Chapter 11
Property: Capital Gains and Losses, and Depreciation Recapture
Capital Assets Defined
All property that taxpayers own is a capital asset unless it falls into one of the following categories:
1. Inventory held primarily for sale to customers
2. Business receivables, including accounts and notes receivable
3. Depreciable property and land used in a trade or business
4. Copyrights; literary, musical, or artistic compositions; letters; memorandums; etc., created by the taxpayer, or letters and memorandums prepared or produced for the taxpayer
5. U.S. government publications purchased for less than the normal sales price
Capital Assets
" Property held by taxpayer
" Used for personal purposes or investment
" Examples - not inclusive
o Stocks or bonds
o Land held for investment purposes
o Personal residence
o Coins, gems, stamp collection
o Gold, silver, other metals
o Antiques & Household furnishings
o Vehicles
o Purchased artwork
o Partnership interest (some exceptions apply)
Sale of Capital Assets
" Schedule D (Federal & State)
" Capital Gain Rates
o Capital gains are taxed at preferential rates - 0%, 15%, 25% or 28% for sales in 2010
o California DOES NOT have preferential rates
" Factors affecting taxability
o Holding Period of a Capital Asset
" If long-term (held for more than 1 year) special rates apply
" If short-term ordinary rates apply
o Holding period
" Starts the day after purchase
" Includes the holding period of the transferor if received as a gift
" Always long-term if inherited
" Netting of Capital Gains and Losses
o ST gain & LT gain = ST gain is taxed at regular rates & LT gain is taxed at capital gain rates
o ST Gain & LT loss = LT loss reduces ST Gain. If ST gain results it is taxed at ordinary rates. If LT loss results, loss is reported (limited).
o ST Loss & LT Gain requires the LT Gain to be broken down into its components and ST loss reduces 28% LT Gain, then 25% LT Gain, then 15% LT Gain and finally 0% LT Gain.
o ST Loss & LT loss = loss. ST loss is deducted first (limited).
" Type of capital asset - some get special treatment
o Collectibles - 28% bracket
o Qualified small business stock - §1202 - 28% bracket
" Domestic corporation where gross assets have at all times after 1993 been less than $50,000,000
" Exclude 50% of the gain if held for more than 5 years
" $3,000 maximum loss per year allowed against other income
" Excess loss must be carried forward
" Capital Gain Distributions and Sales of Mutual Funds
o What is a mutual fund?
o Determining basis of units of shares
" FIFO
" Specific Identification
" Average Basis
" Worthless Securities
o Must be sold, or deemed worthless
o Deemed sold on last day of year
Gains from Sales Between Certain Related Parties
When individuals sell capital assets to a corporation, they should recognize capital gains or losses. However, for individuals who own more than 50% of the value of the corporation's outstanding stock, capital gain treatment does not apply if the property is depreciable property to the corporation.
Other ways of Producing Capital Gains and Losses
" Nonbusiness bad debts (treated as short-term capital losses)
o Amount
o Date
o Relationship with debtor
o Effort to collect
o Reason for Bad debt
" Net personal casualty or theft gains - Form 4684 - Chapter 5
o Reduced by insurance proceeds, 10% of AGI and $100 for each incident
Section 1231 Property
Real and depreciable business property held long-term is known as Section 1231 property.
Sales of Business Property
" Reported on Form 4797 (State D-1)
" See Form 4797 instructions
" Treatment of §1231 assets varies depending upon…
o Sold at a gain or loss?
o If sold at a gain, was the asset depreciated?
o Was the asset sold, real or personal property?
" Net gains & losses
o If gain, taxed at long-term capital gains rates
o If loss, taxed as ordinary loss
" The only "pure" §1231 asset is land used in a trade in business. Usually we are dealing with depreciable equipment and depreciable buildings.
Recapture of Section 1231 Losses
All gain is taxed, some at ordinary rates and some at capital gain rates. Before net Section 1231 gain can become long-term capital gain, taxpayers must look back over the past five years and compute the amount of unrecaptured Section 1231 losses.
In other words, go back 5 years and add up all of the Section 1231 losses. Subtract that from your 1231 gain. The amount remaining is taxed at capital gain rates. The amount of the Section 1231 unrecaptured losses is taxed at ordinary rates.
Unrecaptured Section 1250 Gain
Unrecaptured Section 1250 gain is computed by subtracting any recaptured depreciation from the lesser of (1) the gain or (2) the total depreciation taken on the property. Unrecaptured Section 1250 gain applies only to real property sold at a gain. It does not apply to realty sold at a loss.
Computing Installment Gain
" For sales of real or personal property (equipment) on the installment basis (payments received over a period of time) sold at a gain.
" Must recover ordinary gain portion in year of sale.
" Capital Gain portion is reported over the years you receive payments.
Gain recognized = Payments received x (Gross profit / Contract price)
End of Chapter 11
