©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses.
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Transcript of ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses.
©2003 South-Western College Publishing, Cincinnati, Ohio©2003 South-Western College Publishing, Cincinnati, Ohio©2003 South-Western College Publishing, Cincinnati, Ohio©2003 South-Western College Publishing, Cincinnati, Ohio
Chapter 8
Capital Gains and LossesCapital Gains and Losses
© 2003 South-Western College Publishing Transparency 8-2
Objective
Know the definition of the term “capital asset”
© 2003 South-Western College Publishing Transparency 8-3
Capital Gains and Losses
A capital asset is any asset other than inventory, receivables, and depreciable
or real property used in a trade or business.
© 2003 South-Western College Publishing Transparency 8-4
Capital Gains and LossesA sale or other disposition of capital assets
results in a capital gain or loss Capital gains and losses receive special tax
treatment
A collectible gain or loss results from the sale or exchange of works of art, gems, metals, antiques, rugs, stamps, wine, etc. held more than 12 months.
© 2003 South-Western College Publishing Transparency 8-5
Objective
Know the holding periods and tax rates applied to sales of
capital assets
© 2003 South-Western College Publishing Transparency 8-6
Capital Gains and LossesHolding Period
The holding period for capital assets is how long the taxpayer owned the asset. Long-term means the asset was held for > 12
months. Short-term means the asset was held for < 12
months.
Determining holding period is the first step in determining tax treatment.
© 2003 South-Western College Publishing Transparency 8-7
Property Disposition
Amount realized from dispositionless: Adjusted basis of property
Realized gain (loss)less: Allowed deferral
Recognized gain (loss)
© 2003 South-Western College Publishing Transparency 8-8
Amount Realized
Amount realized = gross sales price less selling expenses Gross sales price is the amount received by the
seller from the buyer and includesCash and FMV of property or services receivedSeller’s liability assumed by or paid by the buyer
Gross sales price is decreased by amounts given to the buyer by the sellerBuyer’s expenses paid by or assumed by the seller
© 2003 South-Western College Publishing Transparency 8-9
Adjusted Basis
Original cost
plus: Capital improvements
less: Accumulated depreciation
Adjusted basis
© 2003 South-Western College Publishing Transparency 8-10
Juliana sold stock in Arco she had purchased in 1997. The stock had cost her $10,000 and she sold it for $19,000 with a commission of $1,300. What is amount realized and gain realized?
Answer
Amount realized = $19,000 - $1,300 = $17,700
Gain realized = $17,700 - $10,000 = $7,700 LT
Examples of Calculating Gain/Loss
© 2003 South-Western College Publishing Transparency 8-11
Long-term gains netted againstLong-term losses
Net Long-termGain or Loss
Short-term gains netted againstShort-term losses
Net Short-termGain or Loss
=
=
Capital Gains and Losses:Netting Procedures
© 2003 South-Western College Publishing Transparency 8-12
Capital Gains and LossesNetting Procedures
The following are treated as long-term gains and losses for the netting procedure Collectible gains and losses Gains on qualified small business stock Unrecaptured Section 1250 gain (applies to sales
of real estate)
© 2003 South-Western College Publishing Transparency 8-13
If net short-term & long-term are opposite signs:
Net Short-term Gain or Lossnetted against
Net Long-term Gain or Loss
Net CapitalGain or Loss=
Capital Gains and Losses:Netting Procedures
If short-term & long-term net results are same sign:Do not net. You will have a net STC and LTC gain or loss
© 2003 South-Western College Publishing Transparency 8-14
Tax Treatment for Net Long-term Gain: Individual Taxpayers Net long-term gain (minus net collectibles gain, gain
on qualified small business stock, and unrecaptured Section 1250 gain) is taxed at a maximum rate of 20% (10% for taxpayers in <20% bracket)
Collectibles held more than 12 months are taxed at a maximum rate of 28%.
50% of the gain on qualified small business stock is excluded, the remainder taxed at a maximum rate of 28%.
Unrecaptured Section 1250 gain is taxed at a maximum rate of 25%.
© 2003 South-Western College Publishing Transparency 8-15
Special rate for assets held > 5 years 20% become 18% (in 2006) 10% becomes 8% (currently)
Tax Treatment for Net Long-term Gain: Individual Taxpayers
© 2003 South-Western College Publishing Transparency 8-16
Tax Treatment for Net Short-term Gain: Individual Taxpayers Net short-term capital gain is taxed as
ordinary income (i.e., taxpayer’s marginal tax rate).
© 2003 South-Western College Publishing Transparency 8-17
Gain Treatment for Corporations
Corporations do not receive special treatment for capital gains.
© 2003 South-Western College Publishing Transparency 8-18
Tax Treatment for Net Loss
Individuals may use only $3,000 to offset other income Excess loss is carried forward indefinitely
Corporations cannot deduct a net capital loss Excess loss carried back 3 then forward 5 years to
offset capital gains
© 2003 South-Western College Publishing Transparency 8-19
Juan has the following capital gains and losses in the current year:
Short-term capital loss $ (2,000)
Long-term capital gain 12,000
Long-term capital loss carryover (7,000)
Example
© 2003 South-Western College Publishing Transparency 8-20
Short-term:
Short-term capital loss $ (2,000)
Long-term:
Long-term capital gain $12,000
Long-term capital loss carryover ( 7,000) Long-term capital gain $ 5,000
Net long-term capital gain $ 3,000
Tax on adjusted net capital gain:
$3,000 x 20% = $ 600
Example
© 2003 South-Western College Publishing Transparency 8-21
Qualified Small Business StockQualified stock is stock that
Has been held for more than 5 years Was purchased directly from a small corporation
Corporation with gross assets < $50 million
Was purchased after 8/10/93
Up to 50% of gain from sale may be excluded Limited to the greater of
10 times basis in the stock, or$10 million for each small business
Exclusion is based on a 28% rateNot eligible for new special CG rates
© 2003 South-Western College Publishing Transparency 8-22
Amount realized from dispositionless: Adjusted basis of property
Realized gain (loss)less: Allowed deferral
Recognized gain (loss)
Ordinary§1231
(Form 4797) Capital
(Schedule D)Personal
Use
Character of gain (loss)
Character of Gain or Loss
© 2003 South-Western College Publishing Transparency 8-23
Section 1231 Assets
Asset must be held > 12 months and used in a trade or business not held for investment
Net all §1231 gains against losses
© 2003 South-Western College Publishing Transparency 8-24
Net Section 1231 gains may be allowed capital gain treatment even though they arise from “ordinary” assets.
Section 1231
© 2003 South-Western College Publishing Transparency 8-25
Section 1231 Netting Results
Net Section 1231 gain is classified as long-term capital gain
Net Section 1231 loss is classified as ordinary loss
© 2003 South-Western College Publishing Transparency 8-26
Objective
Understand what depreciation recapture is and how it is
calculated
© 2003 South-Western College Publishing Transparency 8-27
Prevents taxpayers from receiving the dual benefits of a depreciation deduction and special §1231 capital gain treatment
Depreciation Recapture
© 2003 South-Western College Publishing Transparency 8-28
Depreciation Recapture
Applies to Section 1231 gain property onlyRequires gains to be treated as ordinary to
the extent of prior depreciation deductions
© 2003 South-Western College Publishing Transparency 8-29
Depreciation RecaptureSection 1245
Applies to Depreciable personal property andNonresidential real estate placed in service between
1981 and 1986 and depreciated under ACRS
Requires full recapture of all depreciationGains are treated as ordinary income to the extent of any
depreciation taken
Any gain in excess of depreciation is netted with Section 1231
© 2003 South-Western College Publishing Transparency 8-30
Depreciation RecaptureSection 1250
Applies to depreciable real property Not covered by Section 1245 and Not depreciated using the straight-line method
Requires partial recapture of depreciationGains are treated as ordinary income to the extent of
depreciation taken over straight-line amount
Any gain in excess of depreciation in netted with Section 1231
© 2003 South-Western College Publishing Transparency 8-31
Unrecaptured Section 1250 GainRequires that the portion of the gain
attributable to depreciation that is not §1250 recapture is taxed at a rate of 25%.
Applies to depreciable real property sold after 5/7/97.
Any gain not attributable to depreciation (in excess of original cost) is a §1231 gain.
© 2003 South-Western College Publishing Transparency 8-32
Ella purchases an apartment complex for $7,000,000 on 1/1/85. The property is depreciated on an accelerated basis and her accumulated depreciation is $4,000,000 . She sells the property on 1/1/02 for $8,500,000. What is the realized gain and how is it split between §1231 gain (taxed as capital) and §1250 recap (taxed as ordinary income)? [straight line depreciation would have totaled $2,692,000.]
Answer
Realized gain = $8,500,000 - ($7,000,000 - $4,000,000) = $5,500,000.
Excess depreciation taken = $4,000,000 - $2,692,000 = $1,308,000.
§1250 recaptures the $1,308,000 as ordinary income. The remainder of the gain, $4,192,000, is taxed as §1231 gain.
§1250 Recapture Example
© 2003 South-Western College Publishing Transparency 8-33
Objective
Know how casualty losses are treated for both personal and
business purposes
© 2003 South-Western College Publishing Transparency 8-34
Casualty Gains & Losses: Personal Loss is the lesser of
The property’s adjusted basis, or The decline in the value of the property (repair cost)
Loss is reduced by Insurance proceeds received, $100 per event, and 10% of AGI per year
Any insurance reimbursement reduces loss and may cause gain Gains are separated into ST and LT and included with
appropriate CG or CL
© 2003 South-Western College Publishing Transparency 8-35
Business casualty and theft losses result from damage caused by a sudden, unexpected and/or unusual event For property fully destroyed, deduct the adjusted
basis For property partially destroyed, deduct the lesser
of the property’s adjusted basis, or the decline in the property’s value
Any insurance reimbursement reduces loss and may cause gain
Casualty Gains & Losses: Business
© 2003 South-Western College Publishing Transparency 8-36
Treatment of gains and losses depends on holding period For property held < one year,
Net gains and losses are treated as ordinary income/loss
For property held > one year, Gains are §1231Losses must have components analyzed separately
Casualty Gains & Losses: Business
© 2003 South-Western College Publishing Transparency 8-37
Asset FMV change Basis Received PeriodFences $15,000 $8,000 $15,000 5 years
Boat $44,000 $50,000 $10,000 6 monthsTrailer $8,000 $10,000 $0 6 months
Hurricane results in a casualty gain = $8,000 - $15,000 = $7,000.
Windstorm results in a casualty loss = ($44,000 - $10,000) + ($8,000 - $0) = $42,000 - $100 - $41,900.
The total net casualty loss of $34,900 is further reduced by 10% of AGI.
Casualty Gains and Losses: ExampleSherry incurred the following casualty gains/losses and insurance reimbursements in one year (all personal assets). The fence was destroyed by a hurricane & the boat and trailer by a windstorm:
© 2003 South-Western College Publishing Transparency 8-38
Objective
Be able to calculate income from installment sales
© 2003 South-Western College Publishing Transparency 8-39
Installment Sales - Form 6252
Installment sale treatment is utilized when real or personal property or business/rental property is sold and payment is collected over time
Allows taxable gain to be reported as cash is received, not when transaction completed Must recapture any §1245 or §1250 income first,
then calculate gross profit percentage and multiply that by cash received in that year.
© 2003 South-Western College Publishing Transparency 8-40
Taxable Gain = Realized Gain Contract price
where, Realized Gain = Sales Price
less: Selling Expense less: §1245 or §1250 Recapture less: Adjusted Basis
and, Contract Price = Sales Price – Assumed Liabilities
Installment Sales Computations
x Cash
© 2003 South-Western College Publishing Transparency 8-41
Installment Sales ExampleBaker sold his prize bulls to Larry for $10,000 down and $25,000/year for 4 years (plus interest). Baker had purchased the bulls for $95,000 and had depreciated them $15,000.
Realized gain: $110,000 - $0 - $15,000 (§1245 recap) - $80,000 = $15,000
Gross profit percentage: $15,000/$110,000 = 13.64%
Taxable gain in year of sale: Capital gain: $10,000 x .1364 = $1,364Ordinary income (§1245 recap) = $15,000
Taxable gain in subsequent years:$25,000 x .1364 = $3,410
Interest Income would be reported on each year’s Schedule B
© 2003 South-Western College Publishing Transparency 8-42
Objective
Have a basic understanding of several provisions allowing
deferral or non-recognition of gain or loss on disposition of an asset
© 2003 South-Western College Publishing Transparency 8-43
§1031 Like-Kind ExchangesNo gain/loss is recognized when an exchange of
like-kind property occurs, Like-kind property is real property for real property or
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 cash or any property (inventory, stocks,
bonds, or other securities) that is not like-kind
© 2003 South-Western College Publishing Transparency 8-44
Like Kind Exchanges (models)
Realized Gain = FMV of property received – adjusted basis of property given up
Recognized Gain = Lesser of (1) gain realized, or
(2) boot received
Basis of new property = Adjusted basis of property given up + boot paid – boot received + gain recognized
© 2003 South-Western College Publishing Transparency 8-45
Barry exchanges his apartments for Adolph’s land. The apartments have a FMV $250,000 and an adjusted basis of $175,000. The land has a FMV of $305,000. Barry also gives $25,000 cash. What is Barry’s realized gain, recognized gain, and new basis in the land?
Realized gain: $305,000 – ($175,000 + $25,000) = $105,000
Recognized gain: $0 since no boot was received
Basis for land: ($175,000 + $25,000) +$0 – $0 + $0 = $200,000
Like Kind Exchange Example
© 2003 South-Western College Publishing Transparency 8-46
Involuntary ConversionsWhen a taxpayer involuntarily disposes of
property due to an act of God, theft, condemnation, etc., gain does not need to be recognized if: Insurance proceeds are reinvested in similar property
within 2 years after close of tax year in which conversion occurred
Must recognize gain if insurance proceeds exceed adjusted basis of property
Losses are not deferred
© 2003 South-Western College Publishing Transparency 8-47
Sale of Personal Residence Post-5/6/97
No gain need be recognized on sale of home, as long as taxpayer has used it as a personal residence for two of the last five years
Gain exclusion is up to $500,000 (MFJ) or $250,000 (S) May prorate gain exclusion if residence rule isn’t
met due to employment or health
© 2003 South-Western College Publishing Transparency 8-48
Done!