Tax Consequences of the Disposition of Property - Examples

Question 1

Depreciation and Cost Recovery - Section 179 -
Limitations and Special Rules

Answer 1

For example, Pam owns an unincorporated manufacturing business. In 2024, she purchases and places in service $3,140,000 of qualifying equipment for use in her business. Pam’s taxable income from the business (before deducting any Section 179 amount) is $380,000. The maximum Section 179 deduction of $1,220,000 is initially reduced by $90,000 ($3,140,000 − $3,050,000) to reflect the fact that the qualified property placed in service during the year exceeded $3,050,000. Pam is not allowed to carryover any of the $90,000 reduced by this limitation. However, the $90,000 remains part of the equipment’s basis subject to MACRS depreciation.

The remaining $1,130,000 ($1,220,000 − $90,000) Section 179 expense is further limited to business taxable income, so Pam’s Section 179 deduction in 2024 will be $380,000. She may carry over $750,000 ($1,130,000 − $380,000) to 2024 as Section 179 depreciation in that year. Even though only $380,000 is deductible under Section 179 in the current year, Pam must reduce the cost basis of the equipment by $1,130,000 to prevent double deduction of Section 179 expense caused by the carryover. Thus, she will depreciate $2,010,000 ($3,140,000 − $1,130,000) using MACRS.

Question 2

Definition of a Capital Asset

Answer 2

For example, Eric owns an automobile that is held for personal use and also owns a copyright for a book he has written. Because the copyright is held by the taxpayer whose personal efforts created the property, it is not a capital asset. The automobile held for personal use is a capital asset.

One can conclude that the classification of an asset is often determined by its use. Still, it is easy to be confused. An automobile used in a trade or business is not a capital asset (it is Section 1231 property), but is considered a capital asset when it is held for personal use. Examples of assets that qualify as capital assets include a personal residence, land held for personal use and investments in stocks and bonds. In addition, certain types of assets are specifically given capital asset status, such as patents, franchises and so on.

Question 3

Real Property Subdivided for Sale

Answer 3

For example, Jean subdivides a tract of land held as an investment into seven lots, and all requirements of Section 1237 are satisfied. The lots have a fair market value of $10,000 each and have a basis of $4,000. Jean incurs no selling expenses and sells four lots in 20X2 and three lots in 20X3. In 20X2, all of the $24,000 [4 lots × ($10,000 − $4,000)] gain is capital gain. In 20X3, the year in which the seventh lot is sold, $1,500 of the gain is ordinary income [0.05 × ($10,000 × 3 lots)], and the remaining $16,500 {[3 lots × ($10,000 − $4,000)] − $1,500} gain is capital gain.

Question 4

Non-business Bad Debt

Answer 4

For example, two years ago, Alice loaned $4,000 to a friend. During the current year, the friend declares bankruptcy and the debt is entirely worthless. Assuming that Alice has no other gains and losses from the sale or exchange of capital assets during the year, she deducts $3,000 in determining adjusted gross income (AGI) and has a STCL carry forward of $1,000

Question 5

Capital Gains - Net short-term capital gain

Answer 5

For example, Hal has two transactions involving the sale of capital assets during the year. As a result of those transactions, he has a STCG of $4,000 and a STCL of $3,000. Hal’s NSTCG is $1,000 ($4,000 - $3,000), and his AGI increases by $1,000.

Question 6

Capital Gains - Net long-term capital gain

Answer 6

For example, Clay has two transactions involving the sale of capital assets during the year. As a result of the transactions, he has a LTCG of $4,000 and a LTCL of $3,000. Clay has a NLTCG and a net capital gain of $1,000. His AGI increases by $1,000.

Linda has four transactions involving the sale of capital assets during the year. As a result of the transactions, she has a STCG of $5,000, a STCL of $7,000, a LTCG of $10,000 and a LTCL of $2,000. After the initial netting of short-term and long-term gains and losses, Linda has a NSTCL of $2,000 ($7,000 - $5,000) and a NLTCG of $8,000 ($10,000 - $2,000). Because the NLTCG exceeds the NSTCL by $6,000 ($8,000 - $2,000), her NCG is $6,000.

Question 7

Adjusted Net Capital Gains

Answer 7

For example, Sandy is single with taxable income of $100,000 without considering the sale of a capital asset, Merck stock, during 2024 for $15,000. The stock was purchased four years earlier for $3,000. Sandy has $12,000 of Net Long-Term Capital Gain which the Adjusted Net Capital Gain is taxed at 15%. In order words, Sandy’s adjusted cost basis is $12,000 ($15,000 − $3,000). Since the stock was purchased 4 years ago and, based on her AGI, her gain of $12,000 would be taxed at 15%. To compute her total tax for 2024, ordinary rates would be applied to the $100,000 and then the tax on the net capital gain of $1,800 (15% × $12,000) is added to her tax liability.

Question 8

Adjusted Net Capital Gains - NCG is reduced by collectibles gains to determine ANCG.

Answer 8

For example, Danny, whose tax rate is 32%, purchased Bowling common stock and antique chairs three years ago for investment. He sells the assets in the current year and has a gain of $8,000 on the sale of the stock and $10,000 on the sale of the antique chairs. His NLTCG is $18,000, and his NCG is $18,000. His ANCG is $8,000 since $10,000 of the NCG is a collectibles gain. His tax on the capital gains is $4,000 [(15% × $8,000) + (28% × $10,000)].

Question 9

The exclusion for qualified small business stock(QSBS)

Answer 9

Date QSBS Acquired Exclusion Percentage
Prior to February 18, 2009 50%
February 18, 2009 – September 27, 2010 75%
September 28, 2010 – December 31, 2013 100%

Question 10

Section 1202 provides that non-corporate taxpayers may exclude 50% of the gain resulting from the sale or exchange of qualified small business stock

Answer 10

For example, Roger purchased $200,000 of newly issued Monona common stock on October 1, 2008. On December 15, 2024, he sells the stock for $4 million (a gain of $3.8 million). He excludes $1.9 million of the gain, and the remaining $1.9 million of gain is Section 1202 gain taxed at 28%. Alternatively, if Roger purchased the stock on October 1, 2009 and sold in 2024, he could exclude $2.85 million ($3.8 million × .75) of the gain.

Question 11

Capital Losses - Net short-term capital loss (NSTCL) > Net Long-term capital gain (NLTCG)

Answer 11

For example, Bob has gross income of $60,000 before considering capital gains and losses. If Bob has a NLTCG of $10,000 and a NSTCL of $15,000, he has $5,000 of NSTCL in excess of NLTCG and may deduct $3,000 of the losses from gross income. Assuming no other deductions for AGI, Bob’s AGI is $57,000 ($60,000 − $3,000).

In the example above, $10,000 of the NSTCL is used to offset the $10,000 of NLTCG and $3,000 of the NSTCL is used to reduce ordinary income. However, $2,000 of the loss is not used. This net capital loss is carried forward for an indefinite number of years. The loss retains its original character and will be treated as a STCL occurring in the subsequent year. If a taxpayer dies with an unused capital loss carryover, it expires.

Question 12

Capital Losses - Net Long-term capital gain (NLTCG) > Net short-term capital loss (NSTCL)

Answer 12

For example, In the current year, Gordon has a NLTCL of $9,000 and a NSTCG of $2,000. He must use $2,000 of the NLTCL to offset the $2,000 NSTCG, and then use $3,000 of the $7,000 ($9,000 - $2,000) NLTCL to offset $3,000 of ordinary income. Gordon’s carryforward of NLTCL is $4,000 [$9,000 − ($2,000 + $3,000)]. This amount is treated as a LTCL in subsequent years.

Question 13

Capital Losses Applied to Capital Gains

Answer 13

For example Leroy, whose tax rate is 32%, has NSTCL of $20,000, a $25,000 LTCG from the sale of a rare stamp held 16 months and an $18,000 LTCG from the sale of stock held for three years. The $20,000 NSTCL is offset against $20,000 of the collectibles gain in the 28% group. Leroy’s tax liability for his capital gain is $4,100 [($5,000 × 28%) + ($18,000 × 15%)].

Question 14

Tax Treatment for Net Capital Gain - the basis for their shares is increased by the amount of the gain they recognized but did not receive.

Answer 14

For example, Eunice, a single taxpayer with $400,000 of taxable income, whose marginal tax rate is 35%, is a shareholder of Canyon Mutual Fund. The basis for her shares is $23,000. At the end of the current year, she received a statement from Canyon indicating her share of the following: dividend income, $200; STCG, $300; 28-percent rate gain, $1,000; and ANCG of $1,500. The increase in her taxes as a result of her ownership of the mutual shares is $640 [($200 × 15%) + ($300 × 35%) + ($1,000 × 28%) + ($1,500 × 15%)]. The basis for her shares of Canyon Mutual Fund is $26,000 ($23,000 + $500 + $1,000 + $1,500). Note that Eunice’s income is less than $518,900 in 2024 therefore a 15% rate is used to calculate her ANCG.

Question 15

Holding Period - More than one year - LTCG

Answer 15

For example, Arnie purchased a capital asset on April 20, 2023, and sells the asset at a gain on April 21, 2024, the gain is classified as a long-term capital gain (LTCG). If the asset is sold on or before April 20, 2024, the gain is a short-term capital gain (STCG).

Question 16

Holding Period - Property Received as a Gift

Answer 16

For example, Cindy receives a capital asset as a gift from Marc on July 4, 2023, when the asset has a $4,000 FMV. Marc acquired the property on April 12, 2023, for $3,400. If Cindy sells the asset on or after April 13, 2024, any gain or loss is LTCG or LTCL. Cindy’s basis is the donor’s cost because the FMV of the property is higher than the donor’s basis on the date of the gift. Because Cindy takes Marc’s basis, Marc’s holding period is tacked on.

Question 17

Holding Period - Property Received from a Decedent

Answer 17

For example, the executor of Paul’s estate sells certain securities for $41,000 on September 2, 2023, which are valued in the estate at their FMV of $40,000 on June 5, 2023, the date of Paul’s death. The estate has a LTCG of $1,000 because the securities are considered to have been held long-term. The gain is taxed at 20%, 15% or 0%.

Question 18

Receipt of Nontaxable Stock Dividends or Rights

Answer 18

For example, as a result of owning Circle Corporation stock acquired three years ago, Paula receives nontaxable stock rights on June 5, 20XX. Any gain or loss on the sale of the rights is long-term, regardless of whether any basis is allocated to the rights, because the holding period of the rights includes the holding period of the stock. If Paula exercises the stock rights and receives shares of Circle Corporation stock, her holding period for the stock begins with the day she exercised the stock rights.

Question 19

Sale of a Residence - Sale of Principal Residence

Answer 19

For example, Maki, who is single and 35 years old, sells her principal residence that she purchased four years ago and realizes a $230,000 gain. Maki may exclude the entire gain regardless of her age or whether she purchases a new principal residence.

Question 20

Sale of a Residence - Determining the Realized Gain

Answer 20

For example, Kirby sells his personal residence, which has a $100,000 basis, to Maxine. To make the sale, Kirby pays a $7,000 sales commission and incurs $800 of legal costs. Maxine pays $30,000 cash and assumes Kirby’s $90,000 mortgage. The amount realized is $112,200 [($30,000 + $90,000) − ($7,000 + $800)]. The realized gain is $12,200 ($112,200 − $100,000).

Question 21

Sale of a Residence - Adjusted Basis of Residence

Answer 21

For example, in 1996 Susan paid $200,000 to purchase a new residence. She paid a realtor $4,000 to help locate the house and paid legal fees of $1,200 to make certain that the seller had legal title to the property. As a result of the purchase, she deferred a gain of $50,000 from the sale of a former residence in 1995. In 1997, she added a new porch to the house at a cost of $6,000 and installed central air conditioning at a cost of $5,200. Since purchasing the house, she has paid $1,500 for repairs. The adjusted basis of her house is $166,400 [$200,000 + $4,000 + $1,200 − $50,000 + $6,000 + $5,200].

Question 22

Sale of a Residence - Multiple Use of the Exclusions

Answer 22

For example, Krista, who has owned and used a house as her principal residence for the last seven years, marries Eric in January of 2023. Eric sold his residence in October of 2023 and excluded a $145,000 gain. Krista sells her residence in December of 2023 and realizes a gain of $378,000. She may exclude $250,000 of the gain. Assuming that Krista and Eric use her residence in the above example for a two-year period starting in January 2023, they could exclude up to $500,000 if she waits to sell the house until January 2025.

Question 23

Sale of a Residence - Principal Residence Defined

Answer 23

For example, Len, a 40-year-old college professor, owns and occupies a house in Oklahoma. During the summer, he lives in a cabin in Idaho. After owning the cabin for eight years, Len sells it for $50,000 and realizes a gain. Gain on the sale of the cabin in Idaho must be recognized because Len’s principal residence is in Oklahoma. Condominium apartments, houseboats and house-trailers may qualify as principal residences. Stock held by a tenant-stockholder in a cooperative housing corporation is a principal residence if the dwelling that the taxpayer is entitled to occupy as a stockholder is used as his or her principal residence.

Question 24

Sale of a Residence - Sale of More Than One Principal Residence

Answer 24

For example, Winnie, who is single, sold her principal residence in Detroit on November 1, 2023, and excluded the $127,000 gain because she owned and used the residence for two of the last five years. Winnie purchased another residence in Cleveland on October 1, 2023, that she occupies until June 12, 2024, when she receives a job offer from a new employer in Dallas. She sells the residence in Cleveland on November 15, 2024, and realizes a gain of $40,000. Winnie may exclude all of the gain because the sale of her Cleveland residence was due to a change in employment and (254/730) of $250,000 is more than the $40,000 realized gain. She owns and uses the residence in Cleveland for 254 days, and the period between the sale of the residence in Detroit and the sale in Cleveland is 378 days.

Question 25

Unforeseen Circumstances - Ownership and Use Tests

Answer 25

For example, Tim, a single taxpayer who purchased his home on March 1, 2023 for $500,000, recently became ill and sold his home in order to move closer to a relative who could care for him. Tim sold his principal residence on August 12, 2023, for $620,000, realizing a gain of $120,000. Because he owned and occupied the residence for 164 days and the sale was due to a change in his health, he may exclude $56,164 ($250,000 × 164/730).

Question 26

Unforeseen Circumstances - Involuntary Conversion of Principal Residence

Answer 26

For example, the Koch’s principal residence, with an adjusted basis of $200,000, has been used and owned by them for nine years. The house is destroyed by a hurricane and the Koch’s receive insurance proceeds of $820,000. Four months later, they purchase another residence for $900,000. The Koch’s have a realized gain of $620,000 and may exclude $500,000 under Section 121. The remaining $120,000 gain may be deferred and the basis of their replacement residence is $780,000 ($900,000 − $120,000).

Because the amount realized is reduced by the gain excluded, the Koch’s could have deferred the $120,000 gain in the above example by investing $320,000 in a replacement residence.

If gain due to the involuntary conversion of a principal residence is deferred under Section 1033, the holding period of the replacement residence includes the holding period of the converted property for purposes of satisfying the use and ownership tests of Section 121. The Koch’s satisfy the use and ownership requirements for Section 121 with respect to their new residence in the above example because gain is deferred under Section 1033.

Question 27

Unforeseen Circumstances - Presidentially Declared Disaster of Principal Residence

Answer 27

For example, Nora’s principal residence, with an adjusted basis of $70,000, was destroyed by a flood in May 2023. The area was declared by the President to be a federal disaster area. All the contents of her home, including a Steinway grand piano with a basis of $25,000 and a fair market value (FMV) of $30,000, were destroyed. Nora received the following payments from the insurance company in July 2023: $200,000 for the house, $25,000 for personal property contents with an adjusted basis of $15,000, and $30,000 for the piano, which was separately scheduled property in the insurance policy. The $10,000 ($25,000 − $15,000) gain on the unscheduled personal property is excluded from gross income. The $135,000 gain attributable to the house and the piano is excluded under Section 121.

Question 28

Tax Considerations of Sale of Principal Residence - Multiple Residences

Answer 28

For example, Paula, a business consultant, owns residences in Boston and Philadelphia. She plans to sell both residences in two years and purchase a new residence in California. The Boston residence has a fair market value (FMV) that is $200,000 greater than its basis. The residence in Philadelphia has not appreciated. Paula should plan her activities in a manner that will allow her to occupy the Boston residence more than the Philadelphia residence so the Boston residence will qualify as her principal residence and thus be eligible for the tax exclusion under Section 121.

Question 29

Tax Considerations of Sale of Principal Residence - Property Used as a Residence and for Business

Answer 29

For example, Kate purchased a house in 2005 for $200,000 and uses 15% of the house as an office. The office is used on a regular and exclusive basis and is her principal place of business. Depreciation of $3,400 has been deducted when she sells the house for net proceeds of $430,000. Her gain is $233,400 ($430,000 − $196,600), and she may exclude $230,000 but must recognize $3,400 of the gain.

Question 30

Special Disallowance Rules - Wash Sales

Answer 30

For example, Leslie realizes $10,000 in short-term capital gains (STCGs) through dealings in the stock market during the current year. Realizing that STCGs are fully includible in gross income unless they are offset against realized capital losses, Leslie analyzes her portfolio to determine whether she owns any stocks that have declined in value. She finds that the fair market value (FMV) of her Edison Corporation common stock is only $8,000, even though she originally purchased it for $16,000. Despite this paper loss on the stock, Leslie feels that Edison Corporation is still a good investment and wants to retain the stock. If Leslie attempts to take advantage of the paper loss on the Edison stock by selling the stock she owns and repurchasing a similar number of shares of Edison common stock within the 61-day period, the loss is disallowed.

Question 31

Special Disallowance Rules - Basis of Stock

Answer 31

For example, Ingrid enters into the following transactions with regard to Pacific Corporation common stock:
January 4, 2013 Purchases 600 shares $30,000
October 2, 2023 Purchases 400 shares $10,000
October 12, 2023 Sells original 600 shares $12,000
October 20, 2023 Purchases 200 shares $5,000
October 25, 2023 Purchases 300 shares $8,400

Because Ingrid purchases more than 600 shares within the 61-day period before and after the date of sale (the purchases made on October 2, 20 and 25), the entire loss of $18,000 ($30,000 − $12,000) is postponed. Four hundred shares (two-thirds of the number of shares sold) are purchased on October 2 and 200 shares (one-third) are purchased on October 20. Thus, the basis of the 400 shares of stock purchased on October 2 is $22,000 [$10,000 purchase price + ($18,000 disallowed loss × 0.667)]. The basis of the 200 shares of stock purchased on October 20 is $11,000 [$5,000 + ($18,000 disallowed loss × 0.333)]. Both of these blocks of stock have a holding period that starts on January 4, 2013.The basis of the 300 shares of stock purchased on October 25 is its purchase price of $8,400. Its holding period begins on October 25, 2023.

Question 32

Special Disallowance Rules - Related Parties Defined

Answer 32

For example, if a taxpayer does not own more than 50% of a corporation’s stock, the individual and the corporation are not related, and a loss on the sale of business or investment property between the two is deductible. Occasionally individuals might attempt to circumvent the related party rules by dispersing the ownership of a corporation (for example, among close family members) while retaining economic control. To prevent these tactics, Section 267 contains constructive ownership rules whereby a taxpayer is deemed to own stock owned by certain other persons.

Question 33

Special Disallowance Rules - Disallowed Losses

Answer 33

For example, assume three separate scenarios in which Sam sells a tract of land during the current year. In each case assume that Sam purchased the land from his father, Frank, for $10,000. Frank’s basis at the time of the original sale was $15,000 in each case. Thus, Frank’s $5,000 loss on each land sale was disallowed.

                                                                                     Scenario 1	Scenario 2	Scenario 3 Selling price	                                                                        $17,000	          $12,000	  $ 8,000 Minus: Sam's basis	                                                        (10,000)            (10,000)	  (10,000) Sam's realized gain (loss)	                                                $ 7,000	           $ 2,000	  $(2,000) Minus: Frank's disallowed loss (up to Sam's gain)	         (5,000)	           (2,000)	           0 Sam's recognized gain (loss)	                                        $2,000	           $0	                   $(2,000)

In Scenario 1, Sam and Frank together have incurred an aggregate gain of $2,000 ($17,000 − $15,000). Thus, Frank’s full disallowed loss reduces Sam’s subsequent gain. In Scenario 2, the aggregate economic loss incurred by Sam and Frank is actually $3,000 ($12,000 − $15,000). However, the actual amount of the tax loss recognized for Sam and Frank is zero. In Scenario 3, the actual tax loss would have been $7,000 ($8,000 − $15,000) instead of $2,000 if Frank had held the land until its eventual sale.

Question 34

Special Disallowance Rules - Unpaid Expenses

Answer 34

For example, Michelle owns 100% of the outstanding stock of Hill Corporation. Michelle is a cash method taxpayer and Hill Corporation is an accrual method taxpayer. Both taxpayers are calendar-year taxpayers. In a bona fide transaction, Hill borrows some funds from Michelle. By the end of the current year, $8,000 interest had accrued on the loan. However, Hill Corporation does not pay the interest to Michelle until February of the following year. Because Michelle is a cash method taxpayer, she reports the interest income when she receives it in the following year. Although Hill is an accrual method taxpayer, it must defer the deduction for the interest expense until it pays the interest in February of the following year. The results are the same if Hill Corporation is a personal service corporation and Michelle is an employee and owns any of the Hill stock.

Question 35

Special Disallowance Rules - Bargain Sales -Transaction may be partly a sale but also partly a gift.

Answer 35

For example, if Jones sells land with a fair market value of $500,000 and a basis of $50,000 to a public conservation charity for $200,000, what has occurred is a part sale and part gift. In this case, Jones would be treated as having sold the land, and must declare a gain of $150,000 ($200,000-$50,000). The remainder of the value is a gift to the charity with a zero basis.
The problem with this sort of sale or exchange is that no loss can be recognized in such a part sale—part gift transaction. If Jones had a basis of $250,000 in the land, he would have no gain since the basis exceeds the proceeds, but the $50,000 loss would not be declared.

Question 36

Special Disallowance Rules - Bargain Sales - A transaction may be a part sale and part compensation if an employer sells an employee an asset for less than its fair market value.

Answer 36

For example, ABC Corp. wishes to reward its CEO. For $7,000, the company sells him a company-owned automobile with a basis of $5,000 and a fair market value of $15,000. The results of this bargain sale are:
1. Deduction for the company of $8,000 for compensation paid to the CEO.
2. The CEO’s basis in the automobile is $15,000 ($7,000 he paid and the compensation of $8,000 on which he was taxed).