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2. 2 PROPERTY DISPOSITIONS Computation of gain or loss Character of taxable gains and losses Other property dispositions

3. 3 Computation of Gain or Loss Realized vs. recognized gains/losses Seller-financed sales Installment sales Disallowed losses on related party sales Disallowed losses on related party sales

4. 4 Realized vs. Recognized Gains/Losses Amount realized on disposition -Adjusted basis of property (e.g., cost - accum. depr.) = Realized gain or loss.  Realized gains and losses on disposition generally recognized (taxable t/a’s) unless there is a specific exception.  Unrealized gains and losses (no disposition) are neither realized nor recognized.

5. 5 Amount Realized Amount realized is the FMV of the total consideration received.  Cash received.  FMV of any property received, including note receivable from buyer.  Relief of debt (just like receiving cash).  Amount realized reduced by selling costs such as sales commissions.

6. 6 Adjusted Basis Cost +Capital improvements -Cost recovery Adjusted basis Exceptions  Gift basis - same as donor’s basis.  Property acquired from a decedent – FMV  Property acquired in nonrecognition transaction (see chapter 8).

7. 7 Seller-Financed Sales Seller generally includes principal amount of note as amount realized. Interest income on note recognized separately.  Timing of interest income recognition depends on sellers method of accounting.

8. 8 Installment Sales (§453) Installment method permits deferral of gain recognition until cash is received on the sale. Qualifying sales Installment sale limitations Computing gain recognized Interest on installment obligations is characterized as ordinary income.

9. 9 Qualifying Sales Qualifying sales  Taxpayer must receive at least one payment after the year of sale.  May elect out of installment treatment. Installment method only applies to gains, NOT losses.

10. 10 Installment Sale Limitations Limitations  Not allowed for inventory or securities traded on established markets.  All deferred gain must be recognized if installment note is transferred to another party.  Special limitations for related parties.

11. 11 Gross profit  Contract price =Gross profit % Pmts received xGross profit % = Gain recognized for current year Computing Gain Recognized (1 of 2) Sales price -Adjusted basis -Selling expenses -Depr. Recapture = Gross profit Sales price -Buyer assumed liabs +Mtg in excess of basis = Contract price

12. 12 Computing Gain Recognized (2 of 2) Additional amounts to be recognized in year of sale  Mortgage in excess of adjusted basis plus selling expenses.  Gross profit % will always be 100% if mtg. in excess of adjusted basis.  Portion of gain subject to depreciation recapture under §§1245 and 1250.

13. 13 Disallowed Losses on Related Party Sales §267 (1 of 4) Definition of related party:  Family - spouse, sibling, ancestors, lineal descendants  Corp. if t/p owns > 50% of corp.  Partnership if t/p owns > 50% of ptrshp.  Ownership of corp of partnership can be direct or indirect.  Definition of related party varies throughout Code.

14. 14 Disallowed Losses on Related Party Sales §267 (2 of 4) Losses realized on sale of property between related parties are NONdeductible. Future gain (but NOT loss) by related party can be offset by previously disallowed loss.

15. 15 Disallowed Losses on Related Party Sales §267 (3 of 4) Fawn has stock with a $5,000 basis. Fawn sells stock to brother, Robert for $3,000. Fawn can’t deduct $2,000 realized loss. Three assumptions based on Robert selling the stock to an unrelated party:  A1:Sales price = $8,000.  A2:Sales price = $4,000.  A3:Sales price = $2,500.

16. 16 Disallowed Losses on Related Party Sales §267 (4 of 4) A1A2A3 Amt. Realized (Basis) Gain(loss) realized Previously disallowed loss Gain (loss) recognized

17. 17 Character of Taxable Gains and Losses Capital asset defined. Overview of gain or loss. Taxation of capital losses. Taxation of capital gains. Dispositions of noncapital assets. Disposition of §1231 assets. Disposition of §1231 assets.

18. 18 Capital Asset Defined (§1221) Capital assets are everything except: 1. Inventory. 2. Accounts receivable. 3. Real or depreciable property used in a trade or business (this is §1231 property). 4. Self-created works e.g., copyright, compositions, artistic efforts. Exception: patents created by inventors are capital assets. 5. Certain U.S. government publications.

19. 19 Overview of Gain or Loss Ordinary Capital §1231 Depr. Recapture 1231 lookback net 1231 loss net 1231 gain Tax or deduct at ordinary rates. Net capital gains and losses: Individual may deduct $3,000 net loss. Net LT gain taxed at lower rates.

20. 20 Taxation of Capital Losses (1 of 2) Capital losses can only be deducted UP TO amount of net capital gain.  Excess of capital loss over capital gains  Individuals:  Can deduct $3,000 of net losses per year against ordinary income.  Carryforward excess indefinitely.  Capital loss carryovers retain their character (ST or LT)

21. 21 Taxation of Capital Losses (2 of 2)  Corporations:  NO deduction for net loss in current year.  Carry back 3 years and forward 5 years.  Capital loss carryovers are treated as short- term

22. 22 Taxation of Capital Gains (1 of 2) Individuals obtain preferential taxation if they have a net long-term (> 1 year) capital gains (NLTCG)  Generally 15% tax rate (see ch 15).  A net short-term capital gain (NSTCG) is taxed at ordinary tax rates. Corporations are taxed on a NLTCG at regular tax rates (max of 35%).

23. 23 Taxation of Capital Gains (2 of 2) Netting process 1. Combine all STCG with STCL to arrive at a net STCG or STCL. 2. Combine all LTCG with LTCL to arrive at a net LTCG or LTCL. 3. Combine LT and ST if possible. 1.If LT and ST are opposite sign (one is gain and other is a loss), net the two together. 2.If LT and ST are same sign (both either gains or losses), no further netting is done.

24. 24 Dispositions of Noncapital Assets Sales of inventory, A/R, and supplies result in ordinary income. Taxed at ordinary tax rates.

25. 25 Dispositions of §1231 Assets (1 of 2) Definition of §1231 asset  Real or depreciable property used in a trade or business. General rule: net §1231gains & losses  IF NET GAIN => add to capital gains and losses.  IF NET LOSS => add to ordinary gains & losses. Can offset salary, interest, etc.

26. 26 Dispositions of §1231 Assets (2 of 2) §1231 Lookback rule  Net §1231 gain treated as ordinary income to the extent of unrecaptured §1231 losses during the prior five years.  EXAMPLE: Start business in 1990.  1990 net 1231 gain $10 treated as capital.  1991 net 1231 loss ($15) treated as ordinary.  1992 net 1231 gain $23 treated as $15 ordinary (recapture 1991) and $8 capital.

27. 27 Depreciation Recapture (§§1245, 1250, 291) (1 of 4) Gain on each separate §1231 asset may be subject to depreciation recapture.  Depreciation recapture does NOT apply if the asset is sold at a loss.  Depreciation recapture only affects the character of the gain, not the amount. Depreciation recapture recharacterizes §1231 gain as ordinary income.

28. 28 Depreciation Recapture (§§1245, 1250, 291) (2 of 4) §1245 recapture – applies to sales of depreciable personalty and amortizable intangibles Gain is characterized as ordinary up to the amount of accumulated depreciation.

29. 29 Depreciation Recapture (§§1245, 1250, 291) (3 of 4) Realty: individuals treat lesser of gain or depreciation previously deducted as a capital gain.  Gain subject to a special 25% tax rate - see chapter 15.  §1250 recapture – applies to sales of depreciable realty that was depreciated using ACRS  Property placed in service prior to 1986.

30. 30 Depreciation Recapture (§§1245, 1250, 291) (4 of 4) §291 recapture –  Only applies to corporations.  Applies to depreciable realty.  20% of gain that would be subject to §1245 recapture (portion of gain attributable to basis depreciated) if asset were §1245 property (tangible personal property).

31. 31 Other Property Dispositions (1 of 3) Abandonment & worthlessness  Abandonment loss generally ordinary.  Deduction equals adjusted basis.  Exception for worthless securities:  Worthless securities treated as sold on last day of the year for $0.  Exception for affiliated corporation: Securities in an  80% controlled domestic subsidiary treated as a noncapital asset.

32. 32 Other Property Dispositions (2 of 3) Foreclosures  Recourse debt.  Treat as if property sold on date of foreclosure for FMV.  Any additional debt forgiveness is ordinary income.  Nonrecourse debt.  Treat as if property sold date of foreclosure for face value of mortgage.

33. 33 Other Property Dispositions (3 of 3) Business casualty and theft  Amount realized = insurance proceeds, if any.  Deduct the unrecovered basis. Loss is ordinary. Gain depends on character of property. See Ch. 8 for possible gain deferral.

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