lexisnexis tax advisor -- federal topical § 1j:2

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LexisNexis Tax Advisor -- Federal Topical § 1J:2.06 (Copy w/ Cite) Pages: 26
LexisNexis Tax Advisor -- Federal Topical § 1J:2.06
LexisNexis Tax Advisor -- Federal Topical
Copyright 2009, Matthew Bender & Company, Inc., a member of the LexisNexis Group
Part 1. Computing Federal Income Tax
Vol. 1J Securities Transactions
CHAPTER 1J:2 Capital Gains and Losses **
LexisNexis Tax Advisor -- Federal Topical § 1J:2.06 § 1J:2.06 Computing Capital Gains and Losses [1] Definitions [a] Net Long-Term Capital Gain or Loss. IRC Section 1222(7) defines "net long-term capital gain" as the excess of long-term capital gains realized in the taxable year over long-term capital losses for the same year. Thus, if total long-term gains for a taxable year amounted to $10,000 and total long-term losses to $5,000, the net long-term gain for the year would be $5,000. Conversely, if the amount of gain and loss were reversed, the taxpayer would realize a net long-term capital loss of $5,000.1 [b] Net Short-Term Capital Gain or Loss. Net short-term capital gains and losses are determined in the same fashion as those which are long-term, that is, net short- term gain is the excess of short-term gains over short-term losses,2 and net short-term loss, the excess of such losses over such gains.3 [c] Net Capital Gain and Net Capital Loss. A taxpayer is deemed to have a net capital gain in any year in which the taxpayer's net long-term capital gain exceeds the taxpayer's net short-term capital loss.4 The taxpayer has a net capital loss whenever the losses for the year (long- and short-term taken together) exceed the amount allowed as a loss deduction under IRC Section 1211.5 (If the taxpayer is a corporation, the amount of any loss carried back or forward to the year in question is excluded from the computation of net
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capital loss.)6 [2] The Noncorporate Taxpayer [a] Treatment of Capital Gains [i] In General. Prior to the Tax Reform Act of 1986, the preferential treatment for taxpayers other than corporations was derived from the deduction from gross income of 60 percent of the net capital gain of the taxable year.7 The Act repealed the special treatment, subjecting net capital gains to the same rates as ordinary income. The increase in tax rates brought about by the Omnibus Budget Reconciliation Acts of 1990 and 1993 returned preferential treatment for long-term capital gains to the Code, but did so by capping the rate of tax imposed on such gains at 28 percent.8 The Taxpayer Relief Act of 1997 placed different and additional caps on the tax imposed on net capital gains, the differences depending on the holding period and type of asset. The Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced the rates even further for taxable years prior to January 1, 2009.9 The rates prescribed by that legislation for taxable years ending after May 5, 2003 are-:10
Rate (%) Application
5
Gain from the sale of assets held more than 12 months (adjusted net capital gain), if the taxpayer's regular rate of tax is 15 percent or less.11 Adjusted net capital gain does not include collectibles gain, unrecaptured Section 1250 gain, or Section 1202 gain.12 The rate is reduced to zero for taxable years beginning after 2007.
10
Collectibles gain, Section 1202 gain, and unrecaptured Section 1250 gain realized by a taxpayer whose regular rate of tax is 10 percent.
15
Adjusted net capital gain realized by a taxpayer whose regular rate of tax is greater than 15 percent.13 The rate also applies to collectibles gain, Section 1202 gain, and unrecaptured Section 1250 gain realized by a person whose regular rate of tax is 15 percent.
25
Unrecaptured Section 1250 gain (gain to the extent of prior depreciation deductions realized on the sale of depreciable real property held for more than 12 months), if the taxpayer's regular rate of tax is greater than 25 percent.14
The creation of various categories of net capital gain requires a special sequence of netting of capital gains and losses.15 Short-term capital losses (including short-term capital loss carryovers) are applied, first, to reduce short-term capital gains. If there is a resulting net short-term capital loss, it is applied to reduce any net long-term capital gain from the 28-percent group, then to reduce gain from the 25-percent group, and, finally, to reduce net gain from the 15-percent group (5 percent for gain that would otherwise be taxed at 10 or 15 percent). The netting of long-term capital gains and losses calls for a net loss from the 28-percent group (including long-term capital loss carryovers) to be used, first, to reduce gain from the 25-percent group, and then to reduce gain from the 15-percent group. A net loss from the 15-percent group first reduces net gain from the 28-percent group and, then, net gain from the 25-percent group. The regulations provide for the treatment of look-through capital gain that arises from the sale or exchange of an interest in a partnership, S corporation or nongrantor trust held for more than one year. Look-through capital gain is the share of collectibles gain allocable to an interest in a partnership, S corporation, or trust, plus the share of Section 1250 capital gain allocable to an interest in a partnership.16 The share of collectibles gain taken into account is the amount of net gain that would be allocated to the partner, shareholder, or beneficiary if the partnership, corporation, or trust transferred all of its collectibles for cash equal to the fair market value of the assets in a fully taxable transaction immediately before the transfer of the interest; a similar rule applies to Section 1250 capital gain.17 Any capital gain remaining after accounting for look-
through capital gain is treated in the normal way by the partner, shareholder, or beneficiary.18 For years beginning after 2002 and ending before 2010, net capital gain is increased by the amount of qualified dividend income, namely, dividends received from domestic corporations and qualified foreign corporations.19 Tax years from 2008 through 2010 will be subject to various temporary and transitional rules. Taxation of long-term capital gains from sales or exchanges of securities during these years will be based on three principles: First, the basic tax rate for long-term capital gain and qualified dividend income will be 15 percent. This is the rate that will apply to ordinary sales of securities, that is, sales which are not affected by recapture, special capital gains rates for collectibles, etc. Second, if the taxpayer’s income would otherwise be taxed at the 10 or 15 percent tax bracket, then a zero percent capital gains rate will apply.
Example: In the year 2008, for a married couple filing jointly, the 25 percent marginal bracket starts with taxable income of $65,100. If a couple has $70,000 of taxable income, $10,000 of which is attributable to long-term capital gains, then we look at the marginal bracket that the $10,000 would be in. Thus, hypothetically applying regular rates, $5,100 of that long-term capital gain would be taxed at 15 percent, and $4,900 would be taxed at 25 percent. The $4,900 is subject to the basic long-term capitals gains rate of 15 percent, and the $5,100 is not subject to taxes at all. After calculating the 15 percent tax on $4,900, that product is adding to the tax at the regular rates that would apply to the remaining $60,000 of taxable income. If that same couple had $65,100 or less of taxable income, including long-term capital gains, then there would be no tax at all on their long-term capital gains and only their other income would be taxable.
Third, the scope of the so-called “kiddie tax,” an ever-present consideration when calculating tax liability on investment income, has been expanded in recent years. In the Small Business and Work Opportunity Act of 2007 (the “2007 Small Business Act”),20 there were several changes made to the scope of individuals covered by the kiddie tax, that is individuals whose investment income over an amount exempt from the kiddie tax ($1,800 in 2008) would be taxed at the parent’s marginal bracket:
(1) Prior law enacted in 2006 applied the kiddie tax to individuals who had not attained age 18 at the end of the year. The 2007 Small Business Act extended the kiddie tax to cover individuals who had not attained age 19 at the end of the year.
(2) The 2007 Small Business Act further applied the kiddie tax to an individual who had not attained age 24 at the end of the year if he or she is a full-time student for at least five months of the year, and the individual’s earned income (salary and net income from self-employment) is not more than half of his or her support for the year.
These expanded rules are applicable to tax years after enactment date May 25, 2007, which means for individuals on a calendar year they are first effective with calendar year 2008. Based on tax law in effect as of the end of 2008, the foregoing will determine how qualified dividends and long-term capital gains from sales and exchanges of securities will be taxed in the years 2008 to 2010. Although the tax law is scheduled to return to its pre-2001 state after 2010, the likelihood is that some intervening legislation will be enacted that will continue the lower rates, although perhaps in some modified form. Excluded for the definition of qualified dividend is any dividend received from a tax-exempt corporation, any amount allowed as a deduction for dividends paid by mutual savings banks, and any amount allowed as a deduction for dividends paid on employer securities to pension plan participants.21 Also excluded is any dividend on a share of stock (i) with respect to which the holding period requirements of IRC Section 246(c) are not met, substituting "60 days" for "45 days" each time it appears and "121-day period" for "91-day period," or (ii) to the extent that the taxpayer is under an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property.22 A qualified foreign corporation is defined as any corporation incorporated in a possession of the United States, or any corporation that is eligible for benefits of a comprehensive income tax treaty with the United States that the Secretary of the Treasury determines is satisfactory for purposes of the definition of a qualified foreign corporation and that includes an exchange of information program.23 A foreign corporation can be treated as a qualified corporation if the stock with respect to which the dividend is paid is readily tradable on an established securities market in the United States.24 A corporation cannot be a qualified foreign corporation if, in the year the dividend is paid, the corporation is a foreign personal holding company, a foreign investment company, or a passive foreign investment company.25
Three special rules apply. Qualified dividend income does not include any amount taken into account as investment income under IRC Section 163(d)(4)(B).26 If a taxpayer receives, with respect to a share of stock, qualified dividend income from one or more dividends that are extraordinary dividends (within the meaning of IRC Section 1059(c)), any loss on a sale or exchange of the share is treated as long-term capital loss to the extent of the dividends.27 Any dividend received from a regulated investment company or real estate investment trust is subject to the limitations prescribed in IRC Sections 854 and 857.28 [ii] Gain on Sale or Exchange of Qualified Small Business Stock. IRC Section 1202(a)(1), added by the Omnibus Budget Reconciliation Act of 1993, provides a noncorporate taxpayer with an exclusion from gross income of 50 percent of any gain from the sale or exchange of qualified small business stock held for more than five years.29 However, if the taxpayer has such gain ("eligible gain") for a taxable year from one or more dispositions of stock issued by any corporation, the aggregate amount of eligible gain from dispositions of qualified small business stock of that corporation in the taxable year cannot exceed the greater of (a) $10 million ($5 million in the case of a separate return by a married individual)30 reduced by the amount of eligible gain excluded from gross income for prior taxable years and attributable to dispositions of stock issued by the corporation, or (b) ten times the aggregate adjusted bases of qualified small business stock issued by the corporation and disposed of by the taxpayer during the taxable year.31 Stock is qualified small business stock if:
(1) it is originally issued by a C corporation after August 10, 1993;
(2) the corporation is a qualified small business; and
(3) the stock is acquired by the taxpayer at its original issue (directly or through an underwriter) either in exchange for money or other property (not including stock), or as compensation for services provided to the issuing corporation, other than as an underwriter of the stock.32
Stock acquired by the taxpayer is not treated as qualified small business stock if, in one or more purchases during the four- year period beginning on the date two years before the issuance of the stock, the issuing corporation purchased (directly or indirectly) more than a de minimis amount of its stock from the taxpayer or a person related to the taxpayer within the meaning of IRC Section 267(b) or 707(b).33 Stock issued by a corporation is also not qualified small business stock if, in one or more purchases during the two-year period beginning on the date one year before the issuance of the stock, the corporation purchases more than a de minimis amount of its stock and the purchased stock has an aggregate value (at the time of the respective purchases) exceeding 5 percent of the aggregate value of its stock as of the beginning of the two- year period.34 If any transaction is treated as a distribution in redemption of the stock of the corporation under IRC Section 304(a), the corporation is treated as if it purchased an amount of its stock equal to the amount treated as a distribution under Section 304.35 A transfer of stock to an employee or independent contractor (or to a beneficiary of an employee or independent contractor) is not treated as a purchase of stock by the issuing corporation.36 A stock purchase is disregarded if the stock is acquired in the following circumstances:
(1) The stock was acquired by the seller in connection with the performance of services as an employee or director and the stock is purchased from the seller incident to the seller's retirement or other bona fide termination of such services;
(2) Prior to a decedent's death, the stock (or an option to acquire the stock) was held by the decedent or the decedent's spouse (or by both), by the decedent and a joint tenant, or by a trust revocable by the decedent or the decedent's spouse (or both), and, within three years and nine months from the date of the decedent's death, the stock is purchased from the decedent's estate, beneficiary, heir, surviving joint tenant, surviving spouse, or from a trust established by the decedent or decedent's spouse;
(3) The stock is purchased incident to the disability or mental incompetence of the selling shareholder; or
(4) The stock is purchased incident to the divorce of the selling shareholder.37
For purposes of IRC Section 1202, any domestic C corporation can be a qualified small business if:
(1) the aggregate gross assets of the corporation (or any predecessor) at all times on or after August 10, 1993, and before issuance of the stock, did not exceed $50 million;
(2) the aggregate gross assets of the corporation immediately after the issuance (determined by taking into account
amounts received in the issuance) do not exceed $50 million; and (3)
the corporation agrees to submit such reports to the Service and to shareholders as the Service may require to carry out the purposes of IRC Section 1202.38
All corporations that are members of the same parent-subsidiary controlled group are treated as one corporation for this purpose.39 Stock will not be treated as qualified small business stock unless, during substantially all of the taxpayer's holding period for the stock, at least 80 percent (by value) of the assets of the corporation are used by it in the active conduct of one or more qualified trades or businesses, and the corporation is not:
(1) a domestic international sales corporation (DISC) or former DISC;
(2) a corporation with respect to which an election under IRC Section 936 is in effect or that has a direct or indirect subsidiary with respect to which such an election is in effect;
(3) a regulated investment company (RIC), real estate investment trust (REIT), or real estate mortgage investment conduit (REMIC); or
(4) a cooperative.40
For this purpose, a qualified trade or business is any trade or business other than:
(1) trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or any trade or business where the principal asset is the reputation or skill of one or more of its employees;
(2) any banking, insurance, financing, leasing, investing, or similar business;
(3) any farming business (including the business of raising or harvesting trees);
(4) any business involving the production or extraction of products of a character with respect to which a deduction for depletion is allowable under IRC Section 613 or 613A; or
(5) any business of operating a hotel, motel, restaurant or similar business.41
A corporation will fail the active business requirement for any period during which more than 10 percent of the value of its net assets consists of stock or securities in other corporations that are not subsidiaries; a special exception is provided for assets held as part of the working capital of the corporation.42 It will fail the requirement for any period during which more than 10 percent of the total value of its assets consists of real property that is not used in the active conduct of a qualified trade or business.43 On the other hand, the active business requirement is automatically met for any period during which the corporation qualifies as a specialized small business investment company that is licensed to operate under Section 3(d) of the Small Business Investment Act of 1958 (as in effect on May 13, 1993).44 IRC Section 1202(g) governs the treatment of the holder of an interest in a pass-through entity (partnership, S corporation, regulated investment company, or common trust fund) that sells or exchanges qualified small business stock. First, in determining whether the stock qualifies as qualified small business stock, the entity is treated as an individual and must have held the stock for more than five years.45 Second, the taxpayer must have held the interest in the pass-through entity at the time it acquired the stock and at all times thereafter until the disposition of the stock by the entity.46 Third, the amount excludable by the taxpayer is limited to the interest held by the taxpayer in the pass-through entity at the time the qualified small business stock was acquired.47 Pursuant to IRC Section 1202(j), a taxpayer with an offsetting short position with respect to any qualified small business stock is not permitted to take advantage of the exclusion provided by IRC Section 1202(a) unless the stock was held by the taxpayer for more than five years as of the first day on which there was a short position, and the taxpayer elects to recognize gain as if the stock were sold on that day at its fair market value. The taxpayer is deemed to have an offsetting short position with respect to any qualified small business stock if:
(1) the taxpayer has made a short sale of substantially identical property;
(2) the taxpayer has acquired an option to sell substantially identical property at a fixed price; or
(3) to the extent provided in regulations, the taxpayer has entered into any other transaction that substantially
reduces the risk of loss from holding the qualified small business stock.48
Two other consequences derive from the sale of qualified small business stock come within the ambit of IRC Section 1202. The first is that 42 percent of the excluded gain is treated as an item of tax preference for minimum tax purposes.49 The second imposes a penalty for failure to file any report required under IRC Section 1202.50 A second provision, IRC Section 1045(a) permits a noncorporate taxpayer to elect to roll over tax-free gain from the sale or exchange of qualified small business stock held for more than six months if the taxpayer uses the proceeds of sale to purchase other qualified small business stock within 60 days of the sale.51 Thus, gain from the sale is recognized only if the amount realized on the sale exceeds the cost of the new stock. Generally, the holding period of the stock purchased will include the holding period of the stock sold, except for determining whether the six-month holding period is met.52 A partnership that sells qualified small business stock held for more than six months and purchases replacement qualified small business stock can elect to roll over the gain under IRC Section 1045.53 An eligible partner of a partnership that sells qualified small business stock can make the election if the partner purchases replacement qualified small business stock directly or through a partnership in which the taxpayer is a partner (directly or through an upper-tier partnership).54 A taxpayer (other than a C corporation) that sells qualified small business stock and elects to roll over the gain can satisfy the replacement qualified small business stock requirement with qualified small business stock that is purchased within the 60- day period by a partnership in which the taxpayer is a partner on the day the replacement stock is purchased.55 A partnership that holds qualified small business stock for more than six months, sells the stock and purchases replacement stock can make an election under IRC Section 1045.56 If the partnership makes the election, each partner does not recognize its distributive share of Section 1045 gain unless the partner opts out of the election.57 Partnership Section 1045 gain equals the partnership’s gain from the sale of the stock reduced by the greater of (i) the amount of gain from the sale of the stock treated as ordinary income, or (ii) the excess of the amount realized by the partnership on the sale over the total cost of all replacement qualified small business stock purchased by the partnership (excluding the cost of any replacement stock purchased by the partnership that is otherwise taken into account under IRC Section 1045).58 A partner’s distributive share of partnership Section 1045 gain must be in the same proportion as the partner’s share of the partnership’s gain from the sale of the qualified small business stock.59 The quid pro quo for nonrecognition is a basis adjustment. The amount of gain not recognized is applied to reduce the basis of any qualified small business stock acquired during the 60-day period.60 The election under IRC Section 1045 must be made on or before the later of December 31, 1998, or the due date (including extensions) for filing the income tax return for the taxable year in which the qualified small business stock is sold.61 The election is made by:
(1) reporting the entire gain from the sale of qualified small business stock on Schedule D of the taxpayer's return;
(2) writing "section 1045 rollover" directly below the line on which the gain is reported; and
(3) entering the amount of deferred gain on the same line as (2) as a loss.
The election is revocable only with the prior written consent of the Commissioner. [iii] Gain on Sale or Exchange of DC Zone Asset. A belief that one of the major problems faced by the District of Columbia was insufficient economic activity led Congress to provide, among other things, for a zero percent rate for qualified capital gain from the sale or exchange of any DC Zone asset held for more than five years.62 Qualified capital gain is defined as any gain recognized on the sale or exchange of a capital asset or property used in the trade or business (as defined in IRC Section 1231(b)).63 It does not include any gain
(1) attributable to periods before January 1, 1998, or after December 31, 2007;
(2) that would be treated as ordinary income under IRC Section 1245 or under IRC Section 1250 if that provision applied to all depreciation rather than additional depreciation;
(3) that is attributable to real property, or an intangible asset, that is not an integral part of a DC Zone business; or
(4) attributable, directly or indirectly, in whole or in part, to a transaction with a related person.64
A DC Zone asset can be any DC Zone business stock, any DC Zone partnership interest, or any DC Zone business property.65 DC Zone business stock is defined as any stock in a domestic corporation that is originally issued after December 31, 1997, if:
(1) the stock is acquired by the taxpayer before January 1, 2003, at its original issue (directly or through an underwriter) solely in exchange for cash;
(2) as of the time the stock was issued, the corporation was a DC Zone corporation (or, in the case of a new corporation, the corporation was being organized for purposes of being a DC Zone business); and
(3) during substantially all of the taxpayer's holding period for the stock the corporation qualified as a DC Zone business.66
A rule similar to IRC Section 1202(c)(3), discussed in § 1J:2.06[2][a][ii], applies for purposes of the rules relating to DC Zone business stock.67 A DC Zone partnership interest is defined as any capital or profits interest in a domestic partnership that is originally issued after December 31, 1997, if:
(1) the interest was acquired by the taxpayer before January 1, 2003, from the partnership solely in exchange for cash;
(2) as of the time the interest was acquired, the partnership was a DC Zone business (or, in the case of a new partnership, the partnership was being organized for purposes of being a DC Zone business); and
(3) during substantially all of the taxpayer's holding period for the interest, the partnership qualified as a DC Zone business.68
DC Zone property is tangible property if:
(1) the property was acquired by the taxpayer by purchase after December 31, 1997, and before January 1, 2003;
(2) the original use of the property in the DC Zone begins with the taxpayer; and
(3) during substantially all of the taxpayer's period for the property, substantially all of the use of the property was in a DC Zone business of the taxpayer.69
The first two requirements are treated as met with respect to property that is substantially improved by the taxpayer before January 1, 2003, and any land on which the property is located.70 Any DC Zone business stock, DC Zone partnership interest, or DC Zone property acquired on or after January 1, 2003, will be treated as a DC Zone asset if it was such in the hands of a prior holder.71 If any asset ceases to be DC Zone business stock, DC Zone partnership interest, or DC Zone property because the corporation or partnership no longer qualifies as a DC Zone business or the property is no longer used in a DC Zone business, after the five-year period beginning on the date the taxpayer acquired the asset, the asset will continue to be treated as a DC Zone asset, except that the amount of capital gain excluded from income will be limited to the amount that would be qualified capital gain if the property had been sold on the date of cessation.72 A DC Zone business means any entity that is an enterprise zone business (as defined in IRC Section 1397C), determined
(1) without regard to the requirement that at least 35 percent of the business's employees must be residents of an empowerment zone;
(2) by requiring that at least 80 percent of a qualified business entity's total gross income be derived from the active conduct of a trade or business; and
(3) by treating no area other than the DC Zone as an empowerment zone or enterprise zone.73
[iv] Renewal Community Capital Gain. Pursuant to IRC Section 1400F(a), gross income does not include any qualified capital gain from the sale or exchange of a qualified community asset held for more than five years. Qualified capital gain is any gain recognized on the sale or exchange of a capital asset, or property used in a trade or business (as defined in IRC Section 1231(b)), provided the gain is attributable to the period beginning after January 1, 2002 and ending December 31, 2014.74 A qualified community asset is any qualified community stock, any qualified community partnership interest, or any qualified
community business property.75 Qualified community stock is any stock of a domestic corporation if (i) the stock is acquired by the taxpayer after December 31, 2001, and before January 1, 2010, at its original issue (directly or through an underwriter) from the corporation solely in exchange for cash, (ii) as of the time the stock was issued, the corporation was a renewal community business (or, in the case of a new corporation, was being organized for purposes of being a renewal community business), and (iii) during substantially all of the taxpayer's holding period for the stock, the corporation qualified as a renewal community business.76 A qualified community partnership interest is any capital or profits interest in a domestic partnership that meets the same time and business requirements that are imposed for qualified community stock.77 Qualified community business property consists of tangible property if (a) the property was acquired by the taxpayer by purchase after December 31, 2001, and before January 1, 2010, (b) the original use of the property in the renewal community begins with the taxpayer, and (c) during substantially all of the taxpayer's holding period for the property, substantially all of the use of the property was in a renewal community business of the taxpayer.78 Property that is substantially improved by the taxpayer before January 10, 2010, and any land on which such property is located also can be treated as qualified community business property.79 [v] Gain on Rollover of Empowerment Zone Investments. IRC Section 1397B(a) provides that, at the election of the taxpayer, any gain realized on the sale of a qualified empowerment zone asset held by the taxpayer for more than one year will be recognized only to the extent that the amount realized exceeds (1) the cost of any qualified empowerment zone asset (with respect to the same zone as the asset sold) purchased by the taxpayer during the 60-day period beginning on the date of the sale, reduced by (2) any portion of that cost previously taken into account under the provision.80 The consideration exacted for nonrecognition is a corresponding reduction in the basis for determining gain or loss of any qualified empowerment zone asset that is purchased by the taxpayer during the 60-day period mentioned in the preceding sentence.81 Nonrecognition does not extend to (a) any gain that is treated as ordinary income under the Code, or (b) any gain that is attributable to real property, or to an intangible asset that is not an integral part of an enterprise zone business.82 The term "qualified empowerment zone asset" means any property that would be a qualified community asset (as defined in IRC Section 1400F) if in that section (1) references to empowerment zones were substituted for references to renewal communities, (2) references to enterprise zone businesses (as defined in IRC Section 1397C) were substituted for references to renewal community businesses, and (3) any reference to December 31, 2001 is changed to December 21, 2000.83 [b] Treatment of Capital Losses. Capital gains, being gains derived from dealings in property, form part of gross income, unless nonrecognition of gain is specifically mandated by some provision of the Code. Therefore, finding that a transaction qualifies for capital, as opposed to ordinary, treatment has no effect on includability. The same is true of capital losses. Whether an individual may deduct losses incurred in dealings in property is governed solely by IRC Section 165(c). Unless incurred in a trade or business, or in a transaction for profit, the loss cannot be deducted even if the "capital" label has been affixed.84 The ensuing discussion will assume that the threshold question of deductibility has been resolved in favor of the taxpayer. [i] Limiting the Deduction. Although both ordinary losses and capital losses must meet the same criteria for deduction, the extent to which capital losses are deductible is limited.85 Total deduction of capital losses is permitted in any year that capital gains exceed capital losses. For example, if a taxpayer has long-term gains of $2,000, long-term losses of $3,000, short-term gains of $4,000 and short-term losses of $2,000, deduction would be allowed for all of the long-term losses and all of the short-term losses since total gains ($6,000) are greater than total losses ($5,000). The fact that the taxpayer has a net long-term capital loss is of no moment; the amount of the deduction is tested by reference to aggregate gains and losses. The impact of the limitation is felt whenever the sum of the capital losses sustained in a tax year is greater than the aggregate capital gain for the year. In such event, IRC Section 1211(b)(1) allows a deduction only to the extent of the gains realized during the year, plus the lower of (1) $3,000 ($1,500 in the case of a husband or wife filing a separate return), or (2) the excess of capital losses over capital gains. [ii] Capital Loss Carryover. We have just seen that IRC Section 1211(b)(1) limits the amount of capital loss that can be deducted in the year in which the loss is sustained. Once losses exceed the deductible amount the taxpayer must find relief in the carryover provisions of IRC Section 1212(b).86 We may witness the working of the latter section by considering the taxpayer with taxable income greater than $3,000 who sustains a short-term loss of $1,500 and a long-term loss of $10,500 in the taxpayer's only capital transactions. The
deduction in the year of loss is limited to $3,000; the carryover to the first succeeding year consists of $9,000 of long-term loss.87 If in that year, the taxpayer realizes no capital gains, the deduction will be limited to $3,000. The carryover to the next succeeding year will be $6,000, all of which will be deemed a long-term capital loss. If, in the second carryover year, a capital gain of $3,000 is realized, the balance of the carryover loss will be completely deductible. A special carryback rule comes into play if the taxpayer has a "net Section 1256 contracts loss"88 for the taxable year and elects to have the provisions of IRC Section 1212(c) apply.89 The amount of such loss is allowed as a carryback to each of the three taxable years preceding the loss year, to the extent the amount does not exceed the net Section 1256 contract gain for such year90 or increase or produce a net operating loss, with 40 percent of the amount allowed treated as a short- term capital loss from Section 1256 contracts and the balance as a long-term capital loss from such contracts.91 A further consequence is the effect on the loss carryover rules of IRC Section 1212(b)(1). The amounts carried back are treated as short-term and long-term capital gains in the same percentages as they are carried back, thereby reducing the amount of the carryover.92 In addition, any amount carried forward after the carryback retains its character as a Section 1256 contracts loss.93 [3] The Corporate Taxpayer [a] Treatment of Capital Gains [i] In General. The characterization of gain as capital gain is controlled by the same criteria whether the taxpayer is a corporation or an individual. However, unlike noncorporate taxpayers, net capital gains realized by corporations are taxed at the same rate applied to corporate ordinary income.94 [ii] Gain on Sale or Exchange of DC Zone Asset. Pursuant to IRC Section 1400B, the gross income of corporate taxpayers does not include qualified capital gain from the sale or exchange of a DC Zone asset held for more than five years. See § 1J:2.06[2][a][iii] for a discussion of IRC Section 1400B. [b] Treatment of Capital Losses [i] Limiting the Deduction. As in the case of noncorporate taxpayers, the extent to which capital losses are allowed as a deduction is limited. However, in the case of a corporation, capital losses are allowed only to the extent of capital gains, and no part of any excess loss may be offset against ordinary income.95 The entire excess forms part of the corporation's capital loss carryover. [ii] Capital Loss Carryover. Perhaps the only similarity in the manner in which corporations and noncorporate taxpayers handle capital loss carryovers is in treating the loss as one sustained in the year to which it is carried. The first difference is that, if a corporation cannot fully deduct a long-term capital loss in the year incurred, the nondeductible portion is treated as a short-term loss when carried to another year. The second difference concerns the period to which losses may be carried. The corporate taxpayer that suffers a capital loss has a carryover period of five years and a capital loss carryback to each of the three years preceding the loss year.96 However, if the corporation is a regulated investment company there is no carryback, but the loss may be carried forward for a period of eight years.97 Special rules attend the carryback of a capital loss. It may not be carried back if attributable to a foreign expropriation loss, or98 if it increases or produces a net operating loss (as defined in IRC Section 172(c)) for the taxable year to which the loss is carried back.99100 Furthermore, a loss may not be carried back to a year for which the taxpayer was a regulated investment company or a real estate investment trust. The entire net capital loss for any taxable year must first be carried to the earliest year to which the loss can be carried. Normally, this will be the third year preceding the loss year unless carryback to such year is prohibited by any of the reasons previously mentioned. If net capital gains101 in the year to which the loss is first carried are insufficient to absorb the entire loss, the balance of the loss is carried, in order, to the other years to which it can be carried, until completely deducted or until the period limitation bars further deduction. Although the statute does not specifically provide the order of deduction, it is assumed that if losses incurred in two years are carried back or carried forward to the same year, the earlier incurred loss is the first to be deducted.102 On October 3, 2008, the President signed into law the Emergency Economic Stabilization Act of 2008.103 This is the comprehensive legislation generally known for its $700 billion bailout of financial institutions.
The Act, intended as a multifaceted approach to the financial crises, consisted of three separately-titled divisions: the Emergency Economic Stabilization Act of 2008, the Energy Improvement and Extension Act of 2008, and the Tax Extenders and Alternative Minimum Tax Relief Act of 2008. Most of the Act is beyond the scope of this book, however, the tax provisions that are relevant to this book are mostly contained within the last division, sometimes referred to as the “Extenders Act” or “TEAMTRA.” Although most of the tax provisions of the Act are in the third division, the first division contains some tax provisions as well. The first division is the bail-out core of this massive legislation, centering around a “Troubled Assets Relief Program,” or TARP. Tax provisions of TARP include a special rule regarding financial institutions (as defined by IRC Section 582(c)(2)) holding preferred stock in the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”).104 The Act permits losses on these to be treated as ordinary losses rather than as capital losses. This relief provision generally entitles these corporate preferred shareholders to deduct loses currently, rather than to carry them forward, in case there were inadequate capital gains against which capital losses could be taken (which would likely be the case for these financial institutions). This relief applies to such stock which either:
(1) was held by the applicable financial institution on September 6, 2008, or
(2) (was sold or exchanged by the applicable financial institution on or after January 1, 2008, and before September 7, 2008. 105
The Act authorizes regulations to extend ordinary loss treatment to preferred stock not owned by the financial institution on September 6, 2008, if:
(1) the financial institution sells or exchanges applicable preferred stock after September 6, 2008, which the institution did not hold on such date, but the basis of which in the hands of the institution at the time of the sale or exchange is the same as the basis in the hands of the person which held such stock on such date, or
(2) the financial institution is a partner in a partnership which either (a) held such stock on September 6, 2008, and later sold or exchanged such stock, or (b) sold or exchanged such stock after September 6, 2008.106
This relief provisions applies only to corporations. Noncorporate taxpayers will continue to be able to deduct these losses only to the extent of gains (plus $3,000 in the case of individual taxpayers), with the excess losses carried forward to future years. FOOTNOTES (**) Written by Martin L. Fried, Crandall Melvin Professor of Wills and Trusts, Syracuse University, Syracuse, New York. Chapter excerpted from M. Fried, Taxation of Security Transactions (LexisNexis Matthew Bender & Co., Inc.). Updated by Patricia A. Tyler, J.D., LL.M., LexisNexis Federal Tax Analyst. (1) IRC § 1222(8). (2) IRC § 1222(5). (3) IRC § 1222(6). (4) IRC § 1222(11). (5) IRC § 1222(10). (6) IRC § 1222(10). (7) IRC § 1202 prior to its repeal by the Tax Reform Act of 1986. (8) IRC § 1(h). Notice 2004-39, 2004-1 CB 982, provides guidance to regulated investment companies, real estate
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investment trusts, and their shareholders in applying IRC § 1(h) to capital gain dividends of the entities. (9) Jobs and Growth Tax Relief Reconciliation Act of 2003, § 303. The rates revert to pre-2003 rates for taxable years beginning after Dec 31, 2010. (10) Transitional rules are provided for years that include May 6, 2003. (11) IRC § 1(h)(1)(B). For years 2003-2010, adjusted net capital gain is increased by the amount of qualified dividend income.Adjusted net capital gain must be reduced by the amount of such gain that the taxpayer elects to treat as investment income for purposes of IRC § 163(d)(4)(B). (12) IRC § 1(h)(3). Generally, collectibles gain is gain from the sale of any work of art, any rug or antique, any metal or gem, any stamp or coin, or any alcoholic beverage. IRC §§ 1(h)(5)(A), 408(m)(2).Any gain from the sale of an interest in a partnership, S corporation, or trust that is attributable to unrealized appreciation in the value of collectibles is treated as gain from the sale of a collectible. IRC § 1(h)(5)(B). Rules similar to the rules of IRC § 751 apply for this purpose.For stock acquired before Dec 22, 2000, IRC § 1202 gain is an amount equal to the gain excluded from gross income under IRC § 1202(a). For stock acquired after Dec 21, 2000, IRC § 1202 gain is the excess of (a) the gain that would be excluded from gross income under IRC § 1202 but for the percentage limitation in IRC § 1202(a), over (b) the gain excluded from gross income under IRC § 1202. IRC § 1(h)(7). (13) IRC § 1(h)(1)(C). (14) Regulations provide that, if capital gain from an installment sale of real property includes unrecaptured Section 1250 gain taxed at 25 percent as well as capital gain taxed at 15 or 5 percent, the taxpayer must account for the 25-percent gain before any of the 15- or 5-percent gain is included in income. Treas Reg § 1.453-12(a).The regulations also provide that Section 1231 gain from an installment sale that is recharacterized as ordinary income under either IRC § 1231(a) or IRC § 1231(c) is deemed to consist first of 25-percent gain and then of 15- or 5-percent gain. (15) Notice 97-59, 1997-2 CB 309. See Notice 98-20, 1998-1 CB 776, for use of the netting rules in determining how a charitable remainder trust characterizes capital gain distributions. 1998-1 CB 776, Notice 98-20 was modified by Notice 99- 17, 1999-1 CB 871, to reflect later legislative changes. (16) Treas Reg § 1.1(h)-1(b)(1). In determining whether a partnership, S corporation, or trust has gain from collectibles, the partnership, corporation or trust shall be treated as owning its proportionate share of any partnership, S corporation, or trust in which it owns an interest directly or indirectly through a chain of such entities. This tiered-entity rule also applies with respect to Section 1250 capital gain of a partnership. Treas Reg § 1.1(h)-1(d). (17) Treas Reg § 1.1(h)-1(b)(2)(ii), (3)(ii). The rules do not apply to a transaction that is treated, for federal income tax purposes, as a redemption of an interest in a partnership, S corporation, or trust. (18) Treas Reg § 1.1(h)-1(c).If less than all of the realized gain is recognized upon the sale of the interest, the same methodology applies to determine the collectibles gain recognized by the transferor, except that the partnership, S corporation, or trust is treated as transferring only a proportionate amount of each of its collectibles determined as a fraction that is the amount of gain recognized in the sale or exchange over the amount of gain realized in the transaction. Treas Reg § 1.1(h)-1(b)(2)(ii). The same calculation is made when there is Section 1250 gain and not all of the gain is recognized upon the sale or exchange of a partnership interest. Treas Reg § 1.1(h)-1(b)(3)(ii). (19) IRC § 1(h)(11)(A), (B)(i). Rules similar to the rules contained in IRC § 904(b)(2)(B) (capital gain rate differential) apply in determining any limitation on the foreign tax credit for dividends received from a foreign corporation. IRC § 1(h)(11)(C) (iv). See § 1J:26.02[4][e][i] for a discussion of IRC § 904(2)(b)(B).The Service has determined that it is appropriate for a partner of an electing large partnership to take into account separately the partner's distributive share of the partnership's dividends received that are qualified dividend income. 2004-1 CB 489, Notice 2004-5. (20) This was a part of the U.S. Troop Readiness, Veterans' Care, Katrina Recovery, Iraq Accountability Appropriations Act (Pub L No 110-28, May 25, 2007). (21) IRC § 1(h)(11)(B)(ii). (22) IRC § 1(h)(11)(B)(iii). The rules of IRC § 246(c)(1) can be found in § 1J:5.04[2][a][v]. (23) IRC § 1(h)(11)(C)(i). Notice 2006-101, 2006-47 IRB 930, contains the current list of US tax treaties that meet this requirement. (24) IRC § 1(h)(11)(C)(ii). Common or ordinary stock, or an American depositary receipt in respect of such stock, is considered readily tradable on an established securities market in the US if it is listed on a national securities exchange that is registered under § 6 of the Securities Exchange Act of 1934 or on the Nasdaq Stock Market. As of Sept 30, 2002 registered national exchanges include the American Stock Exchange, the Boston Stock Exchange, the Cincinnati Stock
Exchange, the Chicago Stock Exchange, the New York Stock Exchange, the Philadelphia Stock Exchange, and the Pacific Exchange, Inc.Notice 2003-71, 2003-2 CB 922. (25) IRC § 1(h)(11)(C)(iii). 2004-2 C.B. 724, Notice 2004-70, provides guidance regarding the extent to which distributions, inclusions, and other amounts received by, or included in the income of, individual shareholders as ordinary income from controlled foreign corporations, foreign personal holding companies, foreign investment companies, and passive foreign investment companies may be treated as qualified dividend income. (26) IRC § 1(h)(11)(D)(i). (27) IRC § 1(h)(11)(D)(ii). (28) IRC § 1(h)(11)(D)(iii). Regulated investment companies are the subject of Chapter 1J:15; real estate investment trusts are the subject of Chapter 1J:17. (29) If qualified small business stock is acquired after Dec 21, 2000, in a corporation that is a qualified business entity in an enterprise zone during substantially all of the taxpayer's holding period for the stock, the amount of excluded gain increases to 60 percent. IRC § 1202(a)(2)(A). The provision does not apply to gain attributable to periods after Dec 31, 2014. IRC § 1202(a)(2)(C).The District of Columbia Enterprise Zone is not treated as an empowerment zone for purposes of IRC § 1202 (a)(2). IRC § 1202(a)(2)(D). (30) IRC § 1202(b)(3)(A). The limitation is applied on a shareholder-by-shareholder basis. HR Rep No 213, 103d Cong, 1st Sess 13 (1993). (31) IRC § 1202(b)(1). The adjusted basis of any stock is determined without regard to any addition to basis after the date on which the stock was originally issued. Contributed property is valued at its fair market value on the date of contribution. HR Rep No 213, 103d Cong, 1st Sess 13-14 (1993).In the case of a joint return, the amount of excludable gain is allocated equally between the spouses for purposes of applying the limitation in subsequent taxable years. IRC § 1202(b)(3)(B). (32) IRC § 1202(c)(1). If property other than money or stock is exchanged for stock, the basis of the acquired stock cannot be less than the fair market value of the property exchanged. IRC § 1202(i)(1)(B). If the adjusted basis of any qualified small basis stock is adjusted by reason of a contribution to capital after the date on which the stock was originally issued, in determining the amount of the adjustment the basis of the contributed property is treated as not less than its fair market value on the date of contribution. IRC § 1202(i)(2).Stock in a corporation acquired on the conversion of other stock in the corporation that is qualified small business stock in the hands of the taxpayer is treated as qualified small business stock held during the period that the converted stock was held. IRC § 1202(f)(2). Qualified small business stock acquired by gift, at death, or from a partnership by a partner will also be considered qualified small business stock in the hands of the transferee. IRC § 1202(h)(1), (2). The same holds true for incorporating transfers governed by IRC § 351 or reorganizations defined in IRC § 368, but only to the extent of the gain that would have been realized had the transfer been deemed taxable. The latter limitation does not apply if the issuing corporation is a qualified small business corporation at the time of the transfer. IRC § 1202(h)(4). (33) IRC § 1202(c)(3)(A); Treas Reg § 1.1202-2(a)(1). For this purpose, stock acquired from the taxpayer or a related person exceeds a de minimis amount if the aggregate amount paid for the stock exceeds $10,000 and more than 2 percent of the stock held by the taxpayer is acquired. In ascertaining whether the 2-percent limit is exceeded, the percentage of stock acquired in any single purchase is determined by dividing the stock's value (as of the time of purchase) by the value (as of the time of purchase) of all stock held, directly or indirectly, by the taxpayer and related persons immediately before the purchase. The percentage of stock acquired in multiple purchases is the sum of the percentages determined for each separate purchase. Treas Reg § 1.1202-2(a)(2). (34) IRC § 1202(c)(3)(B); Treas Reg § 1.1202-2(b)(1). Stock exceeds a de minimis amount only if the aggregate amount paid for the stock exceeds $10,000 and more than 2 percent of all outstanding stock is purchased. In ascertaining whether the 2-percent limit is exceeded, the percentage of stock acquired in any single purchase is determined by dividing the stock's value (as of the time of purchase) by the value (as of the time of purchase) of all stock outstanding immediately before the purchase. The percentage of stock acquired in multiple purchases is the sum of the percentages determined for each separate purchase. Treas Reg § 1.1202-2(b)(2). (35) IRC § 1202(c)(3)(C). (36) Treas Reg § 1.1202-2(c). (37) Treas Reg § 1.1202-2(d). (38) IRC § 1202(d)(1). The term "aggregate gross assets" means the amount of cash and the aggregate adjusted bases of other property held by the corporation. IRC § 1202(d)(2)(A). The adjusted basis of any property contributed to the corporation (or other property with a basis determined in whole or in part by reference to the adjusted basis of the property
so contributed) is determined as if the basis of the property immediately after the contribution were its fair market value at that time. IRC § 1202(d)(2)(B). (39) IRC § 1202(d)(3)(A). The term "parent-subsidiary controlled group" means any controlled group of corporations as defined in IRC § 1563(a)(1), except that the required ownership level is reduced from 80 percent to 50 percent. IRC § 1202 (d)(3)(B). (40) IRC §§ 1202(c)(2)(A), 1202(e)(1), (4). A parent is deemed to own its ratable share of the assets and conduct its ratable share of the business of any subsidiary in which it owns at least 50 percent of all classes of stock entitled to vote or 50 percent in value of all of the outstanding stock of the subsidiary corporation. IRC § 1202(e)(5)(A), (C). If in connection with any future qualified trade or business, a corporation is engaged in start-up activities described in IRC § 195(c)(1)(A), activities resulting in the payment or incurring of expenditures that can be treated as research and experimental expenditures under IRC § 174, or activities with respect to in-house research expenses described in IRC § 41(b)(4), then assets used in such activities are treated as used in the active conduct of a trade or business. IRC § 1202(e)(2). (41) IRC § 1202(e)(3). (42) IRC § 1202(e)(5)(B). Assets are categorized as working capital if held as part of the reasonably required working capital needs of a qualified trade or business, or held for investment and reasonably expected to be used within two years to finance research and experimentation or increases in the working capital needs of a qualified trade or business. IRC § 1202 (e)(6). (43) IRC § 1202(e)(7). (44) IRC § 1202(c)(2)(B). (45) IRC § 1202(g)(2)(A). (46) IRC § 1202(g)(2)(B). (47) IRC § 1202(g)(3). In applying the per-issuer limitation of IRC § 1202(b), the taxpayer's proportionate share of the adjusted basis of the pass-through entity in the stock is taken into account. (48) IRC § 1202(j)(2). A taxpayer is treated as holding an offsetting short position with respect to qualified small business stock if such a position is held by any person related to the taxpayer within the meaning of IRC § 267(b) or 707(b). IRC § 1202(j)(2). (49) IRC § 57(a)(7). For taxable years ending before May 6, 1997, 50 percent of the excluded gain was an item of tax preference. (50) IRC § 6652(k). The penalty is $50 for each failure to file. It is increased to $100 if the failure is due to negligence or intentional disregard.No penalty is imposed on any failure that is shown to be due to reasonable cause and not willful neglect. (51) The replacement stock must meet the active business requirement for qualified small business stock only for the first six months following the purchase. IRC § 1045(b)(4)(B).Rules similar to the rules contained in IRC § 1202(f), (g), (h), (i), (j) and (k) apply to IRC § 1045(a). IRC § 1045(b)(5). (52) IRC § 1045(b)(4)(A). (53) Treas Reg § 1.1045-1(a). (54) Id.; Treas Reg §§ 1.1045-1(c)(1)(i), 1.1045-1(g)(3)(i). (55) Treas Reg § 1.1045-1(a). (56) Treas Reg § 1.1045-1(b)(1). (57) Id.; Treas Reg § 1.1045-1(b)(4). (58) Treas Reg § 1.1045-1(b)(1). The adjusted basis of a partner’s interest in a partnership is not increased under IRC § 705 (a)(1) by gain from a partnership’s sale of qualified small business stock that is not recognized by the partner as a result of a partnership election under IRC § 1045. Treas Reg § 1.1045-1(b)(3)(i). (59) Treas Reg § 1.1045-1(b)(2). (60) IRC § 1045(b)(3). The basis of a partnership’s replacement qualified small business stock is reduced by the amount of
gain from its sale of qualified small business stock that is not recognized by a partner as a result of the partnership’s election under IRC § 1045. Treas Reg § 1.1045-1(b)(3)(ii). (61) Rev Proc 98-48, 1998-2 CB 367. A taxpayer with more than one sale of qualified small business stock that qualifies for the election can make the election for any one or more of the sales. (62) IRC § 1400B(a). The legislation is part of the package creating the District of Columbia Enterprise Zone. See IRC § 1400. Notice 98-57, 1998-2 CB 669, identifies the census tracts in the District of Columbia constituting the District of Columbia Enterprise Zone for purposes of IRC § 1400 and the DC Zone for purposes of IRC § 1400B. (63) IRC § 1400B(e)(1). (64) IRC § 1400B(e)(2), (3), (4), (5). Persons are related if described in IRC § 267(b) or IRC § 707(b)(1).In the case of the sale or exchange of an interest in a partnership, or stock in an S corporation, that was a DC Zone business during substantially all of the period the taxpayer held the interest or stock, the amount of qualified capital gain is determined without regard to any gain attributable to real property, or an intangible asset, that is not an integral part of a DC Zone business, and any gain attributable to periods before January 1, 1998, or after December 31, 2007. IRC § 1400B(g). (65) IRC § 1400B(b)(1). The termination of the designation of the DC Zone is disregarded for purposes of determining whether any property is a DC Zone asset. IRC § 1400B(b)(5). (66) IRC § 1400B(b)(2)(A). (67) IRC § 1400B(b)(2)(B). IRC § 1202(c)(3) contains rules relating to purchases by a corporation of its own stock for purposes of the 50 percent gain exclusion for small business stock. Rules contained in IRC § 1202(g), (h), (i)(2), and (j) also apply for purposes of IRC § 1400B. (68) IRC § 1400B(b)(3). A rule similar to IRC § 1202(c)(3) applies for purposes of determining whether a partnership interest is a DC Zone partnership interest. (69) IRC § 1400B(b)(4)(A). Purchase here has the same definition as in IRC § 179(d)(2). In general, this means the property cannot be acquired from a related party or a member of the same controlled group, and cannot have a substituted basis or a basis determined under IRC § 1014 (property acquired from a decedent). (70) IRC § 1400B(b)(4)(B)(i). Property is treated as substantially improved by the taxpayer only if, during any 24-month period beginning after December 31, 1997, additions to basis with respect to such property exceed the greater of the amount equal to the adjusted basis of the property at the beginning of the 24-month period in the hands of the taxpayer, or $5,000. IRC § 1400B(b)(4)(B)(ii). (71) IRC § 1400B(b)(6). (72) IRC § 1400B(b)(7). (73) IRC § 1400B(c). See § 1J:23.03[3][c][ii] for a discussion of IRC § 1397C. (74) IRC § 1400F(c)(1), (2). Rules similar to those contained in IRC § 1400B(e)(3), (4), and (5), relating to gain that is not qualified gain on the sale or exchange of a DC Zone asset apply here. IRC § 1400F(c)(3). In addition, rules similar to the rules of IRC § 1400B(b)(5), (6), and (7), and IRC § 1400B(f), and (g) are also applicable, except that IRC § 1400B(g)(2) is applied by substituting Jan 1, 2002, for Jan 1, 1998, and Dec 31, 2014, for Dec 31, 2008. IRC § 1400F(d). See § 1J:2.06[2] [a][iii] for a discussion of the provisions relating to sales or exchanges of DC Zone assets. (75) IRC § 1400F(b)(1). (76) IRC § 1400F(b)(2)(A). A rule similar to the rule of IRC § 1202(c)(3) is applicable here. IRC § 1400F(b)(2)(B). See § 1J:2.06[2][a][ii] for a discussion of IRC § 1202(c)(3).A renewal community business is any entity or proprietorship that would be a qualified business entity or qualified proprietorship under IRC § 1397C if reference to renewal communities were substituted for references to empowerment zones in that section. IRC § 1400G. See § 1J:23.03[3][b][ii] for a discussion of IRC § 1397C. (77) IRC § 1400F(b)(3). (78) IRC § 1400F(b)(4)(A). The definition of purchase for this purpose is found in IRC § 179(d)(2). (79) IRC § 1400F(b)(4)(B). Property is substantially improved only if, during any 24-month period beginning after Dec 31, 2001, additions to the basis of the property in the hands of the taxpayer exceed the greater of (i) an amount equal to the
adjusted basis of the property at the beginning of the 24-month period in the hands of the taxpayer, or (ii) $5,000. (80) In determining whether nonrecognition treatment applies, (i) the taxpayer's holding period for the qualified empowerment zone asset that is sold, and for any qualified empowerment zone asset that is acquired during the 60-day period beginning with the sale, is determined without regard to IRC § 1223, and (ii) only the first year of the taxpayer's holding period of the asset acquired during the 60-day period is taken into account in considering whether a corporation or partnership qualifies as a renewal community business or property is used in a renewal community business. IRC § 1397B(b) (5). Rev Proc 2002-62, 2002-2 CB 682, sets forth the procedure for making the election under IRC § 1397B(a).The District of Columbia Enterprise Zone is not treated as an empowerment zone for purposes of IRC § 1397B(b)(1)(B). (81) IRC § 1397B(b)(4). The reduction is on a first-acquired, first-reduced basis. The reduction does not apply for purposes of IRC § 1202.A taxpayer is treated as having purchased any property if, but for the reduction in basis, the unadjusted basis of the property in the hands of the taxpayer would be a cost basis. IRC § 1397B(b)(3). (82) IRC § 1397B(b)(2). (83) IRC § 1397B(b)(1)(A). (84) To be allowable as a deduction under IRC § 165(a), a loss must be evidenced by a closed and completed transaction, fixed by an identifiable event or events, and actually sustained during the taxable year. A decline in the value of stock acquired on the open market, even if due to accounting fraud or other illegal misconduct of officers or directors of the corporation, does not result in an allowable deduction unless the stock becomes wholly worthless. Notice 2004-27, 2004-1 CB 782. (85) IRC § 165(f) limits the deduction to the extent allowed in IRC §§ 1211 and 1212.The Fourth Circuit upheld a conviction for willfully making and subscribing false tax returns on which the taxpayer claimed ordinary losses on securities traded for his own account. Since the taxpayer was not a dealer, the losses were capital losses subject to the limitation on deductibility. US v Diamond, 788 F2d 1025 (4th Cir 1986). (86) The deduction can be taken only by the taxpayer who actually sustains the loss. Therefore, excess capital losses incurred by a decedent before his death do not give rise to a capital loss carryover for his estate. Rev Rul 74-175, 1974-1 CB 52. However, an excess loss incurred by one spouse can be carried over and deducted on joint returns. PLR 8510053. (87) IRC § 1212(b), added by the Revenue Act of 1964, Pub L No 88-272, 88th Cong, 2d Sess, § 230(a), became effective for taxable years beginning after Dec 31, 1963. Prior to this amendment any loss carried over was considered a short-term capital loss even if it had been a long-term loss in the year originally sustained. Furthermore, pre-1964 losses could be carried over only to the five succeeding years, not indefinitely, as is now the case.In determining the extent to which losses carried over are offset by gains realized in the succeeding year, the excess deduction is considered a short-term capital gain. IRC § 1212(b)(2).The amount of the loss carryover from one carryover year to another is affected by the amount that could have been deducted in the first of the years, even though the taxpayer does not claim a loss deduction in that year. Rev Rul 76-177, 1976-1 CB 224. A taxpayer, who did not report a loss in the year in which it was incurred, was entitled to carry over the loss to a subsequent year to offset gains realized in the later year, after adjustment as provided in Rev Rul 76-177. Lang v Commissioner, TC Memo 1983-318. (88) The term "net Section 1256 contracts loss" means the lesser of: (1) the net capital loss for the taxable year taking into account only gains and losses from Section 1256 contracts, namely, regulated futures contracts, foreign currency contracts, nonequity options, and dealer equity options; or (2) the amount of any capital loss carryover to the succeeding taxable year. IRC §§ 1212(c)(4), 1256(b). (89) The provision does not apply to estates or trusts. IRC § 1212(c)(7)(B).An Illinois district court has held that losses from IRC § 1256 contracts that are part of a mixed straddle can be carried back under IRC § 1212(c). Roberts v US, 734 F Supp 314 (ND Ill 1990). (90) The term "net Section 1256 contracts gain" means the lesser of the capital gain net income for the year taking into account only gains and losses from Section 1256 contracts, or the capital gain net income for the year. The net Section 1256 gain for any taxable year before the loss year is computed without regard to the net Section 1256 contracts loss for the loss year or for any taxable year thereafter. IRC § 1212(c)(5). (91) IRC § 1212(c)(1), (3). (92) IRC § 1212(c)(6)(A). (93) IRC § 1212(c)(6)(B).
(94) IRC §§ 11, 1201(a). (95) IRC § 1211(a). (96) IRC § 1212(a)(1)(A). This conforms the treatment of capital losses with that of net operating losses under § 172(b)(1) of the Code.IRC § 383 may become operative to limit the extent to which capital losses may otherwise be carried over if certain changes occur in the ownership of the corporation. (97) IRC § 1212(a)(1)(C)(i). (98) IRC § 1212(a)(1)(A)(i). The ten-year carryforward is still available for such losses. IRC § 1212(a)(1)(C)(ii). (99) IRC § 1212(a)(1)(A)(ii). (100) IRC § 1212(a)(3). (101) Net capital gain is to be given the meaning set forth in IRC § 1222(9), except when a net capital loss cannot be carried back in full to a preceding taxable year because it would increase or produce a net operating loss; the net capital gain for such prior year shall not be treated as greater than the amount of loss which can be carried back to the year. IRC § 1212(a) (1). (102) This is the procedure followed in the case of net operating losses, Treas Reg § 1.172-4(a)(3), and pre-1970 net capital losses, Treas Reg § 1.1212-1(a)(1)(ii), Ex (a). (103) Pub L No 110-343. (104) Emergency Economic Stabilization Act of 2008, Pub L No 110-343, Division A, § 301. (105) Emergency Economic Stabilization Act of 2008, Pub L No 110-343, Division A, § 301(b) and (c)(2). (106) Emergency Economic Stabilization Act of 2008, Pub L No 110-343, Division A, § 301(d).
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