Property Transactions

Browne, a self-employed taxpayer, has 2015 business net income of $15,000 prior to any expense deduction for equipment purchases. In 2015, Browne purchases and places into service, for business use, office machinery costing $20,000. This is Browne's only 2015 capital expenditure. Browne's business establishment is not in an economically distressed area. Browne makes a proper and timely expense election to deduct the maximum amount (assumed to be $25,000 ignoring bonus depreciation). Browne is not a member of any pass-through entity. What is Browne's deduction under the election?

$15,000 Property purchased for use in active trade or business is considered Code-Section 1245 property. Code-Section 1245 property is eligible for the Code-Section 179 election. Under this election, taxpayers may expense a statutory amount of the cost of property used by the taxpayers in active trade or business. The statutory amount is $25,000 for 2015. The Code-Section 179 deduction is limited to the amount of taxable income originating from the trade or business in which the property is used and is reduced dollar-for-dollar when the taxpayer places qualifying tangible personal property in service that exceeds $200,000. Since Browne purchases the equipment for use in business, the property qualifies as Code-Section 1245 property and, therefore, is eligible for the Code-Section 179 deduction. Browne's income could limit the amount of the deduction, because the statutory amount, $25,000, is more than Browne's business income of $15,000. Hence, Browne may elect under Code Section 179 to deduct $15,000. The remaining $5,000 of the cost of $20,000 can be carried over to future years.

What is the ordinary loss deduction limit on sale of a worthless small business stock?

$50,000 ($100,000 MFJ)

The results of UNA Corp's first six years of operations are presented below: Y1: Sec 1231 losses of $50,000 Y2: Sec 1231 losses of $30,000 Y3: Sec 1231 gains of $75,000 Y4: Sec 1231 losses of $20,000 Y5: Sec 1231 losses of $30,000 Y6: Sec 1231 gain of $80,000 UNA Corp's year six Sec 1231 gain can best be characterized as...

$55,000 ordinary income; $25,000 Sec 1231 gain The lookback provision states that the net Sec 1231 gains must be offset by net Sec 1231 losses from the five preceding tax years that have not previously been recaptured. To the extent of these losses, the net Sec 1231 gain is treated as ordinary income. The $75,000 gain in Y3 was recaptured as ordinary income by $50,000 of Y1 loss and $25,000 of the Y2 loss. Note that $5,000 of the Y2 loss remains unrecaptured. The $80,000 gain is recaptured as ordinary income to the extent of the $5,000 remaining Y2 loss, $20,000 Y4 loss, and $30,000 Y5 loss for a total of $55,000. The remaining $25,000 gain is treated as a Sec 1231 gain.

Decker sold equipment for $200,000. The equipment was purchased for $160,000 and had accumulated depreciation of $60,000. What amount is reported as ordinary income under Code Sec. 1245?

$60,000 Amount Realized $200,000 Adj Basis ($160,000-$60,000) = $100,000 Recognized Gain $100,000 Personalty is subject to the Sec 1245 depreciation recapture rules which indicate that gain will be taxed as ordinary income up to the amount of depreciation claimed on the property. Since there was $60,000 of depreciation on the equipment, $60,000 of the gain is taxed as ordinary income and the remaining $40,000 is taxed as Sec 1231 gain.

What are the key differences between like-kind exchange and involuntary conversion rules?

- Like-kind exchange rules are mandatory but involuntary conversion rules are elective. - Like-kind exchange rules apply to gains and losses but involuntary conversion rules apply only to gains. - Type of replacement property under involuntary conversion rules is narrower than like-kind property.

Amount realized includes...

- cash received - FMV of any property received - liabilities assumed by buyer - less selling expenses

Describe Section 1231 netting

- to the extent Section 1231 gains exceed 1231 losses, the net gain is treated as long-term capital gain (subject to a lookback limit for losses during the previous 5 years). - the lookback provision states that the net Section 1231 gains must be offset by net Section 1231 losses from the five preceding tax years that have not previously been recaptured - if Section 1231 losses exceed Section 1231 gains, the loss is deductible as an ordinary loss.

What are the 2 limitations on Section 179 deduction?

1) annual limit is reduced dollar-for-dollar for personalty placed in service during the year that exceeds a threshold. The reduction does not create a carryforward to future tax years. 2) the Sec 179 expense cannot exceed taxable income from the business. Any excess is carried forward to future taxable years.

List the qualifying property for like-kind exchanges.

1) business or investment property; 2) not inventory or receivables; 3) must be "like-kind"

Describe the business use test for listed property.

1) business use must exceed 50% of total use; 2) business use is limited to use in the trade or for the convenience of the employer; 3) failure to meet business use means cost recovery limited to straight line; 4) but note that business and investment use can be depreciated

How can corporations use their capital loss deduction?

1) can only use capital losses to offset capital gains net income; no deduction for net capital losses 2) unused losses are carried back 3 years and forward 5 years

List the characteristics of ordinary loss deduction on sale of worthless small business stock

1) corporation issued stock for less than $1 million 2) corporation must conduct an active business 3) taxpayer received stock from corporation in initial offering

Describe the elements of the net capital loss deduction for individuals

1) deductible up to $3,000 per year 2) for AGI 3) also limited to taxable income 4) excess loss carries forward; no limit on carryforward period

List the requirements for deferral due to involuntary conversion

1) disposition qualifies as involuntary conversion; 2) must replace property with property similar or related in service or use; 3) must be made within two years from end of tax year of conversion (three years in the case of condemnation or threat of condemnation of real property held for productive use in a trade or business or for investment); 4) any proceeds not reinvested in qualifying property create gain

What are the requirements for the $250,000 exclusion on sale of a residence rule?

1) frequency test; 2) ownership test; 3) use test

How does one determine the basis of gifts?

1) gain basis = donor's adjusted basis 2) loss basis = lower of gain basis or FMV 3) depreciable basis = gain basis The basis is increased for the portionof any gift tax paid by the donor due to appreciation in the property: adj = (unrealized appreciation / FMV @ gift date - annual exclusion) * gift tax paid

What are the 3 asset classifications?

1) ordinary 2) capital 3) section 1231 classifications are mutually exclusive

What are the 5 fundamental items to know for every property transaction?

1) realized gain or loss 2) recognized gain or loss 3) character of gain or loss 4) holding period of retained asset (could be zero) 5) basis in retained asset, if any (could be zero)

List the qualified small business stock exclusion of gain requirements.

1) stock held for > 5 years after initial issuance; 2) stock from active corporation with assets less than $50 million

On January 1, Fast, Inc. entered into a covenant not to compete with Swift, Inc. for a period of five years, with an option by Swift to extend it to seven years. What is the amortization period of the covenant for tax purposes?

15 years

Describe MACRS for personalty

200% declining-balance method with half-year convention; taxpayer gets one-half year depreciation in the year of acquisition and one-half year in the year of disposal 5-year property: trucks, automobiles, computers, machinery and equipment 7-year property: office furniture and fixtures

What is the maximum tax rate for gain attributable to depreciation claimed on real estate for an individual?

25% for straight line depreciation recapture

What is the class life for realty?

39 years for nonresidential; 27 1/2 years for residential

What is the period of time that lookback rules apply to Section 1231 gains?

5 years

What is the percentage of qualified small business exclusion of stock gain?

50% (increased to higher levels for certain temporary periods)

Under what circumstances must a convention other than the mid-year convention be used for all personalty?

A mid-quarter convention is used for all personalty if more than 40% of personalty is purchased in last quarter of the year.

What is the gain on the sale of residence exclusion rule?

A taxpayer may exclude gains up to $250,000 ($500,000 join return) on the sale of residence.

Is realty considered like-kind property?

All realty is considered to be like-kind; so land is like-kind with a building

How do you calculate a gain/loss on a property sale/disposition?

Amount Realized < Adjusted Basis > --------------------------- Realized Gain/Loss

Define "listed property"

Assets, such as computer and vehicles (but not cell phones), that are commonly used for business and personal purposes.

Who is considered to be a related party for individuals for the loss disallowance rule?

Brother, sister, spouse, ancestors, and descendants.

Most other types of property, including property held for investment use and personal use

Capital Assets

TP has net short-term capital loss of $20,000. He has also realized a net long-term gain of $50,000 comprised of the following net gains & losses: - $10,000 gain on sale of coins held 3 years - $25,000 gain on sale of securities held 3 years - $15,000 gain on sale of realty (attributable to depreciation)

Capital loss $20,000 gain on coins (28% rate) <$10,000> -> $0 gain on sale of realty (25% rate) <$10,000> -> $5,000 gain on sale of securities (15% rate) <$0> -> $25,000 *net $30,000 gain = $5,000 taxed at 25% & $25,000 taxed at 15%

Mr. Monopoly, a corporation, sold equipment used in his business for $11,000. The equipment cost $10,000 and Monopoly had properly claimed MACRS deductions totaling $4,000. Straight-line depreciation, if it had been used, would have been $2,500. What is the amount of gain that should be reported under Sec. 1231 and 1250 for this corporation?

Corporation Solution: Amount Realized $11,000 Adjusted Basis $10,000 - $4,000 = $6,000 Realized/Recognized Gain $5,000 Sec 1250 = $4,000 - $2,500 = $1,500 excess Sec 291 = - Sec 1245 $4,000 - Sec 1250 <$1,500> $2,500 x 20% $ 500 OI Sec 1231 Gain = $3,000

What is the adjusted basis of replacement property after involuntary conversion?

Cost reduced by any deferred gain.

What depreciation is subject to recapture under Section 1250?

Excess depreciation (depreciation claimed over straight-line). Section 1250 = Realty (land and assets permanently attached to land)

How does one determine the basis of inheritances?

FMV on date of death or alternate date (as selected by the executor of the estate) Alt valuation date = 6 mos from date of death

25% Recapture Rate

For Sec 1250 property, the portion of the gain that would be recaptured if all depreciation taken was subject to recapture under Sec 1245 over the regular Sec 1250 recapture is taxed at 25% rather than as a Section 1231 gain. The amount subject to the 25% rate is usually the straight-line depreciation on the asset.

Does the holding period of the donor/decedent carryover to the new owner for gifts/inheritances?

Gifts: - if property is sold for a gain, the holding period carries over - if property is sold for a loss, the holding period does not carry over Inheritances: - holding period is always long-term

What is the net capital loss limit for individuals?

Loss limit is $3,000

How are losses and gains recognized for like-kind exchanges?

Losses are never recognized Gains are the lesser of: 1) realized gain, or 2) boot received Boot is any non-like kind property received as part of the exchange. Liabilities assumed by the other party to the exchange are considered boot

Describe the wash-sale rule

Losses from the sale of securities are not recognized if similar securities are purchased 30 days before or after the sale.

Define "long-term holding period"

More than 1 year

Depreciable property used in a trade/business and realty that have been owned for a year or less

Ordinary Assets

Inventory and Accounts Receivable

Ordinary Assets

Define "Section 1245 property"

Personalty - All property other than land and buildings (or realty)

Define "section 1231 assets"

Realty and depreciable property used in a trade or business owned more than one year.

Section 1250 Recapture - Differences for Corporations

Rules are the same as for individuals, except: 1) straight-line depreciation is not taxed at a 25% rate 2) rather, additional depreciation is recaptured to the extent of 20% multiplied by: - Recapture if the property was Sec 1245 property - Less: Sec 1250 depreciation recapture - this additional amount is Sec 291 recapture

Define "wash sale"

Sale of a security at a loss and repurchase of the same or substantially identical shortly after or before (30 days typically) no gain/loss computed on those shares

Mr. Monopoly sold equipment used in his business for $11,000. The equipment cost $10,000 and Monopoly had properly claimed MACRS deductions totaling $4,000. Straight-line depreciation, if it had been used, would have been $2,500. What is the amount of gain that should be reported under Sec. 1231 and 1245?

Sec 1245 Solution: Amount Realized $11,000 Adjusted Basis $10,000 - $4,000 = $6,000 Realized/Recognized Gain $5,000 Sec 1245 ordinary income (deprecation claimed) = $4,000 Remaining $1,000 = Sec 1231 gain

Mr. Monopoly sold equipment used in his business for $11,000. The equipment cost $10,000 and Monopoly had properly claimed MACRS deductions totaling $4,000. Straight-line depreciation, if it had been used, would have been $2,500. What is the amount of gain that should be reported under Sec. 1231 and 1250?

Sec 1250 Solution: Amount Realized $11,000 Adjusted Basis $10,000 - $4,000 = $6,000 Realized/Recognized Gain $5,000 Sec 1250 = $4,000 - $2,500 = $1,500 excess 25% Gain = $2,500 Sec 1231 Gain = $1,000

Depreciable property used in a trade/business and realty that have been owned for more than a year

Section 1231 assets

At his death, Randy's principal residence was valued at $400,000 (basis of $350,000). Karen & Randy had joint ownership as a tenancy by the entirety for 5 years. What basis does Karen have in the principal residence?

Since the property is jointly owned by Randy & Karen, each is deemed to have a basis of $175,000 ($350,000 / 2) in one-half of the property. When Karen is bequested Randy's 1/2 of the property, she receives a basis equal to FMV of $200,000 ($400,000 / 2). Thus her total basis is $375,000.

Describe MACRS for realty

Straight line depreciation with mid-month convention; taxpayer gets one-half month depreciation in the month of acquisition and one-half month in the month of disposal Residential realty = 27.5 years Nonresidential realty = 39 years

What types of assets are eligible for Sec 179 expensing

Tangible personalty used in a trade or business

Define "return on capital"

The cost of goods or property sold is recovered before any gain is realized.

What is the depreciation method for personalty under MACRS?

The depreciation method is double declining balance.

What is the depreciation method for realty under MACRS?

The depreciation method is straight-line.

Describe the principal residence frequency test

The exclusion is available no more frequently than every 2 years; limited exceptions

What is the general convention for realty under MACRS?

The general convention is mid-month.

What is the general convention for personalty under the Modified Accelerated Cost Recovery System (MACRS)?

The general convention is mid-year.

What is the replacement period for involuntary conversions (except for condemned-business realty)?

The replacement must be made within two years from END of tax year in which the gain is realized.

Describe the principal residence-use test.

The residence is used by taxpayer as a principal residence for at least two of the preceding five years.

Define "involuntary conversion"

The result of a casualty (an unexpected unavoidable outside influence like a storm, fire, shipwreck, a theft, or a condemnation).

Describe the principal residence-ownership test.

The taxpayer must have owned the residence for at least two of the preceding five years. For marital exclusion both must have used the residence but only one had to own it.

Lucas is married and owns Video Productions Company, which began operations in 2010. The business has always been reported as a sole proprietorship on Lucas's tax return. Video Productions owns a factory with the following tax characteristics: Original cost $300,000 Depreciation Claimed $40,000 Straight-Line Depreciation $40,000 Current Fair Market Value $360,000 Holding Period 4 years On January 1, 2015, Lucas sold the building for its current fair market value. Compute the recognized gain on this sale and show the amount of gain for each of the following character types: Total Gain Ordinary Income Gain taxed at 25% rate Capital Gain Sec 1231 Gain

Total Gain $100,000 Ordinary Income $0 Gain Taxed at 25% Rate $40,000 Capital Gain $0 Section 1231 Gain $60,000 Rationale: Recapture applies only to Sec 1231 property. If the Sec 1231 property was depreciable, the gain from the sale is subject to recapture as ordinary income. The amount not recaptured is recognized as a Sec 1231 gain. Depreciable realty is Sec 1250 property. Realty is land and buildings. For Sec 1250 property, only the excess of actual depreciation over straight-line depreciation is subject to recapture as ordinary income. For Sec 1250 property, the portion of the gain that would be recaptured if all depreciation taken was subject to recapture under Sec 1245 over the regular Sec 1250 recapture is taxed at 25%, rather than as a Sec 1231 gain. The amount subject to the 25% rate is usually the straight-line depreciation on the asset. The equipment is Sec 1231 property since it is property used in a trade or business that has been owned for more than a year. Note that none of the gain is capital since the asset is a Sec 1231 asset.

Sandra is single and owns Bakery Products Company (BPC), which began operations in 1995. The business has always been reported as a sole proprietorship on Sandra's tax return. Assume that the BPC owns equipment with the following tax characteristics: Original cost $40,000 Depreciation Claimed $15,000 Straight-Line Depreciation $10,000 Current Fair Market Value $60,000 Holding Period 3 years On January 1, 2015, Sandra sold the equipment for its current fair market value. Compute the recognized gain on this sale and show the amount of gain for each of the following character types: Total Gain Ordinary Income Capital Gain Sec 1231 Gain

Total Gain $35,000 Ordinary Income $15,000 Capital Gain $0 Sec 1231 Gain $20,000 Rationale: Amount Realized $60,000 Cost $40,000 Dep Claimed <$15,000> Adj Basis $25,000 Realized & Recognized Gain $35,000 Recaptured as OI <$15,000> Sec 1231 Gain $20,000

The results of Digimatic Corporation's first 3 years of operations are presented below: Y1: Sec 1231 losses of $10,000 Y2: Sec 1231 losses of $15,000 Y3: Sec 1231 gain of $75,000 Digimatic Corp's Y3 Sec 1231 gain can best be characterized as...

Y3 Gain: $75,000 Y1 Loss: <$10,000> OI Y2 Loss: <$15,000> OI Taxed as LTCG = $50,000 Taxes as ordinary income = $25,000

What depreciation is subject to recapture under section 1245?

all depreciation claimed

Define "capital assets" and list the 2 most common categories of capital assets

assets other than inventory, AR, NR, assets used in a trade or business or creative works (in the hands of the creator) 2 common categories are: 1) assets used in one's personal life and 2) investments

What is the maximum tax rate for capital gains from the sale of collectibles?

max rate = 28%

Kaitlin owns a computer that she uses for business, investment, and personal use, as follows: Personal use. 25% Investment use. 30% Business use. 45% Will Kaitlin's use qualify her to use accelerated or straight-line depreciation, and what percentage of the asset's basis qualifies to be depreciated?

straight line, 75% A computer qualifies as listed property, and MACRS accelerated depreciation can be claimed for listed property only if the business use of the asset exceeds 50% of the total use. Since Kaitlin's business use is 45%, she does not meet the 50% test and must use straight-line (ADS) depreciation. However, she can depreciate both the business and investment use of the asset, so 75% of the asset's basis qualifies to be depreciated.

Adjusted basis equals...

the cost or other acquisition basis of the property - cost includes any liability or expense connected with the acquisition (transportation, installation, taxes, testing) - minus depreciation, amortization, & depletion - plus capital improvements