accy 312 chapter 11
personal asset converted to business asset rules
-Basis for cost recovery is the lesser of the: 1) cost basis, or 2) FMV on date of conversion. -If FMV < cost basis on date of conversion, then follow "dual basis rules".
assets acquired by gift rules
-In general: Adjusted tax basis carries over to the gift recipient. -UNLESS: FMV on date of gift < donor's basis in gift (duel basis rules). •Donee uses carryover basis if asset subsequently sold for a gain. •Donee uses FMV as adjusted basis if asset subsequently sold for a loss. •No gain or loss if FMV < amount realized < carryover basis. -Holding period = date donor acquired property (if gain basis rule applies) or date of gift (if loss basis rules apply)
bargain purchase rules
-Purchase at less than fair market value -Typically an employee purchase from an employer or a shareholder purchase from a corporation. -At time of sale, FMV - Bargain Purchase Price = Recognized Gain (compensation or dividends) -Basis = FMV
requirement 1 for likekind exchanges: The property is exchanged "solely for like-kind" property.
-Real property is considered like-kind with any other type of real property as long as it is used in trade or business or for investment. -Real property held for sale is not eligible for like-kind treatment. -U.S. real property is not like-kind with non-U.S. real property. -Personal property is no longer eligible for Like-Kind Exchange treatment following the TCJA.
assets acquired by inheritance rules
-Recipient's basis in the asset is the FMV on the date of transfer. -Holding period is deemed to be long-term (regardless of actual HP). -In community property states, assets are deemed inherited by surviving spouse, therefore basis is FMV on the date of transfer -In common law state, asset basis is only adjusted to FMV for ½ of jointly property
transactions involving "boot" in a likekind exchange
-Sometimes the FMV of the assets exchanged are not equal to each other. In this case, the party transferring the asset with the smaller FMV will also transfer "boot" to the other party. -Boot includes cash, other property, and liabilities assumed by the other party to the transaction. -The receipt of boot appears to violate requirement 1. •To account for this violation, the T/P receiving "boot" may have to recognize some gain on the exchange. -Recognized gain = Lessor of: 1) Realized gain, or 2) Boot received. -If the T/P receiving boot experiences a realized loss on the transaction, they are NOT required to recognize any gain.
requirement 2 for likekind exchanges: property use
-T/Ps can only exchange property in a qualifying like-kind exchange if: •The T/P used the transferred property in a trade or business or for investment AND •The T/P will use the property received in the exchange in a trade or business or for investment. -One party in the transaction can receive like-kind exchange treatment while the other does NOT. -Each party to the exchange must individually determine whether the exchanges qualifies for like-kind exchange treatment or not.
requirement 3 for likekind exchanges: timing requirement
-The taxpayer must identify the like-kind replacement property within 45 days after transferring the property given up in the exchange, AND -The taxpayer must receive the replacement like-kind property within 180 days (or the due date of the tax return including extensions) after the taxpayer initially transfers property in the exchange. •These rules require T/Ps to complete like-kind exchanges in a reasonable amount of time to report the tax consequences on their tax returns. •These rules also allow T/Ps to use intermediaries to complete the like-kind transaction, which generally do NOT involve simultaneous exchanges of assets. -Aka - delayed like-kind exchanges, or Starker exchanges.
examples of nontaxable exchange
-Transfer of property to a controlled corporation in exchange for stock under IRC Section 351. -Transfer of property to a partnership in exchange for partnership interest under IRC Section 721. -Certain stock for stock exchanges (same company). -Like-Kind Exchange. -Involuntary Conversion. -Installment Sales.
adjusted tax basis special rules
-bargain purchase -personal asset converted to business asset -assets acquired by gift -assets acquired by inheritance
section 1231 assets
-depreciable personal property -depreciable real property -land
2 types of involuntary conversions
-direct conversion -indirect conversion
capital assets
-personal-use property -investment property
gains not eligible for installment reporting
1)T/P's selling marketable securities or inventory on an installment basis must nonetheless recognize all realized gains immediately. 2)Any gains subject to depreciation recapture (including §1245, §1250, and §291 depreciation recapture) must also be recognized in the year of sale. -The remaining §1231 gain can be recognized using the installment method. -The immediately taxable recapture-related gains are added to the adjusted basis of the property sold to determine the gross profit percentage (to avoid double taxation).
three requirements for likekind exchanges
1)The property is exchanged "solely for like-kind" property. 2)Both the property given up and the property received in the exchange by the T/P are either "used in a trade or business" or are "held for investment," by the T/P. 3)The "exchange" must meet certain time restrictions.
how to calculate realized gain/loss
= amount realized - adjusted tax basis
ordinary assets
some business-use property: -inventory -accounts receivable and notes receivable -short term assets
wash sale
•A wash sale occurs when a taxpayer sells/exchanges stocks/securities at a realized loss and, within 30 days before or after the date of the sale/exchange, the taxpayer acquires "substantially identical" stocks or securities. -Basis of replacement stock/security is the cost of such replacement stock/security increased by the amount of disallowed loss. -The holding period of the replacement stock/security begins on the date of the acquisition of the old stock/security. -If taxpayer acquires fewer shares than the number sold, the loss from the wash sale is prorated between recognized and unrecognized loss.
Section 1250 Depreciation Recapture extra info
•Again, §1250 depreciation recapture no longer applies because real property has been subject to straight-line depreciation since 1986! •For corporations any gain from the sale of §1250 property is now classified as §1231 gain, except for the amount recaptured under §291. •§1250 depreciation recapture does not apply to losses, which also receive §1231 tax treatment.
dispositions
•Businesses dispose of assets in many ways: -Sell the asset -Exchange the asset -Donate the asset -The asset is destroyed or stolen -The asset is literally disposed of (i.e., thrown away) •All of these dispositions have tax consequences! -Must compute the amount of gain or loss on the disposition.
capital gain/loss for a corporation
•Capital gains are NOT subject to preferential tax rates. -i.e., Are taxed at ordinary tax rates. •Capital losses only offset capital gains. -i.e., No net capital loss deduction allowed! •Net capital losses can be carried back 3 years and forward 5 years. •Loss carrybacks and carryforwards are always treated as short-term, regardless of their original nature.
Unrecaptured Section 1250 Gain
•For individual taxpayers, the depreciation recapture rules no longer apply to gains related to the sale of §1250 property. -Instead the entire gain is treated as §1231 gain that is netted with other §1231 gains and losses (if any). •If the §1231 gain from the sale of the §1250 property survives the netting process (see later slides), then it is treated as a long-term capital gain, BUT it is subject to a different capital gain tax rate: 25%! -This gain is called "unrecaptured §1250 gain." •The amount of the gain that is subject to the 25% tax rate is limited to the amount of accumulated depreciation. -Any remaining gain is eligible for the 0/15/20% capital gain tax rate.
section 1239 related party transactions
•Gain on the sale of property from one related party to another is treated as ordinary gain (to the seller) when: -The property is depreciable property to the buyer. •Tax law treats the related parties as the same person. -IRC §267 provides the definition of related parties (includes siblings). •While depreciation recapture is determined by depreciation deductions taken in the past (by the seller)... •The §1239 recapture provisions are based on depreciation deductions that will be taken in the future (by the buyer). •When both depreciation recapture and the §1239 recapture provisions apply to the same gain, you apply the depreciation recapture provisions FIRST.
what is a nontaxable exchange
•Generally, a nontaxable exchange is an exchange where the realized gain/loss is not currently recognized. -If the exchange is completely nontaxable, all of the realized gain/loss is postponed. -Exchanges can also be partially nontaxable, postponing only a portion of the realized gain/loss.
section 291 depreciation recapture
•IRC §291 requires corporations to recapture depreciation related to the sale of depreciable real property (i.e., §1250 property). -This recaptured depreciation is treated as ordinary income. •The amount of depreciation recaptured under IRC §291 is 20% of the lesser of the: 1)Recognized gain, or the 2)Accumulated depreciation.
how to calculate tax basis in likekind exchange
•If no "boot" involved in the transaction, then the T/P's -Tax basis in property received = Tax basis in property given up. •If the transaction involves "boot", then the T/P's -Tax basis in property received = FMV of like-kind property received - Deferred gain + Deferred loss - -Where: •Deferred gain = Realized gain - recognized gain •Deferred loss = Realized loss •Basis of boot received = FMV of boot -Boot can be reflected in both the realized and recognized gains.
additional facts for calculating net 1231 gain/loss for individuals
•If the T/P's net §1231 gain (after Step 1) includes both: -Unrecaptured §1250 gain (taxed at 25%) and -"Pure" §1231 gain (taxed at 0/15/20%) then: •In Step 2: §1231 losses first offset the "pure" §1231 gain and then the unrecaptured §1250 gain. •In Step 3: Any unrecaptured net §1231 losses from prior years first recharacterize the unrecaptured §1250 gain and then the "pure" §1231 gain.
dual basis rules
•If the converted asset is later sold, then follow special rules to calculate the amount of gain or loss on the sale of the asset.
Recognized gain/loss
•In general, taxpayers recognize their realized gains and losses on their tax returns. -"Recognize" means that the gains and losses are reported on their tax returns. •But there are many situations -where gains are deferred to the future and -where losses are limited and/or carried forward to other tax years.
installment sales
•Installment sales occur when a seller receives at least one payment related to the sale of an asset in a tax year after the property is sold. -E.g., Swedish Chef Company sells Sweetums Division for $10 million. The Buyer agrees to pay $2 million in cash during the current tax year, and it promises to pay $2 million in each of the following four tax years. •Because the payments are received over 2 or more tax years, the seller needs to determine what proportion of the cash received each year triggers gain recognition. -The installment sale rules do NOT apply to property sold at a loss. •The gross profit rate determines the proportion of cash received each year that triggers gain recognition: -Gross profit percentage = Gross profit / Amount realized •Character of the gain is based on the character of the asset sold!
involuntary conversions
•Involuntary conversions occur when property is partially or wholly destroyed by a natural disaster or accident, stolen, condemned, or seized via eminent domain by a governmental agency. •When T/P's receive replacement property or insurance proceeds in excess of their tax basis in the destroyed property, they experience a realized gain. •Tax law allows T/P's to defer the recognition of gains on involuntary conversions.
like-kind exchanges
•Like-kind exchanges occur when T/Ps exchange similar business assets. Normally the T/P would recognize any realized gains or losses on the transaction. •IRC §1031 provides T/Ps that exchange property for assets other than cash MUST defer gain (or loss) recognition on the exchange if they meet certain requirements. -If the T/P fails to meet these requirements, then the exchange is fully taxable. •What is the purpose behind IRC §1031? -T/Ps exchanging property for assets other than cash have NOT changed their relative economic position. -And exchanges of property do NOT generate cash for T/Ps to pay income taxes on any realized gains.
Depreciation Recapture
•Prior to the §1231 netting process, taxpayers must consider whether any of the gains from the disposition of assets are subject to "depreciation recapture." -What does "depreciation recapture" do? -It converts what would otherwise be capital gain into ordinary income (it does NOT affect the amount of gain or loss). -And so, depreciation recapture is generally viewed as "bad." • •Depreciation gives taxpayers an ordinary (rather than capital) tax deduction, so the IRS wants any gains from the disposition of depreciable assets to be ordinary, too! (Subject to complex limitations...)
Section 1231 Assets
•Section 1231 assets are depreciable and amortizable property - and land - used in a trade or business (including rental property) held by taxpayers for more than one year. •All gains and losses must ultimately be classified as ordinary or capital on the tax return. •But as an intermediate step, Section 1231 assets generate §1231 gains and losses (unless depreciation recapture applies) when they are sold. •When multiple assets are sold, the T/P must net together all of the §1231 gains and losses. -Net §1231 gains are treated as capital gains, while -Net §1231 losses are treated as ordinary losses.
capital gain/loss for individual
•Short-term capital gains are taxed at ordinary tax rates. •Most long-term capital gains taxed at 0%/15%/20%. -0% capital gain rate if taxable income is $39,375 or lower SINGLE ($78,750 MFJ). -20% capital gain rate if taxable income is $434,551 or higher SINGLE ($488,851 MFJ). -Unrecaptured §1250 gains taxed at a max rate of 25%. -Gains on collectibles taxed at a max rate of 28%. •Individuals can annually deduct up to $3,000 of net capital losses against ordinary income. •Net capital losses carry forward indefinitely (but are not carried back). -Net capital losses can include both short- and long-term capital losses. -Short-term capital losses are applied against the $3,000 annual capital loss limitation before long-term capital losses.
holding period
•Short-term ≤ 1 yr. •Long-term > 1 yr. Starting the day after acquisition and including the day of disposition. •Holding period of property received in a nontaxable exchange (e.g. like-kind exchange) includes the holding period of the previous asset. •Holding period for gift includes holding period of giver. •All property acquired via inheritance is deemed long-term.
steps to calculate section 1231 net gain/loss
•Step 1: Apply the depreciation recapture rules (and §1239) to gains on the sale of §1231 property. •Step 2: Net the remaining §1231 gains with the §1231 losses. -If net loss, then it is treated as an ordinary loss. •Step 3: If net gain, then apply §1231 "Look-Back" rule -"Nonrecaptured" net §1231 losses from prior five years cause current §1231 gains to be treated as ordinary gains. •Step 4: Any remaining net §1231 gain is treated as LTCG. • •Must perform this §1231 netting procedure each tax year. •Step 3 does NOT change the amount of gain recognized, it only converts what would otherwise be capital gain into ordinary income!
indirect conversion details
•T/P's have 2 years to acquire qualified replacement property after the close of the tax year in which they receive the proceeds. -3 years in the case of condemned property. •Qualified replacement property is property that is similar and related in service or use, even if replacement property is real property. -These requirements are stricter (more narrow) than those for like-kind exchanges (where real property does not need to be similar to be like-kind). •The character of the gain recognized depends on the character of the asset that was converted, including depreciation recapture. •Casualty losses can be deducted immediately (i.e., not deferred!). •Basis of the replacement property = FMV of new property - Deferred gain on the conversion.
adjusted tax basis
•The "adjusted tax basis" is an asset's original basis adjusted for any cost recovery (e.g., depreciation). Adjusted tax basis = Cost basis - Cost recovery deductions
amount realized
•The "amount realized" includes everything of value received from the buyer, less any selling costs. Amount realized = Cash received + FMV of property received + Buyer's assumption of liabilities - Seller's expenses (including boot paid!)
character of gain or loss
•The character of an asset determines how gains and losses from the disposition of that asset are treated. •The character of an asset is determined by: -How it is used by the taxpayer •Business, investment, inventory, and personal-use property. -How long it was owned by the taxpayer. •Long-term vs. short-term. •Ultimately, every gain or loss is characterized as either ordinary or capital. -But there is an intermediate step for certain assets, known as §1231 assets.
related taxpayer disallowed loss
•The realized losses from the sale or exchange of property, directly or indirectly, between certain related parties can not be recognized. IRC Section 267(a)(1). •Related Parties include: -Members of family (brother, sister, spouse, ancestors, and lineal descendants) -Individual and Corporation (S or C) owned, directly or indirectly, >50% (value) by individual -Partner (Individual) and Partnership owned, directly or indirectly, >50% (capital interest) by partner •"Right of Offset" under IRC Section 267(d): If the related party buyer subsequently sells the property for a gain, they can offset the gain up to the amount of previously disallowed loss.
Section 1231 Look Back Rule
•To prevent taxpayers from benefitting from strategically timing when they recognize §1231 gains vs. §1231 losses, the IRS requires taxpayers to determine whether there are any §1231 losses in the 5 prior years that were NOT netted against §1231 gains in subsequent years (these losses are called "nonrecaptured net §1231 losses"). • •First check the net §1231 result for 5 years prior to the current tax year. •Then check the net §1231 result for 4 years prior, and so on, until either: -All of the current year's net §1231 gain has been recaptured OR -Each of the 5 prior years net §1231 results have been examined.
Character of asset exceptions
•While stocks and bonds are investment property (capital assets) to most, they are inventory (ordinary assets) to a dealer of securities. •While a painting might be an investment property (capital asset) to most, it is considered an ordinary asset to the original artist. •Real estate developers: -Real estate is an ordinary asset (inventory) to a real estate dealer. -However, real estate is a capital asset if the owner engages in "limited development activities" •Holding periods > 5 years •No substantial improvements •Only applies to first 5 lots sold
indirect conversion
•occurs when the T/P receives insurance proceeds or some other type of settlement for the involuntarily converted property. -Can elect to defer gain recognition by acquiring qualified replacement property within a prescribed time limit (generally 2 years). -Recognized gain is the lesser of: 1) realized gain, or 2) amount received that is not reinvested in qualified property.
direct conversion
•occurs when the T/P receives replacement property for the involuntarily converted property. -E.g., Land is seized from taxpayers to build interstates, highways, or to widen roadways. Sometimes T/Ps receive parcels of land in exchange for their property, rather than cash. -Basis in property received = T/P's basis in property given up.
Section 1245 Depreciation Recapture
•§1245 property includes all depreciable and amortizable personal property, including intangible assets and livestock. • •IRC §1245 provides that all gain be treated as ordinary gain to the extent of depreciation taken on the property disposed of. - •The amount of depreciation recaptured under IRC §1245 is the lesser of: 1)Accumulated depreciation, or the 2)Recognized gain. •Any remaining gain will usually be §1231 gain. • •IRC §1245 does NOT apply to losses, which are characterized as §1231 losses.
