1. Chapter 8 Capital Gains and Losses Income Tax Fundamentals 2011 Gerald E. Whittenburg & Martha Altus-Buller Student’s Copy 2011 Cengage Learning

2. Define a Capital Asset 2011 Cengage Learning A capital asset is any asset other than inventory, receivables, copyrights, certain U.S. Government publications and depreciable or real property used in a trade or business. Capital assets are defined by exception

3. Capital Gains and Losses  Sale/exchange of capital asset results in a capital gain or loss °Although not defined precisely – “sale” is receipt of cash or release of debt and “exchange” requires transfer of ownership ◦ Capital gains and losses receive special tax treatment ◦ Tax treatment based on length of time property has been owned 2011 Cengage Learning

4. Realized Gains/Losses vs. Recognized Gains/Losses Amount realized* less:Adjusted basis of property* Realized gain (loss) less:Allowed gain deferral* Recognized gain (loss ) * Models for these items are found on the next slides 2011 Cengage Learning Realization of gain or loss requires the “sale or exchange” of an asset.

5. Amount Realized Amount Realized = Gross sales price - Selling expenses  Gross sales price is the amount received by the seller from the buyer ° Cash and fair market value (FMV) of property received plus ° Seller’s liability assumed by or paid for by the buyer ° Less selling expenses (costs paid to transfer property) 2011 Cengage Learning

6. Adjusted Basis Original cost plus: Capital improvements* less: Accumulated depreciation Adjusted basis *Items that significantly result in increase to property value or increased useful life 2011 Cengage Learning

7. Net Capital Gains  There are complex capital gain rules based on type of capital gain  Study the table “Capital Gains & Applicable Tax Rates” in Section 8.4 and note the following: ◦ Short-term capital gains are taxed at ordinary income rates ◦ Long-term capital gains are taxed at preferred rates, (see next slide) depending on which bracket a taxpayer is normally in ◦ Unrecaptured §1250 gain has differing rates, depending on which bracket a taxpayer is normally in 2011 Cengage Learning

8. Net Capital Losses  Note that net capital losses (short-term and long-term) limited to $3,000/year with an indefinite carry forward  Must maintain ‘nature’ of capital loss (i.e. – short-term or long-term) when carrying it forward ° In subsequent years, must deduct STCL first Note: Must comply with ordering rules 2011 Cengage Learning

9. Section 1231 Assets  §1231 assets are not capital assets, but they are given special tax treatment  Asset must be held > 12 months and used in a trade or business and include: ◦ Depreciable real or personal property used in trade or business ◦ Timber, coal, or domestic iron ore ◦ Livestock (not poultry) held for certain purposes ◦ Unharvested crops on land used in trade 2011 Cengage Learning

10. Depreciation Recapture 2011 Cengage Learning  Prevents taxpayers from receiving the dual benefits of a depreciation deduction and capital gain treatment upon sale of the asset ◦ Requires gains to be treated as ordinary to the extent of prior depreciation deductions  §1245 recapture  §1250 recapture  “Unrecaptured depreciation” previously taken on real estate taxed at 25%

11. Casualty Gains & Losses: Personal  Casualty loss is the lesser of ◦ Property’s adjusted basis or ◦ Decline in the value of the property (repair cost) ◦ Deductible loss is reduced by  Insurance proceeds received  $500 floor (per event)  10% of AGI per year ◦ Shown as itemized deduction on Schedule A  Casualty gain occurs when insurance reimbursement > adjusted basis of property 2011 Cengage Learning

12. Casualty Gains & Losses: Business  Business casualty and theft losses result from damage caused by a sudden, unexpected and/or unusual event ◦ For property fully destroyed, deduct adjusted basis ◦ For property partially destroyed, deduct the lesser of the property’s adjusted basis or the decline in the value  Any insurance reimbursement reduces loss  May cause gain 2011 Cengage Learning

13. Installment Sales - Form 6252  An installment sale occurs when ◦ Real or personal property or business/rental property is sold and ◦ Note is signed and payments are collected over time  Congress allows taxable gain to be reported as cash received, not when sale completed ◦ However, can elect to report all the gain in the year of sale  Otherwise, use Form 6252, Installment Sale Income ◦ Must recapture any §1245 or §1250 first ◦ Then calculate gross profit percentage ◦ Then multiply percentage by cash received each year 2011 Cengage Learning

14. §1031 Like-Kind Exchanges  No gain/loss recognized when an exchange of like- kind property occurs (deferred gain/loss) ◦ Like-kind property transactions occur when  Exchanging real property for real property or  Exchanging personal property for personal property of the same asset class ◦ Rules only apply to business or investment property  May have some recognized gain if “boot” is received ◦ Boot is defined as cas h received in an exchange or any property (inventory, stocks, bonds, or other securities) that is not like-kind 2011 Cengage Learning