R3 - Property Taxation

Question 1

How are gains from the sale of depreciable property that is considered personal property (e.g., machinery, equipment, furniture) recognized?

Answer 1

For machinery and equipment, furniture, sold at gain, and considered personal property (section 1245), the amount of depreciation taken is recaptured as ordinary income. Any gain in excess of the accumulated depreciation would be considered capital gain under section 1231.

Question 2

When can an individual deduct gains and losses on sale of capital assets?

Answer 2

An individual can deduct gains and losses on sale of capital assets as follows:

Capital Assets Investment Property Personal Use
Stocks and bonds gains and losses reported
Home and furnishing gains reported,
loss not reported
Skiing and recreation gains reported,
losses not reported

• Losses on sale of investment property are deductible, but losses on sale of personal use assets such as furniture or recreation equipment is NOT deductible.
• The loss on sale of personal furniture cannot be offset against the sale of stocks and bonds.

Question 3

What is the De Diminish Safe Harbor?

Answer 3

Businesses that have a policy of immediately expensing low-cost personal property items for financial accounting purposes are allowed to immediately expense (deduct) up to a certain amount of those costs for income tax purposes.

Question 4

How much are taxpayers allowed to deduct under the De Diminish Safe Harbor?

Answer 4

• If a taxpayer has an applicable financial statement (AFS) (audited F/S), it can deduct the amount paid for items costing up to $5,000.
• If the taxpayer does not have an AFS, the amount deducted is up to $2,500.
• When the taxpayer/business does not have an AFS and the cost of the property is more than the limitation ($2,500), there is no amount to be deducted.

Question 5

What is Section 1245 gain from disposition of certain depreciable property?

Answer 5

Section 1245 means that you sold an asset (section 1231 asset) at a gain that is considered personal property (e.g., machinery, equipment, furniture).
- These business assets fall under the section 1231. If you sell personal property at a gain within section 1231, it is considered a 1245 gain. The gain should be recaptured as ordinary income.
- If the asset is sold at a loss, don’t look to recapture any depreciation. This is only for gains on assets sold.
- Depreciation recapture = lesser of depreciation amount or realized gain (e.g., realized gain is $4K and acc dep is 48K, the $4K would be considered dep recapture (lesser of the two), no sect 1231. It would also be recognized as an ordinary gain. If the realized gain is greater than depreciation, the entire depreciation is considered depreciation recapture and the excess of the two is considered section 1231 gain).

Question 6

What is the General Business Credit?

Answer 6

The General Business Credit is composed of any of the following:
- Investment credit
- Work opportunity credit
- Alcohol fuel credit
- Research and development tax credit (generally 20% of the increase in qualified research expenditures over the base amount for the year)
- Low-income housing credit
- Small employer pension plan start-up costs credits
- Alternative motor vehicle credit
- Other infrequent credits.

Question 7

Is there a difference if the deduction for a section 179 asset is taken compared to the depreciation of the asset?

Answer 7

There is no difference if the deduction under a section 179 asset is taken subject to limitations or the asset is depreciated. Ultimately, the cost of the asset is the same if the deduction is taken or the asset is depreciated.

Question 8

How to determine the basis of the property received as a gift at the point of sale?

Answer 8

The basis of an item received by gift is not determinable until its sold.
1. Sale price > prior owner’s basis - use prior owner’s basis as your basis to determine the gain.
2. Sale price < prior owner’s basis - use the lower of the FMV or prior owner’s basis to determine the basis of the property and the loss
3. Sales Price is in between FMV or prior owner’s basis at the time of the gift - no gain or loss is recognized.

Question 9

When there are sales of property between related parties, are gain and losses recognized?

Answer 9

When there are sales between related parties gains and losses are treated as follows:
1. Gains - are recognized. There is no exception.
2. Losses - are not recognized
- Losses are disallowed and added to the initial basis of the property. (e.g., initial basis = 5,000, disallowed loss = -500, new basis = 5,500)

Question 10

When there are sales of property between related parties, and then the asset is sold to an unrelated party, how is the disallowed loss treated?

Answer 10

If there is a sale to an unrelated party of the asset previously purchased from a related party, and the sale results in a gain, the gain will be used to offset the disallowed loss. If after applying the gain, a loss remains, the gain is still recognized and the loss is lost forever.

Question 11

When there are sales of property between related parties, and then the asset is sold to an unrelated party, how is the basis of the property determined?

Answer 11

1. if the sales price of the unrelated party is greater than the initial owner’s basis -> basis is the initial owner’s (relative) basis
2. if the sales price of the unrelated party is in between the initial owner’s basis and purchase price -> no gain or loss is recognized and the basis is the same as the sales price.
3. If the sale price is lower than the purchase price by relative -> use the purchase price as a basis to determine the loss and recognize the loss to the unrelated party.

Question 12

When there are sales of property between related parties, and then the asset is sold to an unrelated party, how is the holding period determined?

Answer 12

The holding period starts with the new owner’s period of ownership (e.g., an unrelated party lived in the property for 6 months, the holding period is short-term). You don’t get the holding period of the related party.

Question 13

Can C corps deduct capital losses resulting from the sale of stocks?

Answer 13

No, c corps can only offset capital losses against capital gains. The capital loss is not deducted but can carry back 3 years and forward 5 years.

Question 14

Can individual taxpayers deduct capital losses resulting from the sale of stocks?

Answer 14

Individual taxpayers can deduct up to $3,000 of capital losses against ordinary income.

Question 15

When the taxpayer receives property as a gift and then sells the property, how is the basis of the property determined to recognize a gain or loss?

Answer 15

1. if the sales price of the gift is greater than the donor’s basis -> basis is equal to the donor’s basis.
2. if the sales price of the gift is in between the donor’s basis and FMV -> no gain or loss is recognized and the basis is the same as the sales price.
3. If the sale price is lower than the donor’s basis -> use the lower of the donor’s basis or FMV as the basis to determine the loss

Question 16

What is the holding period of the gain or loss when the property is received as a gift and then sold?

Answer 16

1. If you use the donor’s basis, then you also get to use the donor’s holding period
2. if you don’t use the donor’s basis, your holding period begins on the first day of ownership.

Question 17

What is the formula to determine the taxable income of installment sales?

Answer 17

Gross profit = sales price - adjusted basis
Gross Profit % = GP/sales price or cash collected initially/total sales price
Gain recognized (taxable income) = cash collections (excluding interest) * GP%

Question 18

What is the method used to depreciate residential property and nonresidential (commercial) property?

Answer 18

Straight-line depreciation is used to depreciate residential property and nonresidential (commercial) property.

Mid-Month depreciation is used :
- 1/2 month is taken in the month the property was placed in service
- 1/2 month is also taken in the year the property was disposed of

Question 19

What is the useful life to depreciate residential and nonresidential (commercial) property?

Answer 19

1. residential property - > 27.5 years S/L
2. Commercial property - > 39 years S/L

Question 20

Is land depreciated?

Answer 20

No, land is never depreciated

Question 21

What method is used to depreciate personal property?

Answer 21

MACRS depreciation is used to depreciate personal property. Salvage value is ignored.

Usually, Double Declining balance is used to calculate the depreciation

Uses half-year depreciation in the first year of the asset, in the second year you take full depreciation

Depreciation exp = equipment cost * DDB (1/useful life (e.g. 5 years) * 2) * 1/2

if 40% of assets were purchased in the last quarter of the year, you use mid-quarter conversion (use pro-rata allocation of all purchases to determine if the assets purchased are more than 40%).

Question 22

What personal assets are depreciated with a 5-year useful life?

Answer 22

Auto, light trucks and computers, farming equipment

Question 23

What personal assets are depreciated with a 7-year useful life?

Answer 23

Office furniture, and machinery equipment

Question 24

What is qualifying improvement property?

Answer 24

Represents a major interior renovation of an already existing commercial building, including improvements to restaurants, retail property, and leasehold improvements

Question 25

How is qualified improvement property depreciated?

Answer 25

It is depreciated over 15 years using straight-line method and half-year convention.

Question 26

When does a corporation use the Mid-quarter convention?

Answer 26

When a taxpayer places 40% or more of its personal property into service in the last quarter of the taxable year (e.g., mid November) (use pro-rata allocation of all purchases to determine if the assets purchased are more than 40%).

• Personal property acquisition are segregated by quarter and treated as placed in service in the middle of the quarter
• Mid-quarter % =
  Q1 - (100% + 75%)/2 = 87.5%
  Q2 - (75% + 50%)/2 = 62.5%
  Q3 - (50% + 25%)/2 = 37.5%
  Q4 - [25% + 0]/2 =12.5%

Question 27

What is the nontaxable exclusion amount for taxpayers who sell their principal residence?

Answer 27

1. $500,000 in gain for married filing jointly
2. $250,000 in gain for a single person
3. If the amount of the gain is lower than the maximum exclusion, then the amount excluded is the gain.

Question 28

What are the requirements for a taxpayer to claim a tax-free amount for the sale of a personal residence?

Answer 28

1. A taxpayer can only claim a tax-free amount every two years (must have lived in the property for 2 years).
2. There is no other requirement to buy another residence. One can move into an apartment or with family members and still qualify for exemption of gain.

Question 29

Are losses in the sale of personal residence deductible?

Answer 29

No, losses on the sale of personal use assets are not deductible.

Question 30

How is the gain on the sale of a personal residence applied when the residence is also used as a home office?

Answer 30

Any depreciation taken on a primary residence from the years used as a “home office” must be recaptured. Therefore, depreciation is considered a taxable gain.

Depreciation recapture is taxable at a maximum of 25% rate

Question 31

When a personal residence is sold before the two years requirement due to an unforeseen event (job transfer), is the gain exempt?

Answer 31

The gain is exempt by applying a pro-rata allocation to the exemption within the two year period. For instance, if the residence was sold a year after the purchase and the owner had to move because of a job transfer, the exemption (e.g., 500,000) is multiplied by the pro-rata fraction (e.g., 1year/2 years). The gain less the pro-rata exemption determine the taxable gain.

Question 32

How is the personal residence exemption applied when it is first used as a rental property and then as personal residence?

Answer 32

1. The realized gain on the property is determined first by subtracting the sales price minus the adjusted basis (purchase price - accumulated depreciation).
2. The accumulated depreciation is subtracted from the realized gain to determine the new gain
3. A pro-rata allocation is determined by dividing the # of years the property was rented by the total years (including the ones used as personal property)
4. the recognized gain is determined by multiplying the pro-rata allocation to the new gain and adding the accumulated depreciation.

Question 33

Are personal losses deductible?

Answer 33

No deduction is allowed for a loss on the disposal of a personal asset.

An itemized deduction may be available for a casualty loss attributable to a federally declared disaster.

Question 34

When is bonus depreciation used?

Answer 34

Bonus depreciation is used:
- After section 179 expense deduction has been applied and before regular MACRS depreciation expense deduction.
- Used for qualified personal property with a recovery period of 20 years or less, including qualifying improvements.
- Used only on qualified property that the taxpayer has never used (e.g., recently purchased vehicle) and property is not acquired from a related party (e.g., gifts from grandma).
- Bonus depreciation % is 100%

Question 35

What are section 179 rules?

Answer 35

1. Dollar-for-dollar phase out begins when purchases exceed: $2,700,000
2. Maximum section 179 deduction: $1,080,000
3. Cannot use section 179 deduction to create a loss or if there is alandscaping. This, it cannot excede taxable income.
4. Section 179 rules do NOT apply to land, but it applies to qualified improvement exception for nonresidential buildings

Question 36

How is the section 179 dollar-for-dollar threshold calculated?

Answer 36

When the purchase amount exceeds the section 179 phase out amount ($2.7M), the excees reduces the section 179 deduction amount ($1,080,000). Formula below:

1. Purchase price - dollar-for-dollar phase out amount ($2,700,000) = excess
2. Sec. 179 deduction amount ($1,080,000) - Excess = Adjusted sec. 179 deduction.
3. Adjusted sec.179 deduction cannot be greater than taxable income to create a loss.

Question 37

Are buildings applicable to section 179 deduction?

Answer 37

Buildings do not qualify for the section 179 deduction, but, “qualified improvement property” does.

“Qualified improvement property” is improvement to the interior of nonresidential real property.

Question 38

When is the qualified improvement property placed in service to qualify under section 179?

Answer 38

The qualified improvement must be placed in service after the date the building was placed in service (e.g., a fire alarm system)

Question 39

How is the depreciation basis determined for assets converted from personal use to business use?

Answer 39

The basis is the lesser of the cost and the fair market value (FMV) of the asset at the date of conversion.

Question 40

How is bonus depreciation computed?

Answer 40

Bonus depreciation is the FMV of the property acquired (new) * 100%

Question 41

What happens if a business elects a section 179 deduction when acquiring an asset and there is a net loss?

Answer 41

The business acquiring the asset must be profitable prior the section 179 deduction and can only reduce the taxable income to zero, not create a loss.

Question 42

When is the cost of (or other basis) of worthless stock or securites treated as a capital loss?

Answer 42

The cost of worthless stock or securities is treated as a capital loss if they were sold on the last day of the taxable year in which they became worthless.

Question 43

How are capital gains resulting from a sale of section 1231 asset held for less than 12 months recorded?

Answer 43

Section 1231 assets (used in a trade or business) held for less than 12 months are recorded as ordinary gains, not a section 1231 gain (land would be considered section 1231 if maintained for longer than 12 months).

Question 44

How are section 1231 losses treated with the sale of a rental house?

Answer 44

Section 1231 losses are ordinary loss and the entire loss on the sale of the house is deductible.

Question 45

Are losses from sale of personal items deductible?

Answer 45

No, losses from sale of personal items are non-deductible.

Question 46

How are losses from business use personal property (section 1231) recognized?

Answer 46

Losses from the sale of a business use personal property (long-term use) are considered section 1231 losses, and are not subject to section 1245 depreciation recapture rules.

Question 47

What is section 1250 (real property) and when is it used?

Answer 47

Section 1250 assets are depreciable real property used in a trade or business for more than 12 months (e.g., a warehouse or office building, but not land). It is used for gains only.

Question 48

How is section 1250 (real property) applied for individuals?

Answer 48

For individual taxpayers selling section 1250 property at a gain, the gain is a section 1231 gain and netted with other section 1231 gains or losses

Question 49

How is section 1250 (real property) applied for C corporations?

Answer 49

For C corporation, section 291 applies to section 1250 assets (depreciable real estate) sold at a gain. Under section 291, the amount of recapture as ordinary income is equal to 20% of the lesser of the recognized gain or the accumulated straight-line depreciation taken on the asset. Any remaining gains are section 1231 gain.

Section 291 depreciation recapture only applies to C corporations, not other types of business.

Question 50

How is the section 1231 gains and losses “lookback rule” applied?

Answer 50

1. If section 1231 gain exceeds losses, the net gain is treated as a long-term capital gain subject to a “lookback limit” for losses during the previous five years.
2. lookbak limit - look back up to five years and see if there were any section 1231 losses claimed as ordinary losses.
3. If any sect 1231 losses were claimed in the past 5 years as a result of the losses, current section 1231 gain must be recaptured as ordinary income before they can be considered capital gain.

Question 51

When does a wash sale happens?

Answer 51

A wash sale exists when a security is sold for a loss and is repurchased within 30 days before or after the sale. A loss on a wash sale is disallowed for tax purposes.