Tax Consequences of Property Transactions

Question 1

What are the two broad categories of property a financial planner should first identify?

Answer 1

The characteristics or attributes of the property itself

The activity in which the property is used.

Question 2

What defines a capital asset per section 1221? (Think ACID and exclusion)

Answer 2

Capital assets are all assets except:
A - accounts receivable
C - copyrights and creative works held by the creator
I - inventory
D - depreciable personal and real property

Question 3

What holding period, to include which actual days, are used to determine short vs long term gains?

Answer 3

1 year and 1 day. Day of purchase (or gifting) does not count. Day of disposition counts.

Question 4

What is the recovery of capital doctrine?

Answer 4

Allows taxpayers to recover the cost or other original basis of property tax free.

Question 5

What is the holding period exception for gift property?

Answer 5

If the donor’s basis carries over to the donee, the donor’s holding period is added to the donee’s holding period.

Question 6

What is the holding period exception for inherited property?

Answer 6

Property inherited from a decedent is treated as long-term regardless of the actual original holding period

Question 7

What is the holding period exception of section 1031 exchanges?

Answer 7

The holding period of the property surrendered in the exchange carries over and adds to the holding period of the like-kind property received.

Question 8

What is the capital gains exception for mark-to market rules on futures contracts?

Answer 8

They are treated as though they were sold on the last day of the year: 40% short term and 60% long term

Question 9

What are the general rules of thumb for basis in the following:

Cost
Gift
Inheritance

Answer 9

Cost: the basis is usually the cost of the item (cost basis)
Gift: the basis is usually what the donee paid for the item (carryover basis)
Inheritance: the basis is usually FMV at death (stepped-up (or stepped-down) basis)

Question 10

What is capitalization of acquisition costs?

Answer 10

That is the inclusion (or adding in) of all costs associated with acquiring an asset as part of its basis

Question 11

What is the formula for determining the adjusted basis on an appreciated gift when paying gift tax?

Answer 11

Donor’s basis + (appreciation / FMV - gift tax exclusion) x gift tax paid = donee’s basis

Question 12

What are the five different types of basis?

Answer 12

Original or Cost
Adjusted
Carryover
Stepped-up (or down)
Substituted

Question 13

What are things that impact basis?

Answer 13

Legal fees, commissions, sales tax, transportation charges

Question 14

What are things that do not affect basis?

Answer 14

On going property expenses such as utilities and taxes

Question 15

What are the four types of property?

Answer 15

Realty: real estate property
Personalty: any type of property not realty
Tangible
Non-tangible

Question 16

What is cost recovery?

Answer 16

This is the reduction of the cost basis based on depreciation, amortization, or depletion. Inventory does not count.

Question 17

What are the four types of property and their useful lives under the Depreciation/Modified Accelerated Cost Recovery System (MACRS)?

Answer 17

Autos, light duty trucks, computers (Section 1245) 5 yrs
Office furniture and fixtures (Section 1245). 7 yrs
Residential rental property (Section 1250) 27.5 yrs
Commercial rental property (Section 1250) 39 yrs

Question 18

What is the purpose of the half and mid-quarter conventions?

Answer 18

For the half year, it is a IRS regulation and assumption that a business will purchase property in the last half of the year and therefore can only take half deprecation.

For the mid-quarter, it further reduces the benefits for personal property recovery for those items placed in service either in the last quarter of the year.

Question 19

What is the alternative depreciation system (ADS) used for?

Answer 19

Used to depreciate property that is used less than 50% in a business (such as a phone, entertainment asset, or computer)

Question 20

What is a section 197 asset?

Answer 20

An intangible asset such as a copyright or trademark

Question 21

What is the amortization of intangible assets?

Answer 21

This gives the taxpayer the ability to amortize (or deduct) the value of the intangible item over its useful life

Question 22

What are the two depletion methods?

Answer 22

Cost depletion: Asset basis / total number of recoverable units x units sold

Percentage depletion: A statutory percentage is applied to the gross income from the property

Question 23

What is the lookback rule on 1231 property and how does it affect taxes?

Answer 23

For any 1231 capital gains, the taxpayer must loopback 5 years for any 1231 ordinary income loss to recapture, before the taxpayer can take the capital gains.

Any 1231 losses reported in the past 5 years will be recaptured as ordinary income before allowing additional 1231 gains.

Question 24

What is 1231 property?

Answer 24

Any depreciable real property or personal property used in a trade or business or for the production of income

Question 25

What is 1245 property?

Answer 25

Depreciable tangible personal property used in a trade or business

Question 26

How is section 1245 recapture calulated?

Answer 26

Purchase price of asset - depreciation = adjusted basis

Sales price - adjusted basis = 1245 ordinary income gain - recapture amount (to extent of sales price) = 1231 capital gain

Question 27

What is section 1250 property?

Answer 27

Depreciable real property used in a trade or business or for the production of income. In other words, it is real estate that is a section 1231 asset.

The key difference is that 1250 property is capped at 25% tax rate. 1(25)0 - think 25

Question 28

What is an important rule about the tax percentage in a 1250 asset?

Answer 28

If the taxpayer is above 25% tax bracket, then 25% is the maximum rate at which unrecaptured section 1250 gain will be taxed. If the taxpayers marginal tax rate is lower than 25%, the lower rate will be used.

It is called UNRECAPTURED gain to differentiate it from recaptured 1245 gain

Any remaining gain above recaptured depreciation, will be taxed at LTCG rates

Question 29

What is a section 179 expense election?

Answer 29

It allows a taxpayer to elect for a much larger deduction than would otherwise be available during the year the property was acquired.

• Maximum deduction is $1.08M in 2022. This deduction cannot create a loss.
• For equipment totaling more than $2.7M, the deduction amount allowed is reduced dollar-for dollar. Ex: in service equipment $2.9M - $2.7M allowed =$200k. Taxable income $900K - $200K = $700k deduction allowed
• Cannot reduce the tax liability to less than $0, but carryover is allowed

Question 30

How should one approach netting losses and gains?

Answer 30

Pair short term and long term gains and losses to their respective percentages, highest to lowest. Then use losses, short or long, to begin offsetting gains in the highest to lowest tax brackets.

Question 31

When there are both STCL and LTCLs, in what order are those losses applied to the tax return?

Answer 31

STCL are used first against the $3000 limit, and then LTCL

Question 32

What property qualifies for a section 1031, like-kind exchange?

Answer 32

Only real property and only if the transaction is done through a qualified intermediary. The property also must be domestic (in the US)

Question 33

What is boot and what is its tax consequence in a 1031 like-kind exchange?

Answer 33

Boot “kicks in” recognized taxes during a like-kind exchange. Recognized gain is the lesser of boot received or realized gain.

The receipt of boot with either result in recognition of gain, if there is a gain, or no recognition, if there is a loss.

Question 34

What is the formula for calculating realized and recognized gains?

Answer 34

(FMV of property + boot (cash or liabilities)received) - adjusted basis in property given = realized gain

Recognized gain = boot received. NOTE that recognized gain can only be as much as realized gain, not more.

Question 35

What is the two year rule for like-kind exchanges with related parties?

Answer 35

If a like-kind exchange occurs with a related party (family), then the new owners must wait two years until they can sell or else all previously deferred gains are recognized immediately

Question 36

What is section 1033 and what are the tax consequences and calculation?

Answer 36

1033 is for a taxpayer undergoing an involuntary conversion to postpone recognition of any gains by reinvesting those gains into a similar property

If reinvested into a new property…
Gain realized = Amt received - adj basis
Gain recognized = New property - gain realized

Question 37

What is the time periods associated with replacement property losses / gains?

Answer 37

2-3 years

Question 38

What is the calculation for casualty loss to be deducted from ordinary income?

Answer 38

(pre-casualty FMV - post casualty FMV) - (AGI * 10%) - $100 = casualty loss deduction

Question 39

How do you calculate the taxable portion of an installment sale?

Answer 39

1) Profit / total contract price = gross profit percentage
2) GPP x down payment = taxable capital gain
3) use calculator- N=yrs, I/YR of pmt, PV= amt borrowed, FV=0, solve PMT
4) (multiple PMT by the number of years) - amount originally owed = ordinary income
5) GPP x amount originally loaned = taxable capital gain

Question 40

What are the amounts and rules for primary home exclusions?

Answer 40

$250k single, $500k joint, if this passes both ownership and use tests.

Ownership: must be owned and used as a primary residence 2 of the 5 years preceding the sale - not consecutive

Use: either spouse can meet the ownership, but both must meet it for full exclusion - otherwise prorated to the amount of time one or both owners held the property.

Question 41

What are the rules for determining vacation home vs rental property?

Answer 41

Primarily personal: property is rented fewer than 15 days per year
Primarily rental: the property is rented more than 15 days per year AND personal use is less than 14 days or 10% of the rental days
Mixed: property is rented more than 15 AND personal use for more than 14 days or 10% of the rental days

Rental income and expenses are generated on Schedule E

Question 42

What is the meaning of “Amount Realized”?

Answer 42

The proceeds from the sale

Question 43

What is the meaning of the term “Amount Recognized”?

Answer 43

This is the gain on the sale

Question 44

How is section 1231 property taxed?

Answer 44

If it is a gain, it is a long term capital gain.

If is is a loss, it is an ordinary income loss and you can deduct more than $3000.

Question 45

How is section 1245 income taxed?

Answer 45

Ordinary income - there cannot be a 1245 loss

Question 46

What is the rule for disallowed losses between relatives?

Answer 46

You can’t have one. If one relative sells to another for a loss, and that relative subsequently then sells for a gain, the previous loss is disallowed and subtracted from the total amount of taxable income.

Question 47

What is the table and formula for recognized and realized gain in a 1031 exchange?

Answer 47

Party 1 Party 2
FMV $400k <—————> $500k
Boot $100k——————->
Basis $250k $200k
Realized: ($500-$250) ($400-$200)
New FMV-Basis New FMV - basis
Recognized: $0 $100K
Boot received Boot received
Substitute
Basis: $350k $200k

Question 48

What is the formula for substitute basis?

Answer 48

Adj basis in surrendered property
\+ boot given
\+ gain recognized 
- FMV of boot received
- loss recognized 
= Substitute basis

Question 49

What are the disaster rules, deductible, and minimum AGI rules for claiming a casualty loss?

Answer 49

Must be declared a natural disaster by the government
Must take the lesser of the FMV decrease or adjusted basis
Must include a $100 floor minimum
Loss must be for more than 10% AGI to be claimed. Total loss is reduced by 10% AGI.

Question 50

Is the cost of a repair to keep a business vehicle in working order, deductible?

Answer 50

Yes - completely.

Question 51

What is the calculation for new basis under a section 1033 replacement?

Answer 51

Gain realized (insurance check - old basis)
- gain recognized (insurance check - cost of new property)
= net postponed gain

New basis = cost of new property - net postponed gain

Question 52

During the current year, Sarah gave her daughter, Carol, 1,000 shares of publicly traded stock that Sarah purchased five years ago for $45,000. The stock was worth $100,000 at the time of gift. Sarah paid $41,000 in gift tax out of pocket as a result of this gift. What is Carol’s basis in the stock?

A) $45,000
B) $71,650
C) $71,240
D) $72,850

Answer 52

Because this is not loss property, a portion of the gift tax paid out of pocket by the donor can be added to the donor’s basis of $45,000 to compute the basis in the hands of the donee. The percentage of the gift tax paid that can be added to the basis is the unrealized appreciation divided by the fair market value of the asset at the time of gift reduced by the gift tax annual exclusion taken. This percentage is multiplied by the gift tax paid out of pocket. In this situation, the appreciation of $55,000 is divided by the taxable value of the gift ($85,000—the $100,000 FMV reduced by the gift tax annual exclusion of $15,000) to give us 65%. This percentage is multiplied by the gift tax paid of $41,000 to equal $26,650. This is added to the original basis of $45,000 to give us $71,650.

The formula is shown as follows:

donor’s basis + (appreciation / FMV − gift tax exclusion) × gift tax paid = donee’s basis