Property Taxation (L1) Flashcards
Categorizing Assets for Income Tax Purposes
Capital Asset
Ordinary Income Asset
- Those assets that, when sold, result in ordinary income to the owner of the asset
- Some of the assets listed in Section 1221 (a) that are NOT Capital Assts are actually ordinary income assets, including…
○ Inventory
○ Accounts receivable
○ Creations in the hands of the creator
○ Copyrights in the hands of the creator
Purpose & Use of Basis
Cost Basis
Adjustment to Basis
Adjustable Tax Basis - Property Acquired by NONTAXABLE EXCHANGE
Special Basis Rules
Inherited and Gifted Property
Special Basis Rules
Basis for Property Transferred Between Spouse Incident to Divorce
Related Party Transaction (Section 267) Rules
○ Only affects transaction where there is a loss
○ Transferor’s loss is forever lost, transferee takes asset with DOUBLE BASIS rule (FMV for loss, adjusted basis for gains)
○ Holding period ALWAYS begins at the date of the sale
Bargain Sales to Charity
Tax Rates
Holding Period
○ Although Long-Term capital gains are generally taxed at a minimum rate of 20%, Short-Term capital gains are taxed as ORDINARY INCOME
○ Long Term Capital Gains Tax Rate = asset held for more than ONE YEAR
○ In calculating the holding period, the day of disposition is included in the holding period, but the day of acquisition is NOT included in the holding period
Realization & Recognition
Sale or Exchange Requirements
Calculation of Gain or Loss
Calculation of Amount Realized
Recognition Rules
Losses on Sale/Exchange used for Personal Purposes
Wash Sale
Wash Sales Rules
Substantially Identical (Wash Sale)
Disposition of Personal Residence
If a taxpayer realizes a gain on the disposition of a personal residence that resulted from casualty, theft, or condemnation (involuntary conversion), the gain may either be:
○ Deferred under Section 1033. OR ○ Excluded under Section 121 (subject to limitations)
Qualification requirements for the exclusion under Section 121:
○ FIRST, the property must have been owned and occupied as a principal residence for 2 out of the last 5 years (NOTE : a one-year stay in a nursing home DOES NOT count toward the 2-year requirement)
○ SECOND, the exclusion can only be used once every 2 years
○ Any appreciation during non-qualified use periods are NOT subject to the exclusion
Reduced Exclusion (Section 121)
Worthless Securities
A loss resulting from worthless securities = deductible in the year in which securities become completely worthless
○ Section 165 set the artificial sale date for the securities as the last day of the year in which the securities become worthless.
Gains and Loss for different types of assets
Determining the Net Capital Gains
Gains and losses from capital asset transactions must be netted against each other
○ Net gains and losses by holding period (LT against LT, etc.) ○ If excess losses result, they are shifted to the category carrying the highest tax rate
The step below should be followed to determine the net capital gain or loss
* FIRST, net LTCG and LTCL
- SECOND, net STCG and STCL
○ If the taxpayer has both LT Net Gains and ST Net Gains,
DO NOT proceed to the next step. Both the Net LT Gain and
the Net ST Gain should be RECOGNIZED - THIRD, if the taxpayer has a Net Loss in one category and a Net Gain in the other category, then the Net LT Gain/Loss should be netted against the Net ST Gain/Loss
○ In other words, if the taxpayer has a Net LTCG and Net STCL,
the Net STCL can REDUCE the Net LTCG
○ Similarly, if the taxpayer has a Net LTCL and a Net STCG, the
Net STCG can REDUCE the Net LTCL
Treatment of Net Capital Losses
Net Capital Losses of individuals are deductible FOR AGI to the extent of $3,000 per year
○ Excess capital losses are carried over to the next year INDEFINITELY
○ When carried over, capital losses retain their classification as either ST or LT
Limitations on Recognition of Capital Losses
Section 267
Business Assets
Section 1231 Assets
○ Recall that depreciable or real property used in a trade or business = Section 1231 Assets
○ To be a Section 1231 Asset, the owner of the asset must have a LT holding period (more than 1 year) for the asset being depreciable real or personal property used in a trade or business
○ Basis Rules
* Any asset used in a trade or business that is expected to
decline in value qualifies for depreciation deductions
* Therefore, trade or business assets that qualify for
depreciation deductions = Section 1231 Assets
Benefits of Section 1231
Depreciation Recapture
Section 1245 (Depreciation Recapture)
* EXAM TIP*
The only way to have a Section 1231 gain on a Section 1245 property is to sell it for more than it was originally purchased for
Section 1245 (EXAMPLE)
Section 1250 (Depreciation Recapture)
Section 1250 (EXAMPLE)
5-Year Lookback Rule
NOT IMPORTANT
* Section 1231 gains and losses, much like capital gains and losses, are subject to a netting process * A Net Section 1231 gain in the current year will be taxed at ordinary income tax rates to the extent of any Section 1231 losses claimed in the last 5 years * 5-year look back rule forces the taxpayer to net Section 1231 gains and losses over a 5 year period
Nonrecognition Transactions
○ “Realized” but NOT “Recognized” Income
○ Like-Kind Exchanges
○ Principal Residence
○ Investment Real Estate
○ Life Insurance Polices
Nontaxable vs. Tax Free Transactions
Like-Kind Exchanges (Section 1031)
- Section 1031 provides for the deferred taxation of gains associated with certain exchange transactions
○ ONLY Real Property transaction will receive 1031 treatment - If property is exchanged for Like-Kind Property, no gain or loss is RECOGNIZED if the property is held either:
○ For productive use in a trade or business, OR
○ As in investment - When Like-Kind exchange treatment is available, it is MANDATORY
○ The taxpayer may NOT choose whether to subject the
transaction to current tax, OR defer the gain into the future
○ Taxpayers who wish to subject their gains to current taxation
should make sure that they do not meet all of the requirements
necessary to qualify for Like-Kind exchange treatment under
Section 1031
Section 1031 does NOT apply to:
○ Personal assets
○ Stock in trade held primarily for sale (inventory)
○ Stocks, bonds, notes, interest in partnerships, certificates of trust OR beneficial interests, OR
○ Other securities or evidence of indebtedness or interest, or choices in action
○ Tangible Property
Like-Kind Exchanges - TAX CONSEQUENCES
Summary of calculating the income tax consequences of Section 1031 exchanges:
Basis Adjustments in Like Kind Exchanges:
Like Kind Exchanges & Related Parties ONLY
Exchanges of Stock for Property
- No gain or loss is RECOGNIZED when a corporation receives money or property in return for its stock (including common, preferred, and treasury stock)
- Under Section 1032, sale of stock to investors is treated as an infusion of capital and is NOT subject to income tax
Involuntary Conversions
Insurance Policies - Tax Free Exchanges
Transaction Between Souses Incident to Divorce
Transfers of property between spouses or former spouses’ incident to divorce are NONTAXABLE
○ Carryover basis applies to property transferred
○ A transfer is treated as incident to divorce if it occurs within one year of the date on which the marriage legally ended and is related to the cessation of the marriage.
