Chapter 7 - Property & Special Property Tax Transactions

Question 1

what are the 3 types of assets that may be held by a taxpayer?

Answer 1

• ordinary income assets
• section 1231 assets (non current business assets)
• capital assets (non business assets)

Question 2

what are ordinary income assets (current assets of a business)

Answer 2

these refer to assets that were acquired or produced with the intention of being sold in the ordinary course of business, and include inventory, business receivables resulting from sales of inventory or services and artistic works created by or for the taxpayer:

• • inventory
• *receivables arising from sales
• *self-created artistic work (no special tax rules or limits

Question 3

what are section 1231 assets (non-current business assets)

Answer 3

these are assets that are used in the trade or business and whose eventual sale or disposal is only incidental to the business. they include depreciable and amortizable assets, as well as land used in the business:

• **depreciable and amortizable property
• **land used in business, PP& E
• ** if held over 1 year; net loss is ordinary income; net gain is long term capital gain; prior depreciation is recaptured as ordinary income on tangible personal property.
• ** if held for less than a year its ordinary

Question 4

what are capital assets (non business assets)

Answer 4

these are all assets that do not qualify as ordinary income or section 1231 assets, and include assets held for investment purposes as well as the assets of individual that are held for personal use by the taxpayer or the taxpayers family or household. Goodwill is treated as a capital asset as well as a government bond held by an individual investor, it is also considered a capital asset.

• ** investments (including stock options) , personal, family, household
• ** non business bad debts write offs are always short term capital losses.

Question 5

what items are not considered capital assets according to the definition?

Answer 5

• property normally included in inventory or held for sale to customers in the ordinary course of business
• depreciable property and real estate used in business
• accounts and notes receivable arising from sales or services in the taxpayers business
• copyright, literary, musical or artistic compositions
• treasury stock

Question 6

what is the tax treatment of ordinary income assets?

Answer 6

all gains and losses are fully included in the determination of taxable income with no special treatment or limitations of any kind

Question 7

how are capital gains and losses treated?

Answer 7

capital gains and losses are combined to determine the net capital gain or loss for the year. a net capital gain is reported and included in taxable income (there is no special tax rate on long-term capital gains for a corporation)

a net capital loss of a corporation may not be deducted in the current year. instead, it may be carried back to offset net capital gains reported in one of the previous 3 tax years, and then carried forward to offset net capital gains in the next 5 years (the rules for individuals are radically different, no carryback, $3,000 per year may be deducted, and the remainder may be carried forward forever.

Question 8

how are 1231 gains and losses determined?

Answer 8

it is determined from all of the sales that took place, the amount is transferred to the forms for ordinary or capital assets as follows:

• *net 1231 gain is the amount transferred to the schedule on which capital gains and losses are reported, and it is reported and it is reported as a long-term capital gain.
• *net 1231 loss is the amount transferred to the schedule on which ordinary income assets gains and losses are reported, and it will be treated as an ordinary loss to determine the net ordinary gain or loss for the year.

Question 9

why is the 1231 tax treatment considered the best of both worlds?

Answer 9

because the gain is treated as a capital gain, it can be used to offset net capital losses that might otherwise not have been deductible in the current year.

since the loss is treated as an ordinary loss it is fully deductible with no limits.

Question 10

in general, what are short-term capital transactions?

Answer 10

sales that take place within a year of the acquisition date

Question 11

in general, what are long-term capital transactions?

Answer 11

those transactions held for longer than one year.

Question 12

what are the two exceptions related to short-term & long-term capital transactions?

Answer 12

• inherited assets (sales are always classified as long-term)
• non business bad debts (write-offs are always classified as short-term capital losses)

Question 13

can a corporation deduct a net capital loss?

Answer 13

no, if a capital loss exceed capital gains, the difference is carried back 3 years and forward 5 years. a net loss in any rate group is then applied to reduce the net gain in the highest rate group first (ex. 28%, 25%, then 15%)

Question 14

for short term capital gains and losses, how are they grouped?

Answer 14

they are combined to determine the net short-term capital gain or loss for the year. long-term items are similarly combined to determine the net long term capital gain or loss for the year. if one is a net gain and the other a net loss, they are combined to produce a single net capital gain or loss for the year, which will be treated as having the character of the larger of the two numbers being combined. If the gains, they are reported separately. if both are losses, short-term losses are claimed first and then long-term losses subject to an overall limitation of $3,000 that can be offset against ordinary income each year (the remainder is carried forward indefinitely)

Question 15

how do individuals benefit from a special tax rate of only 15%?

Answer 15

by their long term capital gains. individuals who are in the 15% or 10% tax bracket for ordinary income qualify for a 0% long term capital gains tax rate.

if high income taxpayers, then the 15% becomes 20% for MFJ earning $450,000+and single $400,000+ (457,600, 406,750 for 2014). No special rates for corporations.

Question 16

what is the tax treatment for collectibles?

Answer 16

collectibles include works of art, rugs, antiques, metals (gold), gems, stamps, coins, alcoholic beverages and other certain tangible property. a special long term tax rate of 28% applies to all gains and losses which are reported on schedule D.

Question 17

what is a depreciation recapture for 1245 assets?

Answer 17

the sale of 1245 tangible personal property that results in a gain due to the accelerated MACRS depreciation schedule.

the tax code requires that the gains be reported as ordinary income to the extent of prior depreciation.

Question 18

what is a depreciation recapture for 1250 for real property?

Answer 18

when depreciable real property, consisting of buildings and structural components is sold at a gain, it is subject to section 1250 depreciation recapture. as a result, the amount of the gain up to additional depreciation is treated as an ordinary gain. any gain in excess is treated as section 1231 gain, considered a long term capital gain.

Question 19

how is additional depreciation handled for section 1250 depreciation recapture?

Answer 19

• if the asset was held for 1 year or less, additional depreciation is all depreciation
• if the asset was held for more than 1 year, additional depreciation is depreciation in excess of the amount that would have been taken under straight-line. it is considered an ordinary gain. the uncaptured 1250 gain and treated as a section 1231 gain and taxed as a section 1231 gain and taxed as a long term capital gain at 25%

Question 20

what is section 291?

Answer 20

when a c corporation sells section 1250 property at a gain, a portion of the gain, in addition to the recapture of additional depreciation, is treated as ordinary income. Under section 291 a c corporation calculates the difference between the amount of depreciation recaptured under section 1250 and the greater amount that would have been recaptured if the asset had been a section 1245 asset. basically the difference will be the amount of depreciation that would have been reported under the straight line basis.

• **20% of the difference is also treated as additional depreciation
• **as a result, the total ordinary gain to a C Corporation will include the difference between accelerated depreciation taken and the comparable straight-line amount PLUS 20% of the straight line amount
• **the total depreciation recaptured is limited to the recognized gain.

Question 21

who must follow the uniform capitalization rules (UNICAP-Section 263A)

Answer 21

a corporation, partnership or sole proprietorship that has manufactured or constructed an asset for use, sale or resale, it must follow the uniform capitalization rules (UNICAP). any trade or business that produces real or tangible personal property; acquires property for resale with average annual gross receipts for past 3 years of more than 10 million; these cost will be recovered through either depreciation/amortization, or inventory, through cost of goods sold.

it requires the capitalization into inventory of virtually all direct costs, and part of the indirect costs, associated with the manufacture or resale of the asset (this differs from GAAP so as to increase tax liability to government). the unicap rules apply to costs incurred in manufacturing or constructing real or personal property, or in purchasing or holding property for sale.

Exclusions from UNICAP include:
selling
advertising
marketing and certain administrative expenses are also NOT required to be capitalized

Question 22

what does the capitalized cost include

Answer 22

• pre production: design, bidding exp, purchasing
• production cost: direct materials, labor and production, indirect production costs (factory overhead)
• pre sale costs: storage, handling, excise tax (if levied before sale)

Question 23

what other cost for inventory must generally be capitalized?

Answer 23

-most general, administrative, engineering and overhead costs associated with holding the assets such as storage costs, repackaging, warehousing prior to sale.

capitalized costs are the basis for depreciation of assets used in the trade or business and also determine the gain or loss on sale for all assets subject to these rules.

Question 24

what other cost for inventory must generally would not be capitalized but would be expensed?

Answer 24

nonmanufacturing costs such as selling, advertising, marketing, research and development expenditures would be expensed as incurred. also, businesses with less than 10 million in gross receipts for past 3 years are not required to follow these rules.

Question 25

what is the general rule for section 263 of the cost of an item of property for each invoice?

Answer 25

as long as it can be substantiated by an invoice. there is a de minimis annual expense election safe harbor of $5,000 per invoice or $5,000 per item, but an entity may be able to justify a greater amount if a higher threshold is used for financial reporting purposes.

Question 26

what are the rules to qualify for the $5,000 per item deduction or invoice deduction?

Answer 26

• the entity must prepare audited financial statements and must have a similar policy, effective as of the beginning of the year, for financial reporting purposes. also an annual election is required
• taxpayers that do not prepare applicable audited financial statements are subject to a limit of $500 rather than $5,000
• property with a useful life of 12 months or less may also be deducted. this deduction also requires a comparable policy, as of the beginning of the year, for financial reporting purposes.
• an entity electing to take this deduction must also apply the de minimis safe harbor limitations to expenditures for repairs and maintenance.

Question 27

under de minimis safe harbor rules how are deductible amounts considered?

Answer 27

from an all or nothing basis. if the cost of an item exceeds the limit, no portion of the cost is deductible under the safe harbor, and must be capitalized. an entity may not divide the cost of property into components in order to keep amounts within the limitations.

Question 28

how are betterments, adaptation & restoration handled? BAR

Answer 28

their expenditures are required to be capitalized if the cost incurred result in a betterment to the property, or an adaptation of the property for a different use or a restoration of the property.

• if a taxpayers disposes of property in a circumstance where no gain or loss is recognized, the cost of removal is deducted
• otherwise the cost of removal of the property is capitalized to the property.

Question 29

when can cost result in a betterment?

Answer 29

the expenditure must be used to correct a defect that existed prior to acquisition or occurred during production; must be intended to provide an addition to the property, such as by making it larger; or intended to cause an increase in usefulness of the property, such as increased capacity, productivity, or efficiency.

Question 30

when can cost result in a qualified adaptation expenses?

Answer 30

an adaptation of the property is considered a new or different use that is inconsistent with the taxpayer intended, ordinary use of the property at the time it was originally placed into service. these cost are capitalized. ex. converting a manufacturing facility into a showroom or converting part of a pharmacy into a clinic. these qualify as adaptations.

Question 31

when can cost result in a qualified restoration expenses?

Answer 31

cost of restoration (restores basis, replaces part or a major component of the property) are required to be capitalized if they would be required to be capitalized if incurred for purposes other than restoring property. other costs of restoration are also capitalized up to the excess of the reduction in the assets carrying value that resulted from the casualty or other even requiring the restoration over the amount paid for costs that would otherwise be required to be capitalized.

Question 32

what are incidental materials and supplies?

Answer 32

materials and supplies that can be expensed immediately in the year paid and include:

• property with a cost of less than $200
• tangible property with a useful life of 12 months or less
• spare parts or other items used to repair tangible property but that was not acquired for a specific piece of property
• fuel, lubricants, paper, staplers and other maintenance supplies that are expected to be consumed within 12 months of acquisition
• other items specifically identified in IRS guidance

Question 33

what are non-incidental materials and supplies?

Answer 33

materials and supplies (other tan those that are incidental) are generally deductible (expensed) in the period used or consumed.
-alternate treatment that is available for rotable spare parts and for temporary or standby emergency spare parts. under the alternative, costs are capitalized and depreciated as separate assets.

Question 34

what are rotable spare items?

Answer 34

items such as a stapler attachment on a photocopy machine that may be attached to one item of property, removed and either reattached to the same property, attached to another or stored for future use.

Question 35

what are standby emergency spare parts?

Answer 35

parts acquired for a specific piece of property to make certain that delays for repairs can be minimized.

Question 36

how are repairs and maintenance handled under section 162?

Answer 36

they are expensed when they are incurred to keep existing property operating efficiently and effectively.

• when the property is placed into service the activity must be expected to occur more than once over a 10 year period
• for buildings and structural components of buildings, the activity must be expected to occur more than once over a 10 year period.
• qualified small taxpayers (average gross receipts of $10 million or less over the preceding 3 tax years) can EXPENSE repairs and improvements to a building up to the lessor of 10,000 or 2% of the building cost (original cost of less than $1 million) if the amount repairs and improvements exceed $10,000 then all improvements must be capitalized.

a taxpayer may elect to capitalize and depreciate repairs and maintenance if they are treated similarly on the taxpayers books and records. This requires an annual election

Question 37

what is the tax basis of property?

Answer 37

it normally refers to its costs, adjusted for any depreciation previously claimed.

Question 38

what is the difference between the sales proceeds and the basis of the asset generally its original cost?

Answer 38

it is the basic rule for a capital asset.

Question 39

is the receipt of an inheritance taxable?

Answer 39

no; the basis for inherited property is the basis used to determine estate taxes for the decedent. usually this is the fair market value on the date alternate valuation date. then the basis will be the earlier of:

• *the date the property was transferred to the beneficiary
• *six months after the date of death

Question 40

on the subsequent sale of an inherited gift, how is the gain or loss reported?

Answer 40

it is always reported as long term regardless of the actual holding period.

Question 41

are gifts included in gross income?

Answer 41

no they are excluded from gross income. although the donor of a gift may have to report and pay gift taxes in some cases, the recipient (donee) of the gift does not report any taxable income on the receipt of the gift. if the gift is the form of appreciated property (meaning that the property went up in value from the time it was purchased), the cost basis and acquisition date of the property to the donee is the SAME as for the donor (carryover basis & carry over holding period).

the acquisition date for the donee is the date from which the amount used as basis was derived.

Question 42

what is the cost or tax basis?

Answer 42

1) inherited its at the FMV at the date of death or AVD
2) gift its at the carryover basis and carryover holding period; if dropped in value (dual basis rules apply) and what do you eventually sell it for? if it is sold between the donor cost and fmv on the gift date then there is no gain or loss recorded; the donee basis is the selling price. if the selling price exceeds the donor basis then it is capped at the donor basis.

Question 43

how are capital assets that are for individuals treated for tax purposes?

Answer 43

Long term capital gains have a special rate

short term capital gains have regular rates & net loss is the maximum of $3, 000 during the current year and can be carried forward indefinitely.

Question 44

how are capital assets that are for corporations treated for tax purposes?

Answer 44

• net loss are not deductible
• can carryback 3 years
• can carryforward 5 years
• considered short term

Question 45

how are ordinary assets treated for tax purposes?

Answer 45

inventory, business receivables,

self created artistic works are all at the regular tax rates

Question 46

how are section 1231 assets treated for tax purposes?

Answer 46

depreciable or amortizable business assets, land used in a business (parking lot and shed); net gains are generally considered to be long term capital gains; net losses are generally considered to be ordinary losses

Question 47

how are wash sales handled?

Answer 47

losses from wash sales are not deductible. if an asset that has been sold at a loss is repurchased within 30 days of the sale, the loss may not be deducted, but is added to the assets in the 30 days before or after the sale. gains are taxable, losses are not deductible.

Question 48

how are losses from related party sales handled?

Answer 48

losses from related party sales are not deductible. these are sales between the following:

• husband and wife
• sister and brother
• parent to child
• grandparent to grandchild
• ancestor and descendent
• majority shareholder and corporation
• majority partner and partnership (including a partnership interest owned directly or indirectly)

Question 49

who are not included in related party sales?

Answer 49

does not include an uncle, aunt, nephews, in-laws

Question 50

how are sales from ancestor to descendent treated for tax purposes?

Answer 50

if the asset is sold for less than the purchase price, a loss cannot be deducted. If the recipient (for example the grand-daughter) later sells the asset for more than what it cost the person that sold it to her then the difference in what it is sold for and the original purchase price is what is considered a gain.

• *gains resulting from related party sales are fully taxable
• *losses are treated in a similar manner to gift tax rules (dual-basis rules)

Question 51

how are like kind exchanges sect. 1031 items handled?

Answer 51

first they are tangible investment or business property (not intangible, such as stock and other securities) is exchanged for similar property, neither a gain or loss is reported, unless the taxpayer receives monetary consideration (boot) as part of the exchange. if boot is received, a gain for the excess of the fair value over the tax basis of the property relinquished is recognized up to a maximum of the amount of boot received.

Question 52

how can boot result?

Answer 52

• cash received + unlike property
• relief from debt that exceeds debt assumed ** same nature & character, real for real, personal **no loss deduction
• gain is lessor of **cash + unlike property received (FMV of boot received) or realized gain.

Question 53

for like-kind exchanges that fall under section 1031, what is the basis of the new asset?

Answer 53

the basis of the old asset + liability assumed+ gain recognized-current liability on hand-cash or boot received = new basis

Question 54

how can some or all of the taxes be deferred for like-kind exchanges even when the sale of property and acquisition of similar property are in separate transactions?

Answer 54

all of the following must be satisfied:

• the proceeds from the sale of property must not be received by the taxpayer, but must instead be paid into a separate escrow account held by a qualified intermediary
• the replacement property must be identified within 45 days after the sale (the qualified intermediary must be notified in writing)
• ***the taxpayer may identify more than one property as the potential replacement, as long as either of the following is satisfied: no more than 3 properties are identified or the total fair value of all identified properties doesn’t exceed 200% of the fair value of the property that was sold
• *****the replacement property must actually be acquired within 180 days of the sale

THIS DOES NOT APPLY TO EXCHANGES OF STOCKS, BONDS, NOTES, CONVERTIBLE SECURITIES, THE EXCHANGE OF PARTNERSHIP INTERESTS OR PROPERTY HELD FOR PERSONAL USE.

Question 55

What does like kind mean?

Answer 55

means the same class of property (real estate must be exchanged for real estate); personal property for personal property etc. So an exchange of a personal residence for investment or business property WOULD NOT QUALIFY.

Question 56

how are gains from an involuntary conversion (section 1033 exchange) of property?

Answer 56

the gain may be deferred if the property is replaced within the statutory time limit established by law. the time limit is measured from the calendar year (so the actual date for replacement is ALWAYS DECEMBER 31 OF THE YEAR IN WHICH THE PROCEEDS ARE RECEIVED) the taxpayer received the proceeds and equals:

• *2 years - destruction or theft of property resulting in insurance recovery
• *3 years - government condemnation or eminent domain award
• *4 years - conversion in connection with a declared federal disaster

Question 57

what are the rules for proceeds not fully reinvested in the new property when as loss has occurred due to a disaster?

Answer 57

the gain is taxed at the amount not spent on the property also known as the unreinvested amount. deferred gains reduce the basis of the replacement property. Losses are shown on Schedule A, theft or casualty loss.

Question 58

what kind of treatment does worthless securities generally receive?

Answer 58

they usually receive capital loss treatment, however if the loss is incurred by a corporation on an investment in an affiliated corporation (80% or more ownership), the loss is treated as an ordinary loss item.

Question 59

how is a loss resulting from a nonbusiness deposit in an insolvent financial institution is generally treated?

Answer 59

a non-business bad debt deductible as a short-term capital loss; however in certain circumstances an individual can elect to treat the loss as a casualty loss or as a miscellaneous itemized deduction.

Question 60

how are losses on sales of personal assets treated for tax purposes?

Answer 60

they are not deductible because they are considered a consumption loss b/c the asset has been in use for several years. the only exception is for casualty losses. Now if there is a gain on the sale of personal assets then the gains are taxed.

Question 61

what is the special treatment for a gain on sale of personal residences?

Answer 61

if a taxpayer sells a home that served as the taxpayers principal residence for at least 2 of the previous 5 years, the first $250,000.00 of the gain on sale is NOT RECOGNIZED ($500,000 FOR MARRIED FILING JOINTLY) AND YOU CAN DO THIS EVERY 2 YEARS.

Question 62

what is the special treatment for the basis of stock received as a dividend?

Answer 62

it depends upon whether it was included in income when received

• -if included in income, basis is its FMV at date of distribution
• -if nontaxable when received, the basis of shareholders original stock is allocated between the dividend stock and the original stock in proportion to their relative FMV’s (ex. own common stock as dividend). the holding period of the dividend stock includes the holding period of the original stock.

Question 63

what is the special treatment for the basis of installment sales method (6252)? this area has been tested before

Answer 63

applies to gains NOT LOSSES from the disposition of property where at least one payment is to be received after the year of sale. a portion of the gain is reported as each payment is received

• **a person sells property for periodic installment payments. this installment sale method is not available for sales of stocks or securities traded on an established market. also not allowed for gains on property held for use in the ordinary course of business.
• **all depreciation recaptured is reported in income in the year of sale
• **a portion of the overall gain is recognized and reported on form 6252 and then transferred to either schedule d or form 4797, only as a person collects cash each year as follows:

gross profit / contract price = gross profit % X cash collected = installment sale income

Question 64

how are losses on deposits in insolvent financial institutions (banks) handled for tax purposes?

Answer 64

may deduct the loss if it can be estimated as either:

• *a casualty loss on schedule A (10% of AGI - 100) related to personal use property, filed on form 4864 or
• *an ordinary loss schedule A (miscellaneous itemized 2%); not available if any part of deposits are federally insured; maximum deduction is $20,000 ($10,000 if married filing single), and is subject to reduction by 2% of AGI.

if the actual loss exceeds the estimated amount taken as a casualty loss or ordinary loss, the excess is treated as a nonbusiness bad debt in the year of the actual loss. It is reported on schedule D and treated as a short term capital loss, deductible up to 3,000 per year.

Question 65

what is a long term construction contract?

Answer 65

a contract that cannot be completed within the taxable year to manufacture, build, install or construct property is considered a long term construction contract.

Question 66

how is income generally recognized for long term construction contracts?

Answer 66

under the percentage of completion method of accounting. income is based on the cost to cost method and recognized during the construction period.

contract costs incurred to date / total contract cost.

Question 67

when is the completed contract method of accounting permitted for tax purposes?

Answer 67

• for home construction or contract
• any other construction contract that will be completed within 2 years and their average annual gross receipts and all allocable costs incurred are recognized in the year of completion.

Question 68

what are the type of transactions that are not recognized for tax treatments?

Answer 68

• sales of personal assets (losses only not recognized); its when a person sells personal-use property at a loss
• wash sales (losses only not recognized); its when a person acquires stock within 30 days of selling the same stock at a loss
• sales to a related party (losses not deductible but gains are taxed); its when a person sells property at a loss to a related party, which includes, parent, grandparent, child, grandchild, spouse or sibling; majority owned corporation; majority owned partnership
• like-kind exchanges (losses are not deductible; gains are recognized only to the extent that a cash “boot” is received + debt relief +unlike property); it applies when a person exchanges real estate for other real estate
• involuntary conversions (gain is recognized only to the extent that a person reinvests less in a replacement property than the proceeds received from the original property); it applies when a person who lost property due to a casualty, theft, or condemnation, if: a similar replacement property is purchased within 2 YEARS from the end of the year in which the casualty or theft occurred, or 4 YEARS if a federal disaster area; an appropriate election to not report the gain is filed.
• installment sales (a portion of the overall gain is recognized only as a person collects cash each year as follows: cash collected x (gross profit/contract price); it is when a person sells property for periodic installment payments
• sales of a principal residence (up to $250,000 of reportable gain is not recognized and its $500,000 on a joint return); it is when you have lived in the home for at least two of the prior five years.

Question 69

what is a coinsurance clause?

Answer 69

requires the policyholder to purchase an amount of insurance equal to the fair market value of the property multiplied by a specified percentage. ex.

damage amount x (insurance policy amount / required amount of co-insurance)

co-insurance amount is calculated as follows:
(required percentage x fmv of the property)

Question 70

what are the rules for small business stock?

Answer 70

small business stock held for at least five years is eligible to exclude 50% of the gain on the sale of the stock.

Question 71

how is private company section 1244 treated?

Answer 71

worthless section 1244 stock is not included in capital gains because up to 50,000 of loss from code section 1244 stock may be deducted as an ORDINARY LOSS

Question 72

what is the special rule for listed securities?

Answer 72

the special rule for listed securities causes gains or losses to be realized on the trade date.

Question 73

section 179 deductions affect gains how?

Answer 73

it allows the company to expense the total cost and it will often result in gains on the sale for the full amount