Topic 3 - Gains and Losses

Topic 3 -

Gains and

Losses

Chapters 4LO1, 7LO2, 10(LO1/2), All of Ch 11

Things to know

-capital assets/non capital assets

-calculate capital gains and losses

Gross income

-everything unless Gov says no

-all inclusive income concept

-ordinary or capital income

Capital Income

-promote investment with preferential rate

Capital Assets

-taxpayers buy and hold assets with appreciation potential

-investment type assets/personal use assets

Capital Assets (Sec 1221) Definition

-define capital assets in negative

-CA are everything but inventory, depreciable property or real property in a trade or business

Ordinary (non-capital) Assets (3) Examples

-inventory

-supplies for the business

-real property used for the business

Capital Assets (4) Examples

-investments in securities (by an individual or business)

-personal residence

-personal automobile

Sale of Capital assets generates _______(2)

-gains

-losses

2 Types of Term: Capital Assets

-long

-short

Long Term Capital Gains

-if capital asset held one day longer than a year

-preferential rate

Short Term Capital Gains

-if capital asset is held for one year or less

-ordinary rate

If TP has multiple Capital Assets with both gains and losses_____

-the TP has to recognize a NET to determine overall gain or loss

Capital Assets: Can Recognize loss up to $3,000 against______

-ordinary income

Captial Gains/Losses: Goal of Investments

-make money

-gains deferred until you sell the asset

-CA taxed at preferential rate (Long term)

CA: Unrealized

-growth or loss of asset value on paper

CA: Realized

-sell the asset and have money in hand

CA: Recognized

-required to list gain as income or allowed to take loss as deduction on your income taxes (after considering limitations $3k)

Deductions

-reduce taxable income by allowed deductions

Deductions: For AGI

-deduction taken from gross income before you get to adjusted gross income

-business deductions and some allowable personal deductions

Deductions: For AGI Examples (3)

-business deductions

-student loan interest

-IRA contributions

Deductions: From AGI

-deductions taken after you get AGI

-personal

-standard/itemized

Itemized Deductions Examples (4) (not all of them)

-medical

-taxes

-charity

-gambling losses

Chaper 7: LO2: Capital Gains and Losses

Tax Rate for Capital Gains (documented in topic 2)

0%

15%

20%

-max preferential rate based on TP filing status and income

Capital Loss of $3,000 can

-carryover to subsequent years

Limitations: Capital Loss Deductions (No recognized loss)

-sale of personal use assets (loss on car)

-when TP sell asset to related parties

-TP will typically realize more loss than recognized

-TP can have more realized than recognized

Tax Planning Strategies: Capital Assets

-hold for 1+ year

-preferential rate (no tax when sold)

-must balance tax with nontax factors

-risk of depreciation/loss if you hold the stock

Chapter 10: LO 10-1: Property Acquisition and Cost Recovery

Cost Recovery

-you are business, make big purchase and want to recover cost of purchase

-business must capitalize the cost of assets with useful life of more than a year, not expense cost immidiatly

-depreciation, amortization, or depletion

-business use these methods to recover cost of assets from wear and tear, obsolescence of assets

3 Methods: Cost Recovery

-depreciation

-amortization

-depletion

3 Methods: Cost Recovery: Depreciation

-deducting the cost of tangible personal and real property (other than land) over a specific period of time

3 Methods: Cost Recovery: Amortization

-deducting the cost of intangible property over a specific period of time

3 Methods: Cost Recovery: Depletion

-deducting the cost of natural resources over time

Depreciation: Example (Cost Recovery Method)

-personal property/tangible assets (car, equipment, and machinery

-real property like buildings and land (land not deductible)

Amortization: Example (Cost Recovery Method)

-intangible assets: non physical assets like goodwill and patents

Depletion: Example (Cost Recovery Method)

-natural resources are commodities valuable in material form like oil, coal, timber, and gold

Cost Recovery: Basis

-once use of purchased assets started, recouping cost of assets also starts

-placed asset into service-begin deduction process

-initial basis reduces when cost is recovered through cost recovery process

Assets Adjusted Basis (Tax Basis)

Cost basis-accumulated depreciation

Cost Basis

-an assets cost basis includes all costs needs to purchase the asset, prepare it for use, and being using it

-same for book and tax purposes

-if used for a year depreciate it

All Parts of Cost Basis

-sale price, tax

-installation

-shipping

Cost Basis Example

Mad Hatters buy new industrial sewing machine

Cost of Machine 2100

Cost of Delivery 200

Cost to Install 300

Yearly Tune up 250

What is initial basis for sewing machine?

$2600

Modified Cost Recovery System (MACRS) (pronounce Makers)

-how business compute depreciate for tax purposes to compare to financial (book) depreciation

-depreciate personal and real

-3 methods for personal property

-default method is double declining

3 Choices: Depreciation Personal Property

200 percent double declining method

150 percent declining method

Straightline decining method

What is the default depreciation method for personal property?

-double declining

Government tells you length of time for

-depreciation

Recovery Period: Most Common Business Assets

Car, light trucks, computers/peripheral equipment: 5 Years

Office Furniture, fixtures, and equipment: 7 years

Qualified Improvement Property: 15 years

Recovery Period

-for financial accounting you determine useful life, for tax it is set by the government

How long is recovery period for cars, light general purpose trucks, computers, and peripheral equipment?

5 years

MACRS Chart

-don't have to memorize it

-don't need to know the math

-just need to know how to use chart

For Real property depreciation, subtract the _______out of the purchase price

-land

Assume non-residential, if not

-specified

Special Rules: MACRS Sec 179

-congress allowes TP to consider expensing or increasing deduction amount before using MACRS

-expense up to $1,050,000 of qualified property

-bonus depreciation

Bonus Depreciation

-increase rate of depreciation between 30-100 percent of cost

Chapter 11: Property Disposition

5 Methods: Dispose Asset

-sale

-donate to charity

-throw it away

-trade for similar asset

-destroyed in natural disaster

Every Asset Disposition Triggers

-realization event for tax purposes

Determine Adjusted Basis: If purchased

-price plus cost to put into service-depreciation taken

Determine Adjusted Basis: If Gift

-basis given givers purchase price and your holding period is day bought by giver

-if original owner had asset for 10 years, receiver can treat it as long term asset

Determine Adjusted Basis: If Inherited

-take FMV on date received (Long term asset taken at a stepped-up basis)

-value is what its valued at now

-bought 30 years ago at 10k, now 100k

Disposition: Realized Gain/Loss

-amount realized by a TP from the sale or other disposition of an asset is everything of value received from the buyer less any selling costs

-TP typically receive cash when they sell property

-accept marketable securities, notes receivable

Amount Realized Formula

Cash Received + Fair Market Value (FMV) + Buyer's assumption of liabilities - seller's expenses

Dispositions

-adjusted basis for determining gain or loss on the sale of an asset

Initial Basis

-reduced by the depreciation or other types of cost recovery deductions allowed (or allowable) on the property

Adjusted Basis Formula

initial basis-cost recovery allowed (for allowable

Disposition: Realized Gain or Loss

-amount of gain or loss TPs realize on a sale or other disposition of assets is simply the amount they realize minus their adjusted basis in the disposed asstes

Gain (loss) realized Formula

amount realized - adjusted basis

Recognized Gain/Loss: Dispositions

-gains(losses) that increase (decrease) TPs gross income

-TPs must immediatly recognize the vast majority of realized gains and losses

-may be allowed to permanently exclude the gains from taxable income

-TP will have more realized losses than recognized losses (because limited to deductions)

-TP may have more realized income than recognized income) (no declare tax free income like municipal bonds)

Character: Gain/Loss

-all gains or losses are either characterized as ordinary or capital

Depreciation Recapture (applies to Sec 1231 Assets)

-take depreciation, reduce adjusted tax basis or an item

-avoid favorable tax treatment, need to account for depreciation

-goal is if you depreciated asset, now get taxed on gain at ordinary rate

-changes in character but not amount of gain recognized

Sec 1231 Assets

-land

-personal property

-depreciable real estate

Section 1231 (Subset Sec 1245 Property)

-tangible personal property (machinery, equipment, auto) and amortized intangible property (patents, copyrights, purchased goodwill)

-gain from sales created by depreciation of the items is taxed at ordinary income rate

Depreciation Recapture

-no depreciation recapture on assets sold at a loss

-personal assets are rarely sold at gain, no gain on these sales

-easy to determine: subtract sales price from initial basis

-more than initial basis, you will have capital gain

Other Provisions: Affect Rate Gains are Taxed

-Characterizing Gain on the Sale of Depreciable Property to Related Persons (1239)

Characterizing Gain on the Sale of Depreciable Property to Related Persons (1239)

-all gain recognized from selling property a depreciable asset to a related-person buyer is ORDINARY INCOME

T/F: A personal automobile is a capital asset.

-true

T/F: Accounts receivable and inventory are examples of ordinary assets.

-true

T/F: Dave and Jane file a joint return. They sell a capital asset at a $150,000 loss. Even though they have no capital gains, $6,000 of the loss can still be deducted in the current year.

-false

Can take up to $3000 of net capital losses against ordinary income. Individual taxpayers (including those married filing jointly) may deduct up to $3,000 of net capital losses against ordinary income in a given year.

Kevin bought 200 shares of Intel stock on January 1, 2021, for $50 per share, with a brokerage fee of $100. Then, Kevin sells all 200 shares for $75 per share on December 12, 2021. The brokerage fee on the sale was $150. What is the amount of the gain/loss Kevin must report on his 2021 tax return?

$4750

T/F: The adjusted basis is the initial basis less cost recovery deductions.

-true

In January, Prahbu purchased a new machine for use in an existing production line of his manufacturing business for $90,000. Assume that the machine is a unit of property and is not a material or supply. Prahbu pays $2,500 to install the machine, and after the machine is installed, he pays $1,300 to perform a critical test on the machine to ensure that it will operate in accordance with quality standards. On November 1, the critical test is complete, and Prahbu places the machine in service on the production line. On December 3, Prahbu pays another $3,300 to perform periodic quality control testing after the machine is placed in service. How much will Prahbu be required to capitalize as the cost of the machine?

$93,800

Alan Meer inherits a hotel from his grandmother, Mary, on February 11 of the current year. Mary bought the hotel for $730,000 three years ago. Mary deducted $27,000 of cost recovery on the hotel before her death. The fair market value of the hotel in February is $725,000. (Assume that the alternative valuation date is not used.) What is Alan's basis in the inherited hotel?

$725, 000

You take at current value, this is known as a stepped up basis

Shasta Corporation sold a piece of land to Bill for $45,000. Shasta bought the land two years ago for $30,600. What gain or loss does Shasta realize on the transaction?

$14,400

On September 30 of last year, Rex received some investment land from Holly as a gift. Holly's adjusted basis was $50,000 and the land was valued at $40,000 at the time of the gift. Holly acquired the land five years ago. What are the amount and character of Rex's recognized gain (loss) if he sells the land on May 12 this year for $70,000?

-Long Term Gain $20,000

Sold for $70,000, since sold for a profit your basis is the givers initial basis. Holding period starts day bought by the giver.