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MODULE 19 Computing Gain or Loss on Disposition of Assets
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Menu 1. Computing gains and losses 2. Basis considerations 3. Installment sales
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Computing Gains and Losses Key Learning Objectives The gains and (losses) formula Applicable law Amount realized Adjusted basis
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The Gains and (Losses) Formula Sales price Sales price -Selling expenses Amount realized -Adjusted basis Realized gain (loss) -Deferred gain (loss) Recognized gain (loss)
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Applicable Law n The gain or loss from the sale of property u Determined by the law in force at the date of sale n Depreciation adjustments reduce basis u Determined by the law in force at the time the property is acquired
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Amount Realized n Sum of u Any money received u Plus FMV of property received u Less any selling expenses
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Uncovered Cost of the Asset Adjusted Basis Uncovered Cost of the Asset n Original cost basis n Minus cost recoveries n Plus improvements
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Basis Considerations Key Learning Objectives n n Recovery of capital doctrine n n Determining cost basis n n Cost basis factors n n Gift basis n n Property acquired from decedent n n Property converted from personal use
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Adjusted Basis Determined by n How acquired u Purchase u Gift u Inherited
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Basis Determined by Purchase n Purchase u Cash/FMV of property received u Debt assumption u Non-deductible improvements
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Basis Determined by Gift n Note: D= doner; D'e = donee; Date of gift = DOG n General rule if FMV > basis at DOG u Use D's basis and u Adjust for gift taxes n If FMV < basis at DOG see special rules
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Adjustment for Gift Taxes Paid Basis Determined by Gift Adjustment for Gift Taxes Paid n D = doner; D'e = donee; DOG = date of gift n Gift taxes are paid by D n Gift taxes are based on FMV at DOG n Adjustment to D’e basis only if u FMV > basis at DOG n D’e gets gift taxes relating to appreciation [FMV- basis] FMV FMV
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In Class Exercise: Adding Gift Taxes to Basis n D = doner; D'e = donee; DOG = date of gift n At DOG FMV = $17,000 n D’s basis = 13,500 n Gift tax = 2,000 n Calculate D’e basis
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Solution--In Class Exercise: Adding Gift Taxes to Basis n Property is appreciated at DOG n So start with adjusted basis of $13,500 n Add % of gift taxes relating to appreciation u $412 n Gift taxes x (FMV - AB) ÷ FMV n $2,000 x ($17,000 - $13,500) ÷ $17,000 n Total basis to D'e = $13,912 ( $13,500+$412 )
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FMV < Basis at DOG Basis Determined by Gift FMV < Basis at DOG n n D = doner; D'e = donee; DOG = date of gift n n No adjustment for gift taxes n n Basis (AB) determined when D’e sells n n If used by D’e and subject to depreciation, use FMV at DOG
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FMV < Basis at DOG Basis Determined by Gift FMV < Basis at DOG n D= doner; D'e = donee; DOG = date of gift n Sold for u > D's basis then AB = D's basis u < FMV at DOG then AB = FMV at DOG u FMV at DOG F AB = Amount realized F No gain/loss recognized to D’e
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FMV < Basis at DOG In Class Exercise: Gift Basis FMV < Basis at DOG n D = doner; D'e = donee; DOG = date of gift n At DOG: AB = $12,000 FMV = $10,000 n D’e sells at a later date for: Case A B C Case A B C AR = $13,000 $11,000 $9,000 AR = $13,000 $11,000 $9,000 n What is adjusted basis in each case? n What is total gain realized?
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FMV < Basis at DOG In Class Exercise: Gift Basis FMV < Basis at DOG n At DOG: AB = $12,000 FMV = $10,000 CaseAB C CaseAB C AR = $13,000 $11,000 $ 9,000 AR = $13,000 $11,000 $ 9,000 AB = 12,000 11,000 10,000 GL = $ 1,000 0 (1,000) n Note that you would plug any basis for AR between $10,000 and $12,000
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Conversion From Personal Use n Follow rules similar to gift rules u If FMV > A/B use A/B u If FMV < A/B use FMV
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In Class Exercise: Conversion from Personal Use n John has an automobile used 100% for personal purposes for two years n He converts it to 100% business use when n A/B = $16,000FMV = $8,500 n What is John’s basis for business purposes?
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Solutions: In Class Exercise: Conversion from Personal Use n He converts it to 100% business use when n A/B = $16,000FMV = $8,500 n John uses $8,500 since FMV is lower than A/B when the property is converted n The $7,500 decline in value is considered to be a non-deductible personal expenditure
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Basis Determined by Inheritance n Use value reported on estate’s tax return n Generally FMV at date of death (DOD) n Estate may choose to use alternative valuation date u FMV 6 months after DOD
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Installment Sales Key Learning Objectives n n Eligible sales n n Ineligible sales n n Mandatory reporting n n Gain reported n n Problem areas
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Installment Sale n At least one payment is received after the close of the tax year in which the disposition of the asset occurs
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Ineligible Sales n Dealer disposition of property held for sale to customers n Gains relating of the recapture provisions of §1245 and §1250 n Stock or securities traded on an established securities market n Property of any kind regularly traded on an established market
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Mandatory Reporting Unless Election Out n Any sale that is covered by the definition of an “installment sale” n Must elect out of the installment method to avoid n Election out attached to a timely tax return n Entire gain included in income for the taxable year
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Consequences of Electing Out of Installment Method n Cash basis amount realized u Money and FMV of property n Accrual basis amount realized u Money and FMV of property u Face value of any obligation received
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Installment Method Gain Reported As Cash Collected n Gross profit = A/R - A/B n Gross profit percentage = Gross profit ÷ total contract price Gross profit ÷ total contract price n Gain recognized = Gross profit percentage x am’t received Gross profit percentage x am’t received n Ratio applied to payments received in the current period
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In Class Exercise: Gain Reported on Installment Sale n Mary agrees to sell for $500,000 n Land for which she paid $300,000 n She will receive $100,000 a year for 5 years n Interest will be paid at the required rate n How much gain will she recognize each year ?
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Solution: In Class Exercise: Gain Reported on Installment Sale n Gross profit = A/R - A/B n $200,000 = $500,000 -300,000 n Gross profit percentage = gross profit ÷ total contract price gross profit ÷ total contract price n 40% = $200,000 ÷ $500,000
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Solution: In Class Exercise: Gain Reported On Installment Sale n Gross profit percentage = 40% n Amount received each year = $100,000 n Gain recognized each year = $40,000 Gross profit percentage x am’t received Gross profit percentage x am’t received 40% x $100,000 40% x $100,000 n Total gain recognized is $200,000 u $40,000 x 5
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In Class Exercise: Gain Reported on Installment Sale & §1250 n Gains associated with depreciation cannot be deferred through an installment sale n How would Mary’s gain recognition change if the property she sold was a building AND n $50,000 of the gain is §1250 recapture?
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Solution: In Class Exercise: Gain Reported on Installment & §1250 n Gross profit = A/R - A/B n $200,000 = $500,000 -$300,000 n BUT $50,000 is recognized immediately so gross profit is reduced to $150,000 n Gross profit percentage = Gross profit ÷ total contract price Gross profit ÷ total contract price n 30% = $150,000 ÷ $500,000
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Solution: In Class Exercise: Gain Reported On Installment & §1250 n Gross profit percentage = 30% n Amount received each year = 100,000 n Gain recognized each year = 30,000 Gross profit percentage x am’t received Gross profit percentage x am’t received 30% x $100,000 30% x $100,000 n Total gain recognized is $200,000 u $30,000 x 5 + $50,000
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Installment Method Problem Area: Imputed Interest n If the contract does not specify an interest rate equal to the applicable federal rate n Then interest will be imputed at that rate
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Problem Area-- Related Party Sales n Sale between related parties u Spouses, children, grandchildren, and parents u Controlled corporation, partnership, trust, estate n Normal rules apply, unless u Property is depreciable or u Purchaser resells the property before payment of the original sales price n Rules can be avoided if the taxpayer can establish (to the Secretary’s satisfaction) that tax avoidance was not the motive for the transaction
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Transferring an Installment Obligation n Sale, gift, or other transfer of the installment obligation n Unreported gain may be reported at the time of transfer n Difference between u Basis in the obligation and u Amount realized n Fair market value of the obligation
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Basis in Obligation n Excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full
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Interest on Deferred Taxes n Require the taxpayer to pay interest n Only required if the sales price of the property exceeds $150,000 n Obligations from all such sales that arise during and are outstanding at the end of the tax year exceed $5,000,000 n Gains associated in excess of $5,000,000
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