Tax Consequences of Property Transactions

Question 1

What are the three type of assets that property can be divided into (for tax purposes on gains/losses from sale of asset)?

Answer 1

1. Ordinary assets
2. Capital Assets
3. Section 1231 Assets

Question 2

What are ordinary assets?

Question 3

• Produce ORDINARY income when sold for a gain, and include:
  
  • Remember CAR ID
    
    • Creative works in the hands of the individual or company that created it OR
      
      • Held by a person who received such propery as a gift from the creator of the property
      • Also includes patents, copyrights
    • Accounts Receivable or notes receivable originating from normal operations of a business
    • Inventory held mainly held for sale to customers
    • Depreciable personal property and supplies used in a trade/business
• Does NOT include:
  
  • Musical compositions and copyrights (capital assets)

Question 4

What are capital assets?

Question 5

• Pretty much all assets EXCEPT CAR ID (Ordinary and 1231)
• Pretty much held for personal use or investment purposes

Question 6

What determines taxation of gain/losses on the sale of capital assets?

Question 7

• Holding period
• Type of capital asset

Question 8

Capital Assets - Holding Periods

Question 9

• Long-term capital gain/loss - taxed at prefrential capital gains tax
• Short-term capital gain/loss - taxed at ordinary income tax

Question 10

What are section 1231 assets?

Answer 10

• This is related to:
  
  • Depreciable property used in a trade or business
• Two categories of depreciable property
  
  • Section 1250 - Real Property
  • Section 1245 - Personal Property

Question 11

How does Section 1231 taxation work?

Answer 11

• Provides property transactions with the best tax treatment possible.
  
  • Long-term gains are taxed at long-term capital gains tax rate
  • Losses are deducted as ORDINARY losses against ordinary income
    
    • Depreciation on the asset MUST be RECAPTURED before favorable long-term capital gains rates apply.
• Section 1231 gains/losses are netted against each other each year and then any GAINS are netted against any aggregate net loss from the prevous 5 years in order to determine current year’s recognized 1231 gain/loss

Question 12

Section 1245

Question 13

• Personal Property used in trade or business as part of Section 1231.
• Must be used in a trade or buiness AND
  
  • Held for more than ONE year to qualify under section 1245.

Question 14

Section 1245 - Calculation

Answer 14

At time of sale:

Any depreciation taken on the asset is RECAPTURED as ORDINARY INCOME equal to LESSER of:

• Gain realized OR
• Depreciation taken

And then, any realized gain in EXCESS of the amount of depreciation recaptured is:

• Recognized as a capital gain tax subject to most favorable tax rates

Question 15

Section 1250

Question 16

• The real property that has been depreciated as part of trade/business
• Part of section 1231

Question 17

Section 1250 - Calculation

Answer 17

Unrecaptured Section 1250 gain (not taxed at ordinary rates) on the sale of real estate will equal the LESSER of:

• Amount of single-line depreciation (not accelerated) OR
• Gain realized on sale of the property

Then, anything above the recaptured section 1250 gain will be long-term capital gains rates

Question 18

Adjusted basis of property - What counts towards this and how to calculate?

Question 19

Original Purchase Price

• Purchase price, including sales tax
• Shipping and installation costs
• Transaction costs/commissions

Adjustments to Basis

• Significant improvements
• Investment that exends the life of the asset
• Reinvestment of income (such as reinvested taxable dividends)
• Decreases to basis (such as allowable depreciation, insurance reimbursements after a casualty)

DOES NOT INCLUDE

• Pretax money paid used to purchase the asset
• Routine maintenance and repair of an asset
• Property tax

Question 20

Determine basis of asset - Gifted Assets

Question 21

• Holding period and Basis transfers to donee
• Gift tax paid by donor does affect donee’s basis
• Basis calculation
  
  • On date of gift,
    
    • FMV of asset >= the donor’s adjusted basis
      
      • Donor’s basis carries over to donee’s basis
      • Donor’s holding period carries over as well
    • FMV of asset < donor’s adjusted basis
      
      • Gain basis
        
        • Donee later sells for MORE than donor’s adjusted basis
        • Use donor’s adjusted basis
      • Loss basis
        
        • Donee later sells for LESS than FMV on date of gift
        • Use FMV or asset on date of gift
      • Equal basis
        
        • Donee later sells asset BETWEEN donor’s adjusted basis and FMV on date of gift
        • Donee’s basis is SELLING PRICE
        • No gain or loss is recognized

Question 22

Basis - Gift Tax

Answer 22

• When donor transfers a gift and pays gift tax on the transfer, gift tax attributable to the appreciation of the assets value (while owned by the donor) is added to the donor’s basis to determine donee’s basis

Donee’s basis =

Donor’s basis + [(net appreciation of gift / taxable gift) x gift tax paid]

Question 23

Basis - Inherited Assets

Answer 23

• Heir’s basis is ALWAYS equal to FMV of asset on date of death OR estate’s alternative valuation
• Heir’s holding period is ALWAYS long-term, no matter what

Question 24

Basis - Related Party Transaction

Answer 24

• Can generate DISALLOWED losses
• Related parties include:
  
  • Direct ancestors (parents, grandparents, great-grandpartents, their parents, etc.)
  • Direct decendants (children, grandchildren, their children, etc)
  • Silbings (including half-siblings)
  • Spouse
  • Business interests where a taxpayer owns a 50% interest or more

Question 25

Basis - Related Party Transaction and Holding Period Calculation

Answer 25

• Buyer’s holding period starts on DATE OF PURCHASE (no carryover)
• Basis of related party transactions:
  
  • One the date of related party transaction:
    
    • FMV of asset >= related party seller’s adjusted basis
      
      • Buyer’s basis is the PURCHASE PRICE (assuming sold for FMV) of the asset
    • FMV of asset < related party seller’s adjusted basis
      
      • Gain basis
        
        • If buyer sells the asset for MORE than seller’s adjusted basis
        • Buyer would use seller’s adjusted basis
      • Loss basis
        
        • If buyer sells the asset for LESS than FMV on date of transaction
        • Buyer would use PURCHASE PRICE of asset from the date of the related party transaction
      • Equal basis
        
        • If buyer later sells asset for an amount between seller’s adjusted basis and purchase price of asset on date of realted party transaction
        • Buyer’s basis equals SELLING PRICE
        • No gain/loss is recognized

Question 26

Wash Sale

Answer 26

• Happens when you sell a stock for a loss and then purchases an identical stock within a 60-day window (30 days before the sale and 30 days following the sale)
• Losses are NOT recognized for the wash sale rule
• Index funds from DIFFERENT mutual fund companies are not considered identical

Question 27

Wash Sale - Consequence

Answer 27

• Loss can not be recongized on tax return
• Amount of dissallowed loss will be added to cost basis of newly (identical) purchased stock and then you can recognize loss once the newly purchased stock is sold.

Question 28

Like-kind exchange advantages

Answer 28

• Recognition of gains and losses are DEFERRED through this type of exchange

Question 29

Like-Kind Exchange - How to qualify

Answer 29

• Exchange must consist of qualified like-kind REAL PROPERTY
  
  • NOT PERSONAL PROPERTY
• Real property that qualifies:
  
  • Property held for investment
  • Used in a trade or business
• Like-kind proprety is property of SAME nature or character
  
  • Like real estate for real estate, even if the real estate is used differently
• Cannot be exchanged for foreign country real estate!

Question 30

Like-Kind Exchange - Boot

Answer 30

• Gain is recognized on like-kind exchange IF DISSIMILAR PROPERTY IS IS ALSO EXCHANGED (Boot)
• Common example include:
  
  • Cash
  • Debt assumed
  • Any other dissimiliar property

Question 31

Like-kind exchange - Boot Calculation

Answer 31

• Party that receives the boot must RECOGNIZE GAIN eqaul to the lesser of:
  
  • Boot received OR
  • Gain realized
• Party can then defer the remaining portion of gain

Question 32

Like-Kind Exchange Basis with no Boot

Answer 32

• Taxpayer’s basis in the new porperty carries over from the OLD property

Question 33

Deferred Like-Kind Exchange

Answer 33

• When an individual exchanges an existing investment/business property and a yet-to-be acquired like-kind property

Question 34

Deferred Like-Kind Exchange - How to qualify

Answer 34

• Must use services of a qualified intermediary
• Must NOT take possession of any PROCEEDS from the sale of the like-kind property PRIOR to the acquisition of the new like-kind property
• Any cash NOT reinvested into the new like-kind property is treated as BOOT received
• Holding periods to meet:
  
  • 45-day ID: New property to be recieved must be ID’ed within 45 days of the transfer of property being given up (more than one property can be ID’ed by intermediary)
  • Receipt requirement: New propery must be RECEIVED by the earlier of:
    
    • 180th day after the date of transfer of the property given up OR
    • The due date, including extensions for the tax return of the year in which the transfer of property given up occurs

Question 35

1035 Exchanges

Answer 35

• Note others that you don’t know as well:
  
  • Life to endowment
  • Life to qualified LTC
  • Endowment to Endowment
  • Endowment to life
  • Endowment to LTC
  • LTC to LTC

Question 36

Section 1033 - Involuntary Conversions

Answer 36

• Involves destruction, theft, or condemnation of property the taxpayer experiences an involunatry conversion of property
• If ALL PROCEEDS from insurance or sales proceeds are REINVESTED into a like-kind property WITHIN A SPECIFIC PERIOD OF TIME, then
  
  • All REALIZED gains can be deferred.
• Time period after gain is realized on involuntary conversion:
  
  • Primary residence - 2 years following realized gain OR 4 years if federally declared disaster area
  • Business/Investment Property - 3 years following realized gain

Question 37

Section 121

Answer 37

• 500k exlcusion for MFJ
• 250k for all other filing statuses
• Qualifications:
  
  • Taxpayer owned and used main home last 2/5 years
  • Home was not acquired through 1031 exchange in last 5 years
  • Taxpayer has not claimed any exclusion for sale of home during 2-year period
• Unforseen:
  
  • Does not need to meet 2/5 rule if unforseen shit happens:

Ratio = number of qualifying use and ownership / 24 months

times max exlcusion

Question 38

Section 1202 - Qualified Small Business Stock

Answer 38

• Can exlude GREATER of:
  
  • 10 million of gain OR
  • 10 times the taxpayer’s original basis in stock
• Also applies to AMT
• Any gain in excess of those amounts are taxed at 28%
• Required holding period is 5 years
• Qualified Small business stock requirements
  
  • Domestic C corp
  • Stock purchased as original issue stock directly
  • Company no more than 50 mil gross assets prior to or immediately following issuance of stock
  • Must be engaged in active business
  • Not repurchasing its own shares

Question 39

Worthless Stock

Answer 39

• Becomes worthless during tax year
  
  • will be deemed to have been sold at LAST DAY OF TAX YEAR, which is used for short-term and long-term holding periods

Question 40

Section 1244 - Stock

Answer 40

• Losses can be deducted as ordinary losses (not subject to 3k limit)
  
  • up to 50k annually or 100k for MFJ
  • losses in excess of these amounts are treated as capital losses.
• Gains on 1244 stock treated as long-term capital gains and are NOT offset by other Section 1244 losses.
• Section 1244 is samll business stock
  
  • Domestic corp
  • Purchased directly from corp
  • 50% or more of its income must be from nonpassive activities

Question 41

Section 1244 - Bad Debts

Answer 41

• Nonbusiness debts must be completely worthless before they can be deducted
  
  • Reported as SHORT-TERM capital losses
• Business bad debts
  
  • Arise out of normal course of business transactions
  • Can be deducted for partial worthlessness and offset business income
  • Not subject to 3k net capital loss restriction

Question 42

Loss on personal use property

Answer 42

• Losses on sale of personal use property are NOT allowed to be recognized

Question 43

NIIT

Answer 43

• Will apply to sale of principal (over any 121 exclusion amount)
• NIIT is reduced by deductions attrituble to producing the investment income