Tax Consequences of Property Transactions Flashcards
What are the two broad categories of property a financial planner should first identify?
The characteristics or attributes of the property itself
The activity in which the property is used.
What defines a capital asset per section 1221? (Think ACID and exclusion)
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
What holding period, to include which actual days, are used to determine short vs long term gains?
1 year and 1 day. Day of purchase (or gifting) does not count. Day of disposition counts.
What is the recovery of capital doctrine?
Allows taxpayers to recover the cost or other original basis of property tax free.
What is the holding period exception for gift property?
If the donor’s basis carries over to the donee, the donor’s holding period is added to the donee’s holding period.
What is the holding period exception for inherited property?
Property inherited from a decedent is treated as long-term regardless of the actual original holding period
What is the holding period exception of section 1031 exchanges?
The holding period of the property surrendered in the exchange carries over and adds to the holding period of the like-kind property received.
What is the capital gains exception for mark-to market rules on futures contracts?
They are treated as though they were sold on the last day of the year: 40% short term and 60% long term
What are the general rules of thumb for basis in the following:
Cost
Gift
Inheritance
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)
What is capitalization of acquisition costs?
That is the inclusion (or adding in) of all costs associated with acquiring an asset as part of its basis
What is the formula for determining the adjusted basis on an appreciated gift when paying gift tax?
Donor’s basis + (appreciation / FMV - gift tax exclusion) x gift tax paid = donee’s basis
What are the five different types of basis?
Original or Cost Adjusted Carryover Stepped-up (or down) Substituted
What are things that impact basis?
Legal fees, commissions, sales tax, transportation charges
What are things that do not affect basis?
On going property expenses such as utilities and taxes
What are the four types of property?
Realty: real estate property
Personalty: any type of property not realty
Tangible
Non-tangible
What is cost recovery?
This is the reduction of the cost basis based on depreciation, amortization, or depletion. Inventory does not count.
What are the four types of property and their useful lives under the Depreciation/Modified Accelerated Cost Recovery System (MACRS)?
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
What is the purpose of the half and mid-quarter conventions?
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.
What is the alternative depreciation system (ADS) used for?
Used to depreciate property that is used less than 50% in a business (such as a phone, entertainment asset, or computer)
What is a section 197 asset?
An intangible asset such as a copyright or trademark
What is the amortization of intangible assets?
This gives the taxpayer the ability to amortize (or deduct) the value of the intangible item over its useful life
What are the two depletion methods?
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
What is the lookback rule on 1231 property and how does it affect taxes?
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.
What is 1231 property?
Any depreciable real property or personal property used in a trade or business or for the production of income
What is 1245 property?
Depreciable tangible personal property used in a trade or business
How is section 1245 recapture calulated?
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
What is section 1250 property?
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
What is an important rule about the tax percentage in a 1250 asset?
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
What is a section 179 expense election?
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
How should one approach netting losses and gains?
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.
When there are both STCL and LTCLs, in what order are those losses applied to the tax return?
STCL are used first against the $3000 limit, and then LTCL
What property qualifies for a section 1031, like-kind exchange?
Only real property and only if the transaction is done through a qualified intermediary. The property also must be domestic (in the US)
What is boot and what is its tax consequence in a 1031 like-kind exchange?
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.
What is the formula for calculating realized and recognized gains?
(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.
What is the two year rule for like-kind exchanges with related parties?
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
What is section 1033 and what are the tax consequences and calculation?
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
What is the time periods associated with replacement property losses / gains?
2-3 years
What is the calculation for casualty loss to be deducted from ordinary income?
(pre-casualty FMV - post casualty FMV) - (AGI * 10%) - $100 = casualty loss deduction
How do you calculate the taxable portion of an installment sale?
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
What are the amounts and rules for primary home exclusions?
$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.
What are the rules for determining vacation home vs rental property?
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
What is the meaning of “Amount Realized”?
The proceeds from the sale
What is the meaning of the term “Amount Recognized”?
This is the gain on the sale
How is section 1231 property taxed?
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.
How is section 1245 income taxed?
Ordinary income - there cannot be a 1245 loss
What is the rule for disallowed losses between relatives?
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.
What is the table and formula for recognized and realized gain in a 1031 exchange?
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
What is the formula for substitute basis?
Adj basis in surrendered property \+ boot given \+ gain recognized - FMV of boot received - loss recognized = Substitute basis
What are the disaster rules, deductible, and minimum AGI rules for claiming a casualty loss?
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.
Is the cost of a repair to keep a business vehicle in working order, deductible?
Yes - completely.
What is the calculation for new basis under a section 1033 replacement?
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
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
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
