2010 Pearson Education Inc Publishing as Prentice Hall

PROPERTY TRANSACTIONS: CAPITAL GAINS & LOSSES (1 of 2) ® Determination of gain or loss ® Basis considerations ® Definition of a capital asset ® Tax treatment for capital gains and losses of noncorporate taxpayers ® Tax treatment for capital gains and losses of corporate taxpayers © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -2

PROPERTY TRANSACTIONS: CAPITAL GAINS & LOSSES (2 of 2) ® Sale or exchange ® Holding period ® Justification for preferential treatment of net capital gains ® Tax planning considerations ® Compliance and procedural considerations © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -3

Determination of Gain or Loss Gain/Loss Realized (1 of 2) ® Realized gain or loss Amount realized less the assets’ adjusted basis Amount realized Money + FMV of property received + Taxpayer’s debt assumed by buyer - Costs of sale Amount Realized © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -4

Determination of Gain or Loss Gain/Loss Realized (2 of 2) Determination of basis Original basis (cost) + Capital additions (e. g. , improvements) - Capital recoveries (e. g. , depreciation) Adjusted basis © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -5

Determination of Gain or Loss Gain/Loss Recognized ® Recognized gain or loss may be less than realized gain or loss due to special statutory provisions E. g. , like-kind exchanges, involuntary conversions © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -6

Basis Considerations ® Cost of acquired property ® Property received as a gift ® Property received from a decedent ® Property converted from personal use to business use ® Allocation of basis © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -7

Cost of Acquired Property (1 of 2) ® Generally the beginning basis of an asset ® Uniform capitalization rules Requires certain period costs to be capitalized that are not capitalized for financial accounting purposes Affect inventory and other property used in a taxpayer’s business © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -8

Cost of Acquired Property (2 of 2) ® Capitalization Construction of interest period debt capitalized ¬Applies to real estate and assets with class life ≥ 20 years ® Identification Specific problems identification may not be possible Tax law requires a FIFO approach © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -9

Property Received as a Gift (1 of 2) ® Gain basis Donor’s basis plus a gift tax adjustment Gift tax paid X (FMV at gift time – donor’s basis) Amount of gift ® Loss basis Lesser of ¬Gain basis or ¬FMV at date of gift © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -10

Property Received as a Gift (2 of 2) ® Gain basis used to calculate depreciation Depreciation subtracted from both gain and loss basis upon disposition © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -11

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 months ¬AVD only available if FMV of total assets decreased over the six-month period © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -12

Property Converted from Personal Use to Business Use ® Basis is lower of personal use adjusted basis or property’s FMV at conversion Prevents depreciation on decline in value when asset was personal-use asset © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -13

Allocation of Basis (1 of 2) ® Basket purchase Acquisition cost must be allocated to individual assets on basis of relative FMV ® Common costs Capitalized and allocated based on relative FMV © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -14

Allocation of Basis (2 of 2) ® Nontaxable stock dividends received Allocate basis of old shares to basis of old shares plus new shares ® Nontaxable stock rights received If FMV of stock rights < 15% of FMV of stock, basis is $0 unless elect to allocate ¬Must allocate if value ≥ 15% of stock’s FMV © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -15

Definition of a Capital Asset ® Capital asset defined by § 1221 Definition is other than what is listed as NOT a capital asset, including ¬Inventory, depreciable property, real property used in a trade or business ® Election for self-created musical works ® Influence of the courts © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -16

Election for Self-created Musical Works ®A taxpayer may make a special election to treat sale or exchange of musical compositions or copyrights as sale or exchange of a capital asset © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -17

Influence of the Courts ® Corn Products Refining CO doctrine Created nonstatutory exception to definition of capital asset when asset purchased for business purposes ® Arkansas Limited Best Corporation Corn Products doctrine ¬Stock is within definition of capital asset ¬Motivation for acquiring assets is irrelevant © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -18

Other IRC Provisions Relevant to Capital Gains and Losses ® Dealers in securities Securities ® Real treated as inventory property subdivided for sale Non-dealers in real estate can treat as capital asset Dealers treat as inventory ® Nonbusiness Deductible bad debt as short-term capital loss © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -19

Tax Treatment for Capital Gains & Losses of Noncorp Taxpayers ® Capital gains ®

Capital Gains (1 of 2) ® Assets held ≤ 1 year are short-term ® Assets held > 1 year are long-term ® Net capital gain (NCG) Excess of net LTCG over net STCL NCG may receive favorable tax treatment Must first determine STCG, STCL, LTCG, and LTCL © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -21

Capital Gains (2 of 2) Net short-term capital gain (NSTCG) ¬Excess Net short-term capital loss (NSTCL) ¬Excess Net of STCLs over STCGs long-term capital gain (NLTCG) ¬Excess Net of STCGs over STCLs of LTCGs over LTCLs long-term capital loss (NLTCL) ¬Excess of LTCLs over LTCGs © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -22

Adjusted Net Capital Gains (ANCG) ® Four types of net capital gains 1. 2. 3. 4. Collectibles gain 50% of gain from sale of § 1202 stock Unrecaptured § 1250 gain All other LTCGs Group 4 gets 0% or 15% rate Groups 1 & 2 taxed at max of 28% Group 3 taxed at max of 25% © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -23

Capital Losses ® Net capital losses (NSTCL or NLTCL) offset ordinary income to a $3, 000 maximum, with an unlimited carryover to future years ® Net capital losses applied to net capital gains by groups described previously from highest (28%) to lowest (0% or 15%) © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -24

Tax Treatment for Capital Gains & Losses of Corp Taxpayers ® Corporations do NOT receive preferential tax rates on NCGs ® Corps cannot deduct net capital losses ® Corps carryback NCLs 3 years and then carryforward 5 years Capital loss carryovers are treated as STCLs © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -25

Sale or Exchange ® Worthless securities ® Retirement of debt instruments ® Options ®

Worthless Securities ® Securities that become totally worthless in a tax year are treated as a capital loss on the last day of the year ® Securities in affiliated corporations Not considered a capital asset © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -27

Retirement Of Debt Instruments ® Original issue discount Not treated as capital gain upon retirement Amortized over the life of the bond ¬Applies ® Market to cash and accrual taxpayers discount bonds Acquired on secondary market Discount treated as ordinary income © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -28

Options ® Exercised Basis in option added to basis stock purchased ® Sold or

Patents ® Gain may be treated as LTCG ® Requirements for LTCG treatment Must be transfer of substantially all rights LTCG treatment only applies to holder ¬Individual whose efforts created patent or one who purchases rights from creator ªCorps cannot be a “holder” © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -30

Franchises, Trademarks, and Trade Names ® § 1253 treats exchanges of franchises, trademarks, and trade names as exchanges of capital assets Includes renewals Licensing not treated as a sale Cannot retain significant power, right, or continuing interest in asset © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -31

Holding Period ® Property received as a gift ® Property received from a decedent Always long term ® Nontaxable exchanges ® Receipt of nontaxable stock dividends and stock rights © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -32

Property Received as a Gift ® If donee’s adjusted basis determined by reference to donor’s adjusted basis Donor’s holding period added to donee’s holding period ® If donee’s adjusted basis is FMV at date of gift Holding period begins on day after the date of gift © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -33

Nontaxable Exchanges ® Holding period of qualified property received generally includes holding period of

Receipt of Nontaxable Stock Dividends and Stock Rights ® Generally includes the holding period of the underlying stock ® If stock rights are exercised, holding period for stock purchased begins with date of exercise © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -35

Justification for Preferential Treatment of Net Capital Gains ® Mobility of capital ® Mitigation of the effects of inflation and the progressive tax system ® Lowers the cost of capital © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -36

Tax Planning Considerations ® Selection of property to transfer by gift Consider annual exclusion Unwise to gift depreciated property ® Selection of property to transfer at time of death Retain highly appreciated property until death Sell loss property before death © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -37

Compliance and Procedural Considerations ® Capital gains and losses reported by individuals on Schedule D ® To improve compliance, brokers required to furnish IRS with info pertaining to each customer Reported to taxpayer on Form 1099 -B Use Schedule D to reconcile amounts shown on Form 1099 -B © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -38

Comments or questions about Power. Point Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard. newmark@Ph. Duh. com © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 -39