Tax Consequences on Sale of Assets

Question 1

Capital assets

Answer 1

Examples: Automobile for personal use, personal residence, investments in stocks/bonds

Property owned by a taxpayer other than:
- inventory
- property used in trade/business & subject to depreciation allowance in Section 167/1231
- accounts or notes receivable acquired under trade/business
- other assets like memorandum, copyrights, US govt publication, literary, musical or artistic composition

Question 2

Corn Products Refining Co. v. CIR

Answer 2

Supreme Court determined that sale of futures contracts related to the purchase of raw materials is ordinary rather than capital gains and losses

Question 3

Arkansas Best Corp. v. CIR (1988)

Answer 3

Supreme Court determined that motivation for acquiring assets is irrelevant to whether assets are capital assets- loss related to selling shares to protect its business reputation was a capital loss because the stock is within the broad definition of the term capital asset in Section 1221 and is outside the classes of property that are excluded from capital asset status.

Question 4

loss on the sale or exchange of certain small business stock that qualifies as Section 1244 stock is treated as

Answer 4

ordinary loss rather than a capital loss to the extent of $50,000 per year ($100,000 if the taxpayer is married and files a joint return)

Question 5

Mark to Market method of securities inventory for dealers

Answer 5

From 12/31/1993, securities dealers must use mark-to-market for inventory of securities:
- Valuing- must be at FMV at end of each taxable year
- Recognized Gain/Loss: Must be recognized as if it was sold on the last day of the tax year and treated as ordinary gains/losses
- Adjustments in subsequent years must be adjusted to reflect gains and losses already taken into account when determining taxable income

Question 6

Securities held by dealers in securities are considered

Answer 6

inventory, no capital assets; unless per section 1236, dealer clearly identifies property is held for investment and must occur before the close of business day on which the security is acquired

Question 7

Real Property Subdivided for Sale

Answer 7

special relief provision provided in IRC Section 1237 for non-dealer, non-corporate taxpayers who subdivide a tract of real property into lots (two or more pieces of real property are considered to be a tract if they are contiguous).

Part or all of the gain on the sale of the lots may be treated as a capital gain if the following provisions of Section 1237 are satisfied:

• During the year of the sale, the non-corporate taxpayer must not hold any other real property primarily for sale in the ordinary course of business.
• Unless the property is acquired by inheritance or devise (i.e., a gift of real estate left at death), the lots sold must be held by the taxpayer for a period of at least five years.
• No substantial improvement may be made by the taxpayer while holding the lots if the improvement substantially enhances the value of the lot.
• The tract or any lot may not have been previously held primarily for sale to customers in the ordinary course of the taxpayer’s trade or business unless such tract at that time was covered by Section 1237.

If the Section 1237 requirements are satisfied, all gain on the sale of the first five lots may be capital gain. Starting in the tax year during which the sixth lot is sold, 5% of the selling price for all lots sold in that year and succeeding years is ordinary income.

Question 8

Non business bad debts

Answer 8

Deductible as STCLs (short term capital losses), only in the year in which it becomes totally worthless

Question 9

Adjusted net capital gain (ANCG)

Answer 9

Net capital gain without considering gains subject to 28% (for collectibles) and the 25% unrecaptured Section 1250 gain (i.e., gain from real estate used in a trade or business). Rates of 20%, 15%, and 0% apply to recognized ANCG. based on filing status and taxable income

Question 10

Qualified Small Business Stock (QSBS)

Answer 10

-non-corporate taxpayers may exclude 50% of the gain resulting from the sale or exchange of qualified small business stock (QSBS) issued after August 10, 1993, if the stock is held for more than five years per Section 1202; can exclude up to 100% depending on acquisition date

-corporation may have QSBS only if it is a C corporation, and at least 80% of the value of its assets must be used in the active conduct of one or more qualified trades or businesses

Question 11

If individual has NSTCL and NLTCL, then

Answer 11

NSTCL offsets ordinary income first

Question 12

Tax rate groups of LTCG and LTCL

Answer 12

-28%: collectible held for more than one year, either half/qtr if gain from qualified small business stock (Section 1202) held for >5yrs
- 25% group: unrecaptured Section 1250 gain: no losses
-0/15/20/%:when holding period >1 yr and capital asset is not collectible/1202 small business stock

Question 13

If taxpayer has NSTCL and NLTCG, then

Answer 13

NSTCL is first offset against NLTCG from 28%, 25% then 0/15/20% group.

Question 14

Net Investment Income (NIIT) can increase the LTCG rate by

Answer 14

3.8%, so it could go up to 23.9%, imposed on lesser of:
(i) the excess (if any) of the individual’s modified adjusted gross income for such taxable year, over
(ii) a threshold amount ($250,000 for a married taxpayer filing a joint return, $125,000 for a married taxpayer filing separately, and $200,000 in all other cases).

Question 15

Ordinary loss requirements for Section 1244 stock (small business stock election)

Answer 15

Up to $50K can be deducted per tax year ($100K for MFJ), more than that is a capital loss- if:
-stock is owned by individual/partnership
-originally issued by the corporation to the ind/partnership in which ind is a partner
-stock in US corporation
- issued for cash/property other than stock/securities
-must not have derived >50% of gross receipts from passive income sources during previous 5 years immediately preceeding year of sale/worthlessness
-amount of money/property contributed to both capital and paid-in surplus may not be >$1MM at time stock is issued

Question 16

Difference in tax treatment of corporate taxpayers

Answer 16

Lower tax rates of 0/15/20% on net capital gain for non-corporate taxpayers do not apply to corporations (flat 21%), and corporations may offset capital losses only against capital gains (not ordinary income), and carry back to each of 3 preceding tax years and forward 5 years, treated as STCL

Question 17

Holding period date

Answer 17

Must be more than one year to qualify for LT: excludes day of acquisitin, includes disposal date

Question 18

Nontaxable exchange holding period and basis

Answer 18

Basis carries over. If properties are capital assets or Section 1231 assets, then the holding period of the property given up is tacked on.

Question 19

Lynn has two transactions involving the sale of capital assets during the year resulting in a short-term capital loss of $1,500 and a long-term capital loss of $5,000. What can Lynn offset?

Answer 19

Short-term losses are deducted first. The NSTCL may be deducted in full (i.e., on a dollar-for-dollar basis) against any non-corporate taxpayer’s ordinary income for amounts up to $3,000 in any one year.

Question 20

Sale of principal residence Section 121 exclusion

Answer 20

Up to $250K gain ($500K MFJ) if owned and occupied for 2 out of 5 previous years before sale/exchange, any gain not excluded is capital gain, loss is not deductible since personal-use, applied every two years

Question 21

Selling expenses

Answer 21

commissions, advertising, deed preparation costs, and legal expenses

Question 22

Sale of more than one principal residence within two years- exceptions to exclusion

Answer 22

Part of the gain may be excluded if sale/exchange is due to:
- job relocation
- employment changes
- qualifying for unemployment
-health issues
-divorce/legal separation
-birth of twins/multiples
-damage from disaster
-condemnation/seizure of property
- other unforeseen circumstances

Portion= (shorter of period of ownership or period between last sale until current sale)/730

Question 23

Tax treatment of involuntary conversion of principal residence

Answer 23

Governed by Section 1033, gain may be deferred if requirements are met. Functional use test must be satisfied regardless of type.

A loss due to a condemnation of a personal residence is not recognized. If the loss is due to a casualty, the loss is deductible and is treated like other casualty losses of non-business property.

Question 24

Gain from principal residence due to presidentially declared disaster

Answer 24

Not recognized if the property was unscheduled property for insurance purpose

Question 25

Depreciation recapture

Answer 25

all recognized gains and losses must eventually be categorized as capital or ordinary income

Question 26

1231 property

Answer 26

Real or depreciable property that is held for more than one year and is used in trade/business/production of income: timber/coal/domestic iron ore/livestock/unharvested crops (does not include inventory, US govt publications, copyrights etc)

Question 27

1231 Net Gains and Losses

Answer 27

-If overall result is net 1231 gain, then treated as LTCG (although may be treated as income if previous losses over previous 5 years equate to non-recaptured net loss)
-if overall result is net loss, then treated as ordinary loss

Question 28

T/F: If Section 1231 gains and losses are treated as ordinary income, they are fully deductible in the current year.

Answer 28

True: If the gains and losses were classified as long-term capital gains and losses, only $3,000 of the NLTCL would have been deductible against other income.

Question 29

Tax rate for net section 1231 gain

Answer 29

Similar to cap gain tax: max of 20%; however all or part of gain is unrecaptured section 1250 gain if asset is a building

Question 30

Gain/loss treatment for timber and requirements

Answer 30

-Own/hold contract right on 1st day of year and for >1yr, timber must be cut for sale/use in trade/business
-Ordinary gain/loss is determined by FMV on 1st day and adjusted basis for depletion

Question 31

Requirements for Section 1231 treatment of disposal of coal/lignite/iron ore mined in US

Answer 31

• owned longer than 1 year before disposal
  -owner retained economic interest in coal/iron ore

Date mined=disposal date

Question 32

1231 requirements for livestock

Answer 32

If held for draft, breeding, dairy, or sporting for >=12months from date of acquisition. Cattle and horses >=24 months

Question 33

1231 requirements for unharvested crops and land

Answer 33

crop and land: sold at same time, to the same person and land held >1 yr (does not apply if retain rights to reacquire land). Costs producing crop must be capitalized

Question 34

When does involuntary conversion/exchanges occur?

Answer 34

When a property is destroyed, stolen, condemned, or disposed of under threat of condemnation, and other property/money in payment is received (insurance/condemnation award).

Gain is not reported if the property received is similar/related in service- basis remains the same, so gain is deferred until taxable sale/exchange occurs

Question 35

Gains/losses from condemnations of Section 1231 property and capital assets

Answer 35

If held for more than one year, and if capital assets are held in connection with a trade/business/income generating purpose, then classified as 1231 gains/losses

Question 36

Gains/losses from other involuntary conversions due to fire, storm, shipwreck, or theft

Answer 36

If gains > losses, then Section 1231 gains and losses
If losses>gains, then ordinary losses/gains

Question 37

Steps for Analyzing Section 1231 Transactions

Answer 37

1) Determine net gain from casualty or thefts of Section 1231 property and non-personal use capital assets held more than one year.
2) Combine the following gains and losses: Net casualty and theft, sale or exchange of Section 1231 property, and condemnation of Section 1231 property and non-personal use capital assets held more than 1 year.
3) If a net Section 1231 gain results from Step Two, determine if the taxpayer has any non-recaptured net Section 1231 losses.
4) Any net Section 1231 gain in excess of non-recaptured Section 1231 loss is treated as LTCG.

Question 38

Recapture provision of Section1245

Answer 38

Gain from disposition of Section 1245 property treated as ordinary income to the extent of total depreciations (cost recovery) deductions allowed since 1962. Gain recaptured cannot exceed realized gain. If realized gain > total depreciation, then portion of gain will receive 1231 treatment

The main purpose of Section 1245 is to eliminate any advantage taxpayers would have if they were able to reduce ordinary income by deducting depreciation and subsequently receive Section 1231 capital gain treatment when an asset was sold.

Question 39

Recapture Provisions of Section 1250

Answer 39

Includes most depreciable real property and applies to additional/excess depreciation, converts a portion of 1231 gain into ordinary income when real property is sold/exchanged

Question 40

Section 1250 property

Answer 40

Any depreciable real property other than Section1245 and includes:
- all other depreciable real property except non-residential real estate that qualifies as recovery property (1980-1987) unless straight-line method of cost recovery is elected
- low income housing
-Depreciable residential rental property.

Question 41

Unrecaptured Section 1250 Gain

Answer 41

For sales of real property after May 6, 1997, some or all of the Section 1231 gain may be a long-term capital gain (LTCG) that is unrecaptured Section 1250 gain taxed at a rate of 25%. Amounts over depreciation are taxed at 15/20%

Question 42

In the case of Section 1245 recapture treatment, if gain realized is greater than depreciation, under what section would the gain be taxed?

Answer 42

Under Section 1245 recapture, gain is characterized\ as ordinary income to the extent of total depreciation deductions. Therefore, if the gain realized is greater than depreciation the tax treatment should be under Section 1231.

Question 43

During the current year, Max recognizes a $30,000 Section 1231 gain and a $20,000 Section 1231 loss. Prior to this, Max’s only Section 1231 item was a $15,000 loss two years ago. What must Max Report?

Answer 43

Due to the five-year lookback rule, $10,000 of the non-recaptured Section 1231 loss is recaptured as ordinary income.

Question 44

wash sale

Answer 44

-realizes loss on sale of stock/securities
-acquires substantially identical stock/securities within 61 days (30 days before and after sale)

Question 45

transactions between related parties

Answer 45

Section 267 stipulates that related taxpayers may not take current deductions on 2 specific types of transactions between them:
- Losses on sales of property
-accrued expenses that remain unpaid at the end of the tax year

Question 46

related parties

Answer 46

-ind and families
-in and corporation with ind owning >50% of value of outstanding stock
-various relationships between grantors, beneficiaries, and fiduciaries of a trust or trusts, or between the fiduciary of a trust and a corporation if certain ownership requirements are met.
-corporation and a partnership if the same persons own more than 50% in value of the stock of the corporation and more than 50% of the partnership.
-Two corporations if the same persons own more than 50% in value of the outstanding stock of both corporations and at least one of the corporations is an S corporation.
Other complex relationships involving trusts, corporations, and individuals.

Question 47

bargain sales

Answer 47

sales or exchanges of assets for less than FMV, usually 2 separate transactions: part sale and part gift

Question 48

T/F: Robert bought 100 shares of stock X on each of three occasions during 2008. He paid $158 a share for the first block of 100 shares, $100 for the second block, and $95 a share for the third block. On December 20, 2020, Robert sold 300 shares of X stock for $125 a share. On January 5, 2021, he bought 250 shares of identical X stock. He can deduct the loss realized on the first block of stock.

Answer 48

Robert cannot deduct the loss of $33 a share on the first block because within 30 days after the date of sale he bought 250 identical shares of X stock.

In addition, Robert cannot reduce the gain realized on the sale of the second and third block of stock by this loss.

Question 49

Tammi, a single taxpayer bought a condominium for $225,000 that she used as her primary residence. Seven months later, Tammi suddenly lost her job and began collecting unemployment. Tammi promptly sold her condo for $300,000 and moved into an inexpensive rental apartment. The total number of days Tammi lived in the condo was 257 days.

How much of the gain will be taxed?

Answer 49

Section 121 Exclusion = $250,000 x 257/730 = $88,014.

Total gain = $75,000 ($300,000 - $225,000).

Therefore, the entire $75,000 of gain is excluded.

$0 is taxable.

Question 50

Herbert and Betty are married and file jointly. They bought a small 2-bedroom condo for $250,000 in a rapidly appreciating development. Nine months later, Betty gave birth to triplets. They immediately realized they needed more room, sold the condo for $445,000, and bought a larger condo in the same development for $695,000. They had lived in the small condo for a total of 283 days.

How much gain must be reported on the transaction?

Answer 50

Reduced Exclusion: $500,000 X 283/730 = $193,836

Gain: $445,000 - $250,000 = $195,000

Taxable Amount: $195,000 - $193,836 = $1,164

Question 51

Non-business bad debt losses are ____________________________.

Answer 51

deductible as a short-term capital loss

Question 52

Each of the following is an acceptable reason for a Section 121 exclusion reduced exclusion

Answer 52

Job relocation
Employment change leaves you unable to pay your living expenses
Qualifying for unemployment benefits
Health issues
Divorce or legal separation
Birth of twins or other multiples
Damage to home from disaster
Condemnation or seizure of the property
Other unforeseen circumstances

Question 53

During the current year, Barry purchases land as an investment for $70,000. Ten months later he contributes the land to the St. Jude’s Hospital. At the time of the contribution, the property’s FMV is $85,000.

Calculate the amount of Barry’s contribution.

Answer 53

The amount of Barry’s contribution is $70,000 ($85,000 - [$85,000 - $70,000]) because he held the land for less than one year.

Question 54

Which of the following is categorized as a capital asset?

Answer 54

The personal residence is the only capital asset listed. The artistic composition, notes receivable, and Section 1245 asset (i.e., computer) used in the ordinary course of business to produce income are not considered capital assets, per the IRC.

Question 55

Elizabeth has owned and lived in her principal residence in Hartford, CT, for the last three years.

Fourteen months ago, Elizabeth married Pierre, and he moved into Elizabeth’s home. Following their wedding, Elizabeth changed the titling on the home to JTWROS. The couple currently files as MFJ.

Today, they are moving across the country because Pierre has been hired as Head of School at a Private School in Northern California. If Elizabeth sells her home, what is the maximum amount they may exclude under Section 121, the sale of a primary residence?

Answer 55

Elizabeth and Pierre qualify for a reduced exclusion under Section 121.

For a couple that files MFJ and meets the ownership and usage tests (2 out of 5 years), up to $500,000 from the sale of a personal residence can be excluded.

In this situation, Elizabeth meets the requirements but Pierre does not. Because the couple is relocating for a job, a special reduced exclusion applies to Pierre.

Elizabeth = $250,000
Pierre = (14 ÷ 24) x $250,000 = $145,833
$250,000 + $145,833 = $395,833

Below is the list of acceptable reasons for a reduced Section 121 exclusion as stated in the IRC:

Job relocation
Employment change leaves you unable to pay your living expenses
Qualifying for unemployment benefits
Health issues
Divorce or legal separation
Birth of twins or other multiples
Damage to home from disaster
Condemnation or seizure of the property
Other unforeseen circumstances

Question 56

In September 2021, Paul and Nadine bought a new home. In November 2021, they sold their old home at a $40,000 gain. They had owned and lived in the old home for four years. They excluded the gain on the sale of the old home.

On October 1, 2023, Paul and Nadine sold the home they purchased in September 2021 at a $15,000 gain. The sale was not due to a change in place of employment or health.

Can Paul and Nadine exclude the gain on the October 2023 sale?

Answer 56

Because Paul and Nadine had excluded gain on the sale of another home within the two-year period ending on October 1, 2032, they cannot exclude the gain on this sale.

Question 57

Mutual fund custodians prefer to report cost basis information using ____________________.

Answer 57

Mutual fund custodians prefer to report cost basis information using the average cost method.

On an asset-by-asset basis, once you commit to a particular method you must continue to use that method until the asset is completely sold.

Question 58

Tom, a single taxpayer bought a condominium for $225,000 that he used as his primary residence. Seven months later, Tom suddenly lost his job and began collecting unemployment. Tom promptly sold his condo for $300,000 and moved into an inexpensive rental apartment. The total number of days Tom lived in the condo was 257 days.

How much of the gain will be taxed?

Answer 58

Section 121 Exclusion = $250,000 x 257/730 = $88,014.

Total gain = $75,000 [$300,000 - $225,000].

Therefore, the entire $75,000 of gain is excluded.

$0 is taxable.