©2003 south-western college publishing, cincinnati, ohio chapter 8 capital gains and losses

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©2003 South-Western College Publishing, Cincinnati, Ohio ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

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Page 1: ©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

Page 2: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 2003 South-Western College Publishing Transparency 8-2

Objective

Know the definition of the term “capital asset”

Page 3: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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.

Page 4: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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.

Page 5: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 2003 South-Western College Publishing Transparency 8-5

Objective

Know the holding periods and tax rates applied to sales of

capital assets

Page 6: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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.

Page 7: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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)

Page 8: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 9: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 2003 South-Western College Publishing Transparency 8-9

Adjusted Basis

Original cost

plus: Capital improvements

less: Accumulated depreciation

Adjusted basis

Page 10: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 11: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 12: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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)

Page 13: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 14: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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%.

Page 15: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 16: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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).

Page 17: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 2003 South-Western College Publishing Transparency 8-17

Gain Treatment for Corporations

Corporations do not receive special treatment for capital gains.

Page 18: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 19: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 20: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 21: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 22: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 23: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 24: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and 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

Page 25: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 26: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 2003 South-Western College Publishing Transparency 8-26

Objective

Understand what depreciation recapture is and how it is

calculated

Page 27: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 28: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 29: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 30: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 31: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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.

Page 32: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 33: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 2003 South-Western College Publishing Transparency 8-33

Objective

Know how casualty losses are treated for both personal and

business purposes

Page 34: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 35: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 36: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 37: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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:

Page 38: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 2003 South-Western College Publishing Transparency 8-38

Objective

Be able to calculate income from installment sales

Page 39: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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.

Page 40: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 41: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 42: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 43: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 44: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 45: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 46: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 47: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 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

Page 48: ©2003 South-Western College Publishing, Cincinnati, Ohio Chapter 8 Capital Gains and Losses

© 2003 South-Western College Publishing Transparency 8-48

Done!