock and the common stock substantially identical.
- is convertible into common stock,
-same voting rights as the common stock
-subject to same dividend restrictions
-trades at prices that do not vary significantly from the conversion ratio
-is unrestricted as to convertibility

If the number of shares you buy within 30 days before or after the sale is either more or less than the number of shares you sold you must determine the particular shares to which the wash sale rules apply. You do this by matching the shares bought with an equal number of shares sold. match the shares bought in the same order that youbought them, beginning with the first shares bought.

Question 22

How is a gain deferred under section 1033?

Answer 22

If a taxpayer realizes a gain on the disposition of a personal residence that resulted from casualty, theft or condemnation (involuntary conversion)

Question 23

What are the qualification requirements for the exclusion under section 121?

Answer 23

First, the property must have been owned an doccupied as a principal reseidence for 2 out of the last 5 years. Any appreciation during non-qualified use periods are not subject to exclusion. Exclusion can only be used once every 2 years. Single taxpayers may exclude up to $250,000 of gain from sale of their principal residence. Married taxpayers filing jointly may exclude up to $500,000 of gain from the sale of their principal residence. For married taxpayers, they must both meet the use requirements and not have utilized the exclusion within the last two years but either may meet the ownership requirement

Question 24

What are some unforseen circumstances that can have a reduced exclusion even if taxpayers do not meet other requirements.

Answer 24

1. Change in employment- qualified move for you or your spouse
2. Change of health- diagnosis, cure, mitigation, treatment for parent, grandparent, child, grandchild, sibbling, in-laws, aunt, uncle, niece or cousins.
3. other unforeseen circumstances. included disaster area, involuntary conversion ,death, unemployment, divorce/breakup of engaged couples, multiple births from same pregnancy, bullying.

When reduced exclusion is available, the amount excluded is based on the period of ownership between the last sale and current sale (Pro-Rata) Lets say you own the property 18 of last 24 months you would multiply for up to 75%

Exclusions are only based on personal use. Meaning if you purchase property and make 200k gain over 5 years, but the first year you rented out the property only 160k would not be taxable and 40k would be taxable.

Question 25

When are losses from worthless securities deductible?

Answer 25

They are deductible in the year they become completely worthless. Section 165 sets the artificial date for the securities as the last day of the year in which the security becomes worthless

Question 26

How do we determine net capital gains

Answer 26

Net gains and losses byholding period (long-term against long-term, ect)
If excess losses result they are shifted to category carrying the highest tax rate. Net capital losses of individuals are deductibile for AGI to thee extent of $3,000 per year. Excess capital losses are carried over to next year indefinitely. When carried over capital losses retain their classification as either short- or long term.

Question 27

How does IRC Sec. 1244 work?

Answer 27

A single taxpyaer can deduct up to $50,000, (100,000 for maried individuals filing jointly) of the loss on small business stock as ordinary loss in any given year if the following requirements are ment
-Stock represents ownership of domestic corporation. (less than $1 million in total capital contributions plus paid-in capital) at the time the stock was issued.
- Incorporated after November 6, 1978
- Loss sustained by original owner of the stock (person to whom the stock was issued by the corporation) who is not a corporation, trust, or estate.
- Stock was issued to the original owner in exchange for money or property. Stock issued in return for services or other stock does not qualify.
- For 5 years prior to the loss, the corporation must have earned more than 50% of its gross receipts from sources other than royalties, rents, dividends, interest, annuities, and capital gains.
- Any loss in excess of the per year limit is treated as capital loss. Section 1244 does not apply to gains. Any gains associated with 1244 stock as treated as capital gains.

Question 28

How does section 267 work?

Answer 28

Disallows losses from direct sales or exchanges of property between related parties. Section 267 applies to losses only and does not apply to gains. Related parties include
-Siblings
-Lineal descendants
-Ancestors
-Spouse

Never gift or sall an asset to a related party when the donor’s basis is greater than the FMV of of the Asset
Related parties do not include
-In-Laws
-Aunts/Uncles
-Cousins

Question 29

How is loss or gain calculated under section 1231?

Answer 29

When taxpayer disposes of depreciable property at a gai, the taxpayer must have to recognize all or part of the gain as ordinary income under the depreciable real or personal property used in trade or business. To be classified as 1231 asset, the owner oof the asset must have a long-term holding period (must have held the asset for more than 1 year) in addition to the asset being depreciable real or personal property used in trade or business.

*Only way for to have a 1231 gain is to sell equipment for more than it was originaly purchased for
* Section 1245 gain (depreciation recapture)

If equipment is sold for less than basis under section 1231 it will be considered a loss.

1245 has to do with depreciation recapture, 1231 have to do with loss or gain beyond recapture, the loss will be ordinary while gains being capital gains

Question 30

What does Section 1250 govern instead of 1245?

Answer 30

Section 1250 governms the recapture of depreciation on real estate section 1231 assets as opposed to personalty Section 1231 assets, which are governed by section 1245. Real Section 1231 assets include business realty such as buildings and real estate.

Before all depreciable property in service before 1/1/81 and between 1981 and 1986 was eligbile for accelerated depreciation. When real probperty that was depreciated on a an accelerated basis is sold, Section 1250 requires that the excess depreciation be recaptured as ordinary income at ordinary income rates.

Question 31

How is the gain treated when property subject to section 1250 is sold?

Answer 31

• the lesser of the gain or difference between the depreciation taken and the straight line depreciated. Excess depreciation recaptured at ordinary tax rate. With the rest captured at 25%

Question 32

What are sone nonrecognized transactions when it comes to taxes?

Answer 32

-Realized but not recognized income
-Like-Kind Exchanges
Principal Residence
-Investment Real Estate
-Life Insurance Policies.

Question 33

Child and Dependent Care Credit

Answer 33

Applicable percentages ranges from 20-35%. AGI of $43,000 and above at 20% The expenditures that qualify are the lesser of actual costs or $3,000 for one qualified individual and $6,000 for two or more qualified individuals. The deduction for care cannot be made for care provided by a dependent of the taxpayer. For example, you cannot pay your 16 year old child to watch your 9 year and take a tax credit. Cost for care of qualified individual within the taxpayer’s home or outside the home. If outside the home handicapped dependent or spouse must spend at least 8 hours a day within taxpayer’s home.

Question 34

American Opportunities Tax Credit

Answer 34

100% of first 2k
25% of next 2k

Refundable tax credit up to 40% of $1,000 Must be 1/2 of full time course loan. Taxpayers cannot calim a credit for otherwise amount excluded from income.

Question 35

How does Kidding tax work?

Answer 35

• Net earned income of a child under age of 19 with a living parent is taxed a the parent’s rate (Or AMT Rate, if applicable)
  -Standard deduction of $1250
  -Next $1250 of income is taxed at child’s marginal rate. Therefore kiddie tax does not apply unless child has unearned income greater than $2500.

If child has earned income, the standard deduction is the greater of $1250 or earned income plus 400
After that idditional unearned income is taxed at parent’s rate. This is for amount over 2500

Question 36

Alternative Minimum Tax, how is it computed?

Answer 36

Taxpayer is liable for greater of his regular tax liability of AMT. Basis for AMT equals taxable income with certain adjustments for preference items. Deductions allowed for:
-charible contributions
-Certain deductions for estate tax for income in respect of a decedent, gambling losses to the extend of winnings, casualty losses from federally declared disasters, and Medical expenses in excess of 7.5% of AGI

Question 37

What deductions are lost under the AMT?

Answer 37

1. State and Local Taxes
2. Itemized deductions subject to 2%

Additional adjustment sinclude
1. Real property, depreciation in excess of 40- year, straight-line
2. Personal property, depreciation in excess of 150% declining balance method.

-Standard deduction if itemized deductions are not used
-Itemized deductions not allowed for AMT:
(State and Local Taxes)

Question 38

What are the three preference items that provide substantial benefits?

Answer 38

Unlinke adjustments, preferences can only be positive (inrease AMTI)
1. Percentage depletion - amount pof percentage depletion taken for regular tax in excess of the adjustment basis of the property at the end of the year is a preference item
2. Intangible drilling costs- AMT requires 10-yar amortization. Intangible drilling costs are currently deductible for regular tax. Preference is excess of regular tax deduction over {AMT amortization plus (65% x net oil & gas income)
3. Interest on private activity bond- not taxable for regular tax purposes but is included in income for AMT purposes. Expense incurred in carrying these bonds are not deductible for regular tax purposes but offset the interst income in computing the AMT preference.

Question 39

Nonvacation Rental Property

Answer 39

Generally considered trade or business and all ordinary and necessary business expenses are deductible against income. Some rental activities are deemed passive losses and are only deductible to the extent of passive income
-Rental activities by dealers are considered active
-Residential rental losses up to $25,000 are deductible for taxpayers with AGI less than or equal to $100,000 Phaseouts between $100,000 and 150k

Question 40

Rental Vacation homes

Answer 40

Presumed that taxpayer is not engaged in activity for profit (presumption as hobbies) Rental treated similar to a hobby (No rental expenses in excess of rental income are allowed and expenses are deducted in same order as for hobby). May have both personal and rental use for vacation home.

Fewer than 15 days. No gross income from rentals and no deductible rental expenses. In addition, mortgage interest and property taxes are treated as if on personal residence (Generally deductible in full)

More than 14 rental days: treatment depends on amount of personal use. If personal use days are not more than the greater of 14 days or 10% of fair rental days then the taxpayer can deduct all expenses allocated to rental use even if loss results.

Question 41

What are Hobby Rules

Answer 41

Profit activity- if activity is entered into for profit, taxpayer can deduct expenses for AGI even in excess of income from the activity, at-risk and passive loss rules may apply.

If activity shows profit 3 out of 5 years. (2 out of 7 for horses) it is assumed that taxpayers has profit motive.