Chap-3-1B-Property Disposition Cap. Assets, etc. Howard Godfrey, Ph.D., CPA Professor of Accounting Howard Godfrey-2016 Case 1. Asset cost $400,000. Deduct depreciation of $100,000 and save tax of $40,000 (40%). Adjusted Basis is now $300,000. Case 2. Sell asset for $200,000 and have a loss of $100,000 Case 3. Sell asset for $400,000 and have a gain of $100,000. Case 4. Sell asset for $430,000 and have a gain of $130,000. Sec Losses (a) General Rule. There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. (b) Amount of Deduction. the basis for determining the amount of the deduction for any loss shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property. Sec Losses (c) Limit on Losses of Individuals. In the case of an individual, the deduction limited to- (1) losses incurred in a trade or business; (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and (3) except as provided in subsection (h), losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck,.. or from theft. (f) Capital Losses. Losses from sales or exchanges of capital assets shall be allowed only to the extent allowed in sections 1211 and 1212. Sec Limit on Capital Losses (a) Corporations. In the case of a corporation, losses from sales or exchanges of capital assets shall be allowed only to the extent of gains from such sales or exchanges. (b) Other Taxpayers. In the case of a taxpayer other than a corporation, losses from..capital assets shall be allowed only to the extent of the gains from such sales or exchanges, plus (if such losses exceed such gains) the lower of- (1) $3,000 ($1,500 in the case of a separate return), or Sec Capital Loss Carrybacks (a) Corporations. (1) In general. If corporation has a net capital loss..amount shall be- (A) a capital loss carryback to each of the 3 taxable years preceding the loss year,..and (B) a capital loss carryover to each of the 5 taxable years succeeding the loss year; and Sec Capital Loss Carrybacks (b) Other Taxpayers. (1) In general. If a taxpayer other than corporation has a net capital loss for any taxable year- (A) the excess of the net short-term capital loss over the net long-term capital gain for such year shall be a short-term capital loss in the succeeding taxable year, and (B) the excess of the net long-term capital loss over the net short-term capital gain for such year shall be a long-term capital loss in the succeeding taxable year. Sec Capital Asset Defined. (a) In General. . capital asset means property held by the taxpayer (whether or not connected with his trade or business), but does not include- (1) property of a kind which would properly be included in inventory , or property held by the taxpayer primarily for sale to customers.. (2) property, used in his trade or business, subject to the allowance for depreciation provided in section 167, or real property used in his trade or business.. Sec Capital Asset Defined. (a) In General. . capital asset means property held by the taxpayer (whether or not connected with his trade or business), but does not include (3) a copyright, a literary, musical, or artistic composition, a letter or memorandum, by (A) a taxpayer whose personal efforts created such property, (B) in the case of a letter, memorandum, or similar property, a taxpayer for whom such property was prepared or produced, or.... Sec Property Used in the Trade or Business. (a) General Rule. (1) Gains exceed losses. If- (A) the section 1231 gains for any taxable year, exceed (B) the section 1231 losses for such taxable year, such gains and losses shall be treated as long-term capital gains or long-term capital losses, as the case may be. Sec Property Used in the Trade or Business. (2) Gains do not exceed losses. If- (A) the section 1231 gains for any taxable year, do not exceed (B) the section 1231 losses for such taxable year, such gains and losses shall not be treated as gains and losses from sales or exchanges of capital assets. Sec Property Used in the Trade or Business. (3) Section Gains and Losses. For purposes of this subsection- (A) Section gain. The term section gain means- (i) any recognized gain on the sale or exchange of property used in the trade or business, and.. Capital Gains and Losses A capital asset is any asset other than inventory, receivables, copyrights, assets created by the taxpayer, and depreciable or real property used in a trade or business. 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. Capital Gains and Losse Holding Period The holding period for capital assets is how long the taxpayer owned the asset. Long-term means the asset was held for more than 12 months. Short-term means the asset was held for < 12 months. Determining holding period is the first step in determining tax treatment. Tax Treatment for Net Short-term Gain Individual Taxpayers Net short-term capital gain is taxed as ordinary income (i.e., taxpayers marginal tax rate). Gain Treatment for Corporations Corporations do not receive special treatment for capital gains. Tax Treatment for Net Loss Net Capital Loss Individuals may use only $3,000 of capital loss to offset other income Excess loss is carried forward indefinitely and retains its short term or long term class for netting purposes Corporations cannot deduct a net capital loss Excess loss carried back 3 then forward 5 years to offset capital gains. No capital loss deduction against ordinary income Sharons Capital Asset Sales-1 Sharon has salary income of $68,000, a net short-term capital gain of $15,000, and a net long-term capital loss of $24,000. What is Sharons adjusted gross income if she has no other income items? Sec Property Used in the Trade or Business and Involuntary Conversions. (2) Gains do not exceed losses. If- (A) the section 1231 gains for any taxable year, do not exceed (B) the section 1231 losses for such taxable year, such gains and losses shall not be treated as gains and losses from sales or exchanges of capital assets. (3) Section Gains and Losses. For purposes of this subsection- (A) Section gain. The term section gain means- (i) any recognized gain on the sale or exchange of property used in the trade or business, and.. Sec Property Used in the Trade or Business and Involuntary Conversions. (b) Definition of Property Used in the Trade or Business. For purposes of this section- (1) General rule. The term property used in the trade or business means property used in the trade or business,..subject to the allowance for depreciation provided in section 167, held for more than 1 year, and real property used in the trade or business, held for more than 1 year, which is not (A) property of a kind which would properly be includible in inventory. Section 1231 Asset Definition Asset used in a trade or business not for investment Held long term Section 1231 Net Section 1231 gains may be allowed capital gain treatment even though they arise from ordinary assets. Net Sec losses are ordinary. Case 1. Asset cost $400,000. Deduct depreciation of $100,000 and save tax of $40,000 (40%). Adjusted Basis is now $300,000. Case 3. Sell asset for $400,000 and have a gain of $100,000. Case 4. Sell asset for $430,000 and have a gain of $130,000. Sec Gain from Dispositions of Certain Depreciable Property (a) General Rule. (1) Ordinary income. Except as otherwise provided in this section, if section 1245 property is disposed of the amount by which the lower of- (A) the recomputed basis of the property, or (B)(i) in the case of a sale, exchange, or involuntary conversion, the amount realized, or (B)(ii) in the case of any other disposition, the fair market value of such property, exceeds the adjusted basis of such property shall be treated as ordinary income. Such gain shall be recognized notwithstanding any other provision of this subtitle. Sec Gain from Dispositions of Certain Depreciable Property (2) Recomputed basis. For purposes of this section- (A) In general. The term recomputed basis means, with respect to any property, its adjusted basis recomputed by adding thereto all adjustments reflected in such adjusted basis on account of deductions (whether in respect of the same or other property) allowed or allowable to the taxpayer [Instructor: means add back depreciation.] (d) Application of Section.- This section shall apply notwithstanding any other provision of this subtitle. Depreciation Recapture Prevents taxpayers from receiving the dual benefits of a depreciation deduction and special Section 1231 gain treatment. Applies to Sec gain property only Requires gains to be treated as ordinary to the extent of prior depreciation deductions Depreciation Recapture-Section 1245 Requires full recapture of all depreciation Gains are treated as ordinary income to the extent of any depreciation taken Any gain in excess of depreciation is netted under Section 1231 Depreciation Recapture-Section 1245 Applies to Depreciable personal property and Nonresidential real estate placed in service between 1981 and 1986 and depreciated under ACRS Depreciation Recapture Depreciation recapture converts part or all of the gain on the sale of depreciable assets to ordinary income to the extent of the reduction in basis attributable to depreciation expense previously claimed The amount of income recaptured as ordinary income can never exceed either the realized gain or prior depreciation deductions Recapture rules cannot apply to assets on which there is a realized loss Section 1245 Full Recapture Applies to machinery, equipment, furniture, and fixtures (but not to buildings or structural components) Any gain on the sale of section 1245 property is ordinary income to the extent of all depreciation allowed or allowable for the property Any amount expensed under section 179 is included in the depreciation allowed The income recaptured is the lesser of all depreciation taken or the realized gain The next slide has an illustration of how the tax law worked for accelerated depreciation on residential real estate. However, only the straight-line method has been allowed for buildings acquired in last 25 years. Buildings bought more than 25 years ago would actually already be fully depreciated by now (shorter life used then). But this shows how it worked. Depreciation Recapture-Section 1250 Requires partial recapture of depreciation Gains are treated as ordinary income to the extent of depreciation taken in excess of straight-line amount (but the excess is likely zero) Any gain in excess of depreciation is netted under Section 1231 (all gain?) Depreciation Recapture-Section 1250 Applies to depreciable real property Not covered by Section 1245 and Not depreciated using the straight-line method Eliminates most MACRS realty Unrecaptured Section 1250 Gain Requires that the portion of the gain attributable to depreciation that is not Section 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 (SP in excess of original cost) is a Section 1231 gain taxed at 15%. Added Section 291 Recapture for Corporations Section 291 applies to corporate dispositions of realty (Section 1250 property) Converts to ordinary income (as Section 1250 recapture) 20% of any Section 1231 gain that would have been ordinary income if Section 1245 full recapture applied For realty acquired after 1986, Section 1245 full recapture x 20% = Section 291 recapture Eliminates some of the capital gains that would otherwise be available to offset corporate capital losses Section 1231 Look-Back Rules Net Section 1231 gains are taxed as ordinary income to the extent of any unrecaptured net Section 1231 losses in the five preceding years This prevents taxpayers from generating tax savings by bunching their Section 1231 gains into one year (to receive tax-favored long-term capital gains treatment) and losses into alternate years (deducting the Section 1231 losses in full against ordinary income) End