1. Chapter 5
Property Transactions:
Capital Gains and Losses 1

2. Learning Objectives
Determine the realized gain or loss from the sale or other disposition of property
Determine the amount realized from the sale or other disposition of property
Determine the basis of property 2

3. Learning Objectives
Distinguish between capital assets and other assets
Understand how capital gains and losses affect taxable income
Recognize when a sale or exchange has occurred
Determine the holding period for an asset when a sale or disposition occurs

4. Determination Of Gain Or Loss
Realized gain or loss
Amount realized $ less the assets’ adjusted basis 3

5. Determination Of Gains And Losses
Amount realized consists of money and FMV of property received plus taxpayer’s debt assumed by the buyer less costs of sale 4

6. Determination Of Basis
Original basis (Cost)
+ plus additions (i.e., Capital improvements)
less reductions (i.e., Depreciation)
= Adjusted basis 5

7. Recognized Gain Or Loss
The amount of recognized gain or loss on disposition may be less than the realized gain or loss due to special statutory provisions
Like-kind exchange rules
Involuntary conversions rules 6

8. Basis Considerations
In most cases the cost of acquired property is the basis. 7

9. Basis Considerations Original cost basis includes
Cash
FMV of other property
Debt
Transactional cost
Uniform capitalization rules are mandated for inventory 8

10. Basis Considerations
Construction period interest and taxes must be capitalized for certain “ long useful life” property
Homogenous property
Specific identification may not be possible
Tax law requires a FIFO approach 9

11. Property Received As A Gift After 1921
Donee’s adjusted basis for gain is donor’s basis plus a gift tax adjustment
The donee’s adjusted basis for loss is the lesser of the gain basis or FMV at the date of gift
The gain basis is used for calculating any depreciation
The amount of depreciation is subtracted from applicable gain basis or loss basis in the event of disposition 10

12. Property Received From A Decedent
Basis of inherited property
FMV at date of death, or
Alternate valuation date (AVD)
Six months from date of death or
Disposition date if not held for six month 11

13. Property Converted From Personal Use To Business Use
Basis is the lower of the personal use adjusted basis or the property’s FMV at conversion 12

14. Allocation Of Basis
If multiple assets are acquired for a single purchase price, the acquisition cost must be allocated to individual assets on the basis of their FMV
See example in textbook on page 5-10. 13

15. Definition Of Capital Assets
For tax purposes capital assets are defined as assets other than inventory, depreciable property, or real property used in a trade or business 14

16. Definition Of A Capital Asset
Influence of the courts
Corn Products Refining CO
Arkansas Best Corporation 15

17. Other Code Provisions Relevant To Capital Gains And Losses
Dealers usually treat securities as inventory
Non-business bad debts are treated as short-term capital losses
Certain taxpayers can subdivide land and sell a limited number of lots and retain capital gain treatment 16

18. Tax Treatment For Capital Gains And Losses Of Non-corporate Taxpayers
Net capital gains result when net long-term capital gains exceed net short-term capital losses
Capital losses
Net capital losses offset ordinary income to a $3,000 maximum, with an unlimited carryover to future years 17

19. Long Term Capital Assets
Capital assets held for more than 12 months.
Tax rate for Net Capital Gains may be taxed
5%, 15%, 25%, 28%
Be sure to read this section in the carefully. 18

20. Sale Or Exchange Worthless securities
Securities that become totally worthless in a tax year are treated as a capital loss on the last day of the year 19

21. Sale or Exchange Retirement of Debt Instruments Options Patents
Franchises, Trademarks and Trade Names
Lease Cancellation Payments

22. Holding Period
Holding period for long-term treatment is more than 12 months
Holding period of more than 5 years
After December 31, 2000
Maximum rate is 18% (8% for taxpayers whose tax rate is 15%)

23. Holding Period Property received as a gift
If the donee’s adjusted basis is determined by reference to the donor’s adjusted basis, the donor’s holding period is added to the donee’s holding period
If the donee’s adjusted basis is the FMV at date of gift, the holding period begins on the day after the date of gift 20

24. Holding Period
Property received from a decedent is always subject to a long-term holding period
Non-taxable exchanges
Property given in a tax-free exchange is added to the holding period of the property received in the exchange
Non-taxable stock dividends and stock rights
Generally includes the holding period of the underlying stock 21

25. Justification for Preferential Treatment of Net Capital Gains
Mobility of capital
Mitigation of the effects of inflation and the progressive tax system
Lower the cost of capital

26. Tax Planning Considerations
Selection of property to transfer by gift
Decision may be influenced by annual exclusion
Unwise to gift depreciated property
Selection of property to transfer at time of death
Highly appreciated property should be retained until death
Loss property should be sold before death 22

27. Compliance and Procedural Considerations
Capital gains and losses are reported by individuals on Schedule D
To improve taxpayer compliance, every broker is required to furnish the government with information pertaining to each customer.
This is reported to the taxpayer on Form 1099-B.
Taxpayer must use Schedule D to reconcile amounts shown on Form 1099-B