24211_ch17_final_p001-014

24211_ch17_final_p001-014 - 17 Property Transactions...

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Unformatted text preview: 17 Property Transactions: Dispositions of Trade or Business Property Solutions to Problem Materials DISCUSSION QUESTIONS 17-1 Section 1231 property consists of depreciable property and land used in a trade or business or for rental and held for more than one year. In addition, timber, coal, and iron ore to which 631 applies, unharvested crops sold along with land that is 1231 property, and certain livestock are included. [See pp. 17-3 through 17-6 and 1231(a).] Section 1231 assets are assets other than capital assets and ordinary income or loss assets (and held for more than one year). Specifically excluded by statute are properties held primarily for sale to customers in the ordinary course of a trade or business or includible in inventory if on hand at the end of a taxable year. Other excluded assets are copyrights and similar properties and certain government publications acquired other than by purchase. All of these are examples of ordinary income or loss property. [See p. 17-3 and 1231(b)(1).] The first step is to net casualty and theft gains and losses related to (1) capital assets held for either business or investment purposes for more than one year and (2) 1231 assets. If a net gain results, the gain is treated as a gain from the sale of a 1231 asset. If a net loss results, 1231 is not applicable and each gain and loss is treated separately without regard to 1231. The next step is to combine the (1) net gain, if any, from above with (2) other involuntary conversions that involve, for either business or investment purposes, capital assets held for more than one year and 1231 assets and (3) sales or exchanges of 1231 assets. If a net gain results, it is treated as a long-term capital gain. If a net loss results, it is treated as an ordinary loss. Gains from the disposition of 1231 assets are subject to this treatment only after taking into account any depreciation recapture. Personal use assets are not included in this process. (See Exhibit 17-1 and pp. 17-7 through 17-11.) A net 1231 gain (after the netting process and the lookback rule) is treated as a long-term capital gain. It is first combined with other long-term capital gains and losses. If an overall net long-term capital gain results, it is combined with other long-term capital gains and offset against long-term capital losses and net shortterm capital losses, including any carryovers from prior years. (See pp. 17-7 through 17-11.) A net 1231 loss (after the netting process) is treated as an ordinary deduction. As a result, the loss is fully deductible without limit in arriving at A.G.I. Since a net 1231 loss is treated as an ordinary loss, it may also be used to generate or increase a net operating loss. (See pp. 17-7 through 17-11.) 17-2 17-3 17-4 17-5 17-1 17-2 Chapter 17 Property Transactions: Dispositions of Trade or Business Property 17-6 Casualty and theft gains and losses related to 1231 assets and capital assets held in connection with a trade or business are combined in the first step of the 1231 netting process. If a net gain results, it is included in the 1231 netting process. If a net loss results, each gain or loss is treated separately outside the 1231 netting process. (See Exhibit 17-1 and pp. 17-7 and 17-8.) Under the 1231 lookback rule, a taxpayer with a net 1231 gain must treat that gain as ordinary income to the extent that he or she has deducted a net 1231 loss as an ordinary deduction in any of the previous five years. Treating this gain as an ordinary gain rather than a capital gain is referred to as recapturing the ordinary deduction allowed in the prior year. Congress passed the 1231 lookback rule to prevent taxpayers from gaining advantage from timing sales so as to report net 1231 gains in some years and net 1231 losses in others. A taxpayer can still take limited advantage of this by reporting net 1231 gains one year and net 1231 losses the next (i.e., the year following the gains). However, these losses are subject to recapture in the next five years if the taxpayer has net 1231 gains. (See Exhibit 17-1 and p. 17-11.) Generally, 1245 property is depreciable personalty, such as automobiles, other equipment, and furnishings. It is specifically extended to include certain other properties as listed in 1245(a). Among other properties included is nonresidential real property acquired between 1981 and the end of 1986 if accelerated ACRS was applied. (See pp. 17-16 through 17-19.) Section 1245 recapture potential is the amount of depreciation allowed or allowable with respect to the particular property. Since it includes all depreciation, it is sometimes referred to as the full recapture rule. Any gain in excess of the 1245 recapture is treated as 1231 gain (assuming a long-term holding period). However, the amount of recapture on the sale or other disposition of a 1245 asset never exceeds the gain realized. (See p. 17-17.) a. b. The recapture potential is the depreciation allowed. In this case the amount expensed under 179 is treated as depreciation allowed, so the recapture potential is $3,600. Ordinary income. 17-7 17-8 17-9 17-10 (See pp. 17-16 through 17-19.) 17-11 An asset will be subject to both 1245 and 1231 only when the gain recognized exceeds the depreciation allowed or allowable. This can occur only if the sales price exceeds the original cost of the property. This, of course, occurs only in rare instances with depreciable personalty. Depreciation recapture applies only to gains. As a result, a net loss on the sale or other disposition of a 1245 asset will be treated as a 1231 loss (assuming it was held for more than one year). (See pp. 17-16 through 17-19.) Generally, no gain is recognized on a transfer by gift. Section 1245(b) provides that when there is no gain on a transfer by gift, there is also no recapture. Therefore, F has no gain. When D sells or otherwise disposes of the property at a gain, all or part of her gain will be ordinary. The basis for gain is found with reference to the donor's basis. Accordingly, the depreciation claimed by F, as well as that claimed by D, may be required to be recaptured. (See p. 17-18.) If no gain is recognized in a like-kind exchange, there is no recapture (i.e., 1245 does not supersede 1031); however, the recapture potential stays with the replacement property. If gain is recognized because "boot" is received (including liability "boot"), 1245 may make some or all of the gain ordinary income. (See p. 17-18.) For purposes of 1245, any 179 expense is treated as depreciation allowed. As a result, the amount thereof is included in the depreciation recapture potential. The basis of an asset that is totally expensed under 179 is zero. If the asset is ever sold at a positive price, there will be a gain and the 179 expense will be recaptured (limited to the original cost). (See p. 17-17.) Section 1250 property is any depreciable property other than 1245 property. It does not include land because land is not depreciable. It does include real property depreciated using the straight-line method; however, 1250 has no effect on this property since there is no depreciation recapture (assuming that the property has been held for more than one year). (See pp. 17-19 and 17-20.) 17-12 17-13 17-14 17-15 Solutions to Problem Materials 17-3 17-16 No. Under the original ACRS depreciation system, nonresidential real property that was depreciated using the accelerated method (as opposed to the optional straight-line method) was classified as 1245 property. As a result, all depreciation allowed is subject to recapture. This rule does not apply to real property placed in service between 1981 and 1986 and depreciated using the optional straight line method or to any real property placed in service after 1986 since the straight-line method is required for all real estate. (See p. 17-19.) Real property placed in service after 1986 must be depreciated using the straight-line method. As a result, there is no 1250 recapture potential and, therefore, no 1250 recapture (assuming that the property has been held for more than one year). Since there is no 1250 recapture, any gain would be 1231 gain, which would be treated as long-term capital gain if there were no offsetting losses. The gain will be 25% gain to the extent of the depreciation allowed and 15% gain to the extent of the excess. (See pp. 17-19 and 17-20.) Section 1250 requires that any depreciation in excess of straight-line be recaptured (i.e., reported as ordinary income). Since this applies only to the amount in excess of straight-line, 1250 is sometimes referred to as the partial recapture rule. After the asset is fully depreciated, accumulated straight-line depreciation equals accumulated accelerated depreciation. Therefore, there is no 1250 recapture potential after the asset is fully depreciated. (See p. 17-20.) As a practical matter, after 2006 1250 recapture has limited application. Historically, 1250 has applied primarily to residential real estate that was depreciated using the accelerated method. The accelerated method for residential real estate was last available in 1986. When used in 1986, the recovery period was 19 years. All of these buildings are now fully depreciated and consequently accelerated and straight-line depreciation are the same so 1250 does not apply. Note that beginning in 1987, taxpayers have been required to use straight-line depreciation on residential real estate so no excess depreciation is produced for these assets. Despite these rules, there are certain situations where 1250 could still apply. For example, 1250 property also includes 15- and 20-year realty which is depreciated using the 150 percent declining balance method and, therefore, is capable of creating excess depreciation. This category includes such assets as multi-purpose agricultural structures (e.g., barns), land improvements (roads, sidewalks, fences, landscaping, shrubbery, docks), gas stations, convenience stores and more. (See p. 17-20). a. b. $2,500. It is the excess of the depreciation allowed ($27,000) over the depreciation that would have been allowed using the straight line method (this must have been before 2007). The total gain is $62,000, Of this total, $2,500 is ordinary income under 1250 and $59,500 is 1231 gain. 17-17 17-18 17-19 (See pp. 17-20 and 17-21.) 17-20 The additional recapture rule of 291 applies only to corporations, including certain S corporations that were once C corporations. Under this rule, a corporation increases the recapture amount with respect to 1250 property. The additional recapture is determined as follows: Recapture if 1245 property (i.e., lesser of gain recognized or depreciation allowed) Less: Recapture under 1250 Excess Times: Percentage Additional recapture under 291 $xxx (xxx) (a) $xxx 20% $xxx (b) The total recapture is (a) (b). Any gain in excess of the recapture will be 1231 gain. (See p. 17-28.) 17-21 Yes. Since all depreciation could be recaptured under 1245, 20 percent could be recaptured under 291. In the formula presented in Question 17-20 above, the 1250 recapture is zero, but 20 percent of the hypothetical 1245 recapture must be recaptured. (See Example 21 and p. 17-28.) Dispositions of depreciable property and land used in a trade or business (or rental) operation are reported on Form 4797. All recapture is reported on the back of the form and, since it is always ordinary income, is carried forward to the front of the form (line 15) and then to the front of Form 1040 (line 15). Any 1231 gain is carried forward to the front of the form and is then carried to Schedule D (Capital Gains and Losses). (See Exhibit 17-4 and Example 19, pp. 17-27 through 17-33.) 17-22 17-4 Chapter 17 Property Transactions: Dispositions of Trade or Business Property 17-23 A taxpayer with involuntary conversion gain should consider not using the election if the gain would be a 1231 gain (especially a 25 percent gain) in a year in which there are no offsetting 1231 losses and there are substantial excess capital losses that would otherwise be carried forward, possibly for long periods of time. In this case, there is no current tax and no loss of any tax benefit in the near future. Other situations could also warrant recognizing the gain. (See pp. 17-10 and 17-25.) A loss on the sale of the property would be a 1231 loss, which, unless offset by 1231 gains, would be deductible as an ordinary deduction. If the property is traded in, however, the trade-in is a like-kind exchange and the loss would be deferred. So if it is economically practical to sell and reinvest, rather than trade in, you should recommend this to the taxpayer. (See pp. 17-10 and 17-25.) When property subject to recapture under 1245 and 1250 is sold on the installment basis, all of the recapture is ordinary income in the year of sale. Only the excess gain receives 1231 treatment and is deferred in the installment sale. Taxpayers should therefore consider negotiating for an immediate cash payment sufficient to pay any increase in the current year tax liability. (See p. 17-36.) 17-24 17-25 PROBLEMS 17-26 a. b. c. d. e. f. g. 1231 property Capital asset. This assumes that the goodwill was not subject to amortization. If the goodwill was amortized under 197, it is 1231 property and the amortization is subject to recapture under 1245. 1231 property. This house is treated as two properties. One (80 percent) is a capital asset. The other (20 percent) is treated as a 1231 asset. Neither a capital asset nor a 1231 asset. It would have been a 1231 asset if it were held more than one year. 1231 asset. Capital asset. However, since this is a personal use asset, the loss would not be deductible by an individual taxpayer. (See pp.17-3 through 17-6.) 17-27 Vacant land held for investment is a capital asset. So, H has a long-term capital gain of $52,000 and a 1231 loss of $12,000. The gain is a 15% group gain. The loss (assuming there are no 1231 gains) is an ordinary deduction. (See pp. 17-3 and 17-17.) There is no recapture of depreciation when an assent is sold at a loss. Furthermore, there is no excess depreciation when real property is depreciated using the straight line method. Therefore, H has a 1231 gain of $34,000 and a 1231 loss of $3,000. The net 1231 gain of $31,000 is treated as a long-term capital gain. Assuming the stock was held more than one year, the net capital gain is $19,000 ($31,000 $12,000). (See pp.17-7 through 17-25.) The casualty loss of $2,000 is deductible as an ordinary deduction. The involuntary conversion gain of $5,000 is added to the other 1231 gain of $31,000 for a combined result of $36,000 (netted against the $12,000 loss later in the process), which is treated as a long-term capital gain. (See pp. 17-7 through 17-25.) The net result of casualties and thefts of capital assets and 1231 assets is a gain of $180,000. It is combined with the other 1231 gains and losses of $121,000 for an overall 1231 gain of $301,000. This is then treated as a long-term capital gain, and when combined with the long-term capital loss, results in a net longterm capital gain of $231,000. (See pp. 17-7 through 17-10.) To apply the lookback rule, one must know exactly how 1231 gains and losses were treated in each of the five previous years: 2006 2007 2008 2009 2010 $13,000 ordinary deduction $13,000 ordinary income $52,000 long-term capital gain No gain or loss $35,000 ordinary deduction $12,000 ordinary income 17-28 17-29 17-30 17-31 Solutions to Problem Materials 17-5 The $50,000 gain for 2011 is ordinary income to the extent of any unrecaptured 1231 losses from 20062010. The 2006 loss was fully recaptured in 2007 and $12,000 of the 2009 loss was recaptured in 2010. Only $23,000 remains unrecaptured. Therefore, $23,000 of the 2011 gain is ordinary income and $27,000 is longterm capital gain. The $27,000 1231 gain that is treated as a long-term capital gain could be 25% (unrecaptured 1250 gain) or 15% gain. (See p. 17-11.) 17-32 a. A has gain of $30,000. The difference between the basis of the timber and its fair market value at the beginning of the year of harvest is 1231 gain ($40,000 $25,000 = $15,000). The other $15,000 is reportable as ordinary income. Yes, the costs of cutting the timber would be deductible as ordinary deductions for harvesting, etc. b. (See Example 1 and p. 17-5.) 17-33 a. L has a 1231 gain of $40,800. She is required to capitalize the cost of the crop as part of her cost of the land. There is no recapture. The gain is calculated as follows: Sales price (including crop) Adjusted basis (including costs of crop: $36,000 $3,200) Gain realized b. A long-term capital gain of $40,800 is included in adjusted gross income. $ 80,000 (39,200) $ 40,800 (See p. 17-6.) 17-34 The basis of the press is $344 ($820 $476). a. Gain of $156 is all ordinary under 1245. (See Example 8.) b. Loss of $244 is subject to 1231 treatment.(See Example 10.) c. Gain of $556 is $476 of ordinary income under 1245 and $80 subject to 1231 treatment. (See Example 9.) (See Examples 8 through 10 and pp. 17-16 through 17-19.) 17-35 Processing Machine-- 1245, $400 [the gain recognized is $1,200 ($1,400 $600) = $400]. Work Table-- 1245, $500 of the depreciation allowed; 1231 of $300. Automatic Stapler-- 1231 ($100) loss [$500 ($900 $300)]. Total gain--Summarized as follows: 1245 (ordinary income of $400 $500) 1231 (gain of $300 $100) Total $ 900 $ 200* $ 1,100 *Becomes LTCG, and if there are no capital losses and the "lookback" rule is not applicable is subject to favorable treatment. (See Examples 7 through 9 and pp. 17-14 through 17-16.) 17-36 Sales price Cost Depreciation allowed Depreciation recapture 1231 gain or (loss) (See Examples 7 through 9 and pp. 17-14 through 17-16.) A $105 100 30 30 $ 5 Assets B $ 90 125 25 0 $ (10) C $ 90 100 30 20 $ 0 17-6 Chapter 17 Property Transactions: Dispositions of Trade or Business Property 17-37 a. Sales price Less adjusted basis: Cost 179 expense Depreciation allowed: 2009 2010 2011( $524) Gain--All depreciation recapture $ 3,500 $ 13,000 (10,000) (429) (735) (262) (1,574) $ 1,926 If the problem was interpreted to suggest that the 2011 depreciation allowed was $524 (not the $262 allowed under the half-year convention), the basis would be $1,312 and the gain would be $2,188. b. Sales price Less: Adjusted basis Gain Character of gain: Depreciation recapture (all depreciation, including 179 deduction) 1231 gain $13,500 (1,574) $11,926 $11,426 $ 500 Similar to a., if the problem was interpreted to suggest that the 2011 depreciation was $524, the gain would be $12,188. Depreciation recapture would be $11,688 and the 1231 gain would be $500. (See Example 8 and pp. 17-15 through 17-17.) 17-38 Sales price Cost Depreciation allowed Straight-line depreciation Depreciation recapture 1231 gain or (loss) (See Examples 10 through 13 and pp. 17-15 through 17-22.) 17-39 a. Sales price Less adjusted basis: Cost Less depreciation allowed Gain Character of gain: 1250 recapture (additional depreciation) 1231 gain ($19,127 $0) b. $ 75,000 $60,000 (4,127) X $100 135 55 55 0 20 Assets Y $110 100 30 20 10 30 Z $200 100 30 20 10 120 (55,873) $ 19,127 $ 0 $ 19,127 Since the building was held more than 12 months, the gain is 25% gain and 15% gain. The unrecaptured depreciation of $4,127 is 25% gain and the remaining $15,000 is 15% gain. (See p. 17-18 and 17-22.) Solutions to Problem Materials 17-7 17-40 The sale is treated as sales of two separate properties: the land and the building. In computing the gain on each, the sales prices must be allocated between the land and the building based on their fair market values. a. Gain on the sale of the land and building and its character is computed separately as follows: Total Amount realized Adjusted basis Cost Depreciation Adjusted basis Gain (loss) realized Character 1245 ordinary income 1231 (See pp. 17-15 through 17-34.) The land is considered 1231 property since it is real property used in a trade or business. Thus the $20,000 gain on the land is 1231 gain (potential long-term capital gain taxed at 15 percent). Similarly, the building is also 1231 property but is subject to the full recapture rules of 1245 since it was acquired between 1982 and 1986 and an accelerated method of depreciation was used. Consequently, of the $90,000 gain attributable to the building, all of depreciation, $40,000, is recaptured, resulting in ordinary income under 1245 of $40,000. The balance of the $90,000 gain on the building, $50,000, is 1231 gain. b. If the taxpayer had used straight-line depreciation, there would be no recapture. The gain on the sale, $110,000, remains the same. Similarly, the gain allocable to the land sale, $20,000 remains 1231 gain and is potentially taxed as long-term capital gain at 15 percent. The total $90,000 gain on the sale of the building remains the same but its character changes. Although the building was acquired during 1982 and 1988, the straight-line method was used (rather than an accelerated method) so the fullrecapture rule of 1245 does not apply. As a result, the property is subject to 1250 which requires recapture of any excess depreciation. However, since the straight-line method was used there is no excess depreciation (i.e., excess of accelerated over straight-line) so there is no depreciation recapture under 1250. Thus there is no recapture of depreciation under either 1245 or 1250 and the entire gain is 1231 gain. Nevertheless, any gain realized to the extent of any unrecaptured depreciation on 1250 property, $40,000, is taxed at a 25 percent rate. In summary, the $110,000 gain is taxed as follows: Total Total Character 1231 25% gain Unrecaptured depreciation on 1250 property 1231 15% gain c. $110,000 Land $20,000 Building $90,000 $120,000 (50,000) 40,000 ($10,000) $110,000 Land $ 30,000 (10,000) -- ($10,000) $ 20,000 Building $90,000 (40,000) 40,000 ($ 0) $90,000 $20,000 $40,000 $50,000 $20,000 $40,000 $50,000 If the taxpayer in (b) is a corporation, the special provisions of 291 apply. Under 291, 20 percent of the excess of the gain that would have been recaptured under 1245 and any gain actually recaptured under 1250 is treated as ordinary income. In this case, if the building had been 1245, all $40,000 of the depreciation would have been recaptured. There is no actual 1250 recapture. Therefore $8,000 (20% of the excess of the hypothetical 1245 recapture of $40,000 and the actual 1250 recapture $0) is 17-8 Chapter 17 Property Transactions: Dispositions of Trade or Business Property ordinary income and the remaining $82,000 is 1231 gain. The gain on the land of $20,000 is still 1231 gain. These calculations are shown below. Realized gain on sale of building Character of gain on sale of building Section 291 calculation Amount treated as ordinary income if 1245 Amount actually treated as ordinary income under 1250 Difference between recapture amounts Rate specified in 291 Amount treated as ordinary income under 291 Balance of gain on building is 1231 gain Total gain on building Gain on sale of land is 1231 gain $90,000 $40,000 ( 0) $40,000 20% $ 8,000 82,000 $90,000 $20,000 This 1231 gain is, barring offsetting 1231 loss, is capital gain to the corporation. Corporations pay tax on their capital gains at the same rate as their ordinary income (hence, there is no distinction between unrecaptured 1250 gains and other capital gains). 17-41 a. Multi-purpose agricultural buildings are considered 1250 property (see. p. 17-20). Thus, taxpayers are required to recapture as ordinary income the excess of accelerated depreciation over straight-line (not to exceed the gain realized). Amount realized Adjusted basis Cost Accelerated Depreciation Adjusted basis Gain realized Character of gain Accelerated depreciation actual Hypothetical straight-line Excess depreciation 1250 ordinary income (excess depreciation) 1231 25% gain (unrecaptured straight-line) 1231 15% gain b. $500,000 $300,000 (125,000) (175,000) $ 325,000 $125,000 (105,000) $ 20,000 $ 20,000 $105,000 $200,000 c. The amount taxed at 25 percent is $105,000, representing the unrecaptured straight-line depreciation on 1250 property. Gains on the sales of 1250 property are taxed at a rate of 25 percent to the extent of any unrecaptured straight-line depreciation. If the taxpayer in (a) was a corporation, the special provisions of 291 applying only to corporations must be observed. Under 291, 20 percent of the excess of the gain that would have been recaptured under 1245 and any gain actually recaptured under 1250 is treated as ordinary income. In this case, if the building had been 1245, all $125,000 of the depreciation would have been recaptured. The actual 1250 recapture is $20,000. Therefore $21,000 (20% of the excess of the hypothetical 1245 recapture of $125,000 and the actual 1250 recapture $20,000 or $105,000) is ordinary income and the remaining $304,000 is 1231 gain. These calculations are shown below. Realized gain on sale of building Character of gain on sale of building Section 291 calculation Amount treated as ordinary income if 1245 Amount actually treated as ordinary income under 1250 Difference between recapture amounts Rate specified in 291 Amount treated as ordinary income under 291 Amount treated as ordinary income under 1250 Balance of gain on building is 1231 gain Total gain on building $325,000 $125,000 (20,000) $105,000 20% $ 21,000 20,000 284,000 $325,000 Solutions to Problem Materials 17-9 17-42 a. This problem illustrates the basic operation of 1250 and assumes the LLC is not treated as a corporation. The gain realized is $700,000, $250,000 is ordinary income under 1250, $300,000 is 1231 15% gain and $150,000 is 1231 25% gain. The calculations are shown below. Amount realized Adjusted basis Cost Accelerated Depreciation Adjusted basis Gain realized Character of gain Accelerated depreciation actual Hypothetical straight-line Excess depreciation 1250 ordinary income (excess depreciation) 1231 25% gain (unrecaptured straight-line) 1231 15% gain $1,000,000 $700,000 (400,000) (300,000) $ 700,000 $400,000 (150,000) $250,000 $ 250,000 $ 150,000 $ 300,000 b. c. The amount of gain taxed at 25 percent is equal to the amount of unrecaptured straight-line depreciation on 1250 property or $150,000 computed above. The amount of the gain would be $450,000. It is all 1231 gain: $150,000 is 25% gain and $300,000 is 15% gain. Amount realized Adjusted basis Cost Straight-line depreciation Adjusted basis Gain realized Character of gain 1231 25% gain ( unrecaptured straight-line) 1231 15% gain $1,000,000 $700,000 (150,000) (550,000) $ 450,000 $ 150,000 $ 300,000 d. None of the gain is taxed at a 25% rate if the taxpayer is a corporation since capital gains of corporations are treated the same as other income. The $700,000 gain would be characterized as follows: $250,000 as ordinary income under 1250, $30,000 ordinary income under 291 and $420,000 1231 gain. The computations are shown below. Amount realized $1,000,000 Adjusted basis Cost $700,000 Accelerated Depreciation (400,000) Adjusted basis (300,000) Gain realized $ 700,000 Character of gain Accelerated depreciation actual Hypothetical straight-line Excess depreciation 1250 ordinary income (lesser of realized gain or excess depreciation) Amount that would be treated as ordinary income under 1245 Amount actually treated as ordinary income under 1250 Difference between recapture amounts Rate specified in 291 Amount treated as ordinary income under 291 Balance of gain on building is 1231 gain Total gain on building $700,000 $400,000 (150,000) $250,000 $250,000 $400,000 (250,000) $150,000 20% $ 30,000 $420,000 $700,000 17-10 Chapter 17 Property Transactions: Dispositions of Trade or Business Property 17-43 The results are explained as follows: 1. 2. All 1250 recapture of $250,000 is recognized at the time of sale, and Years one and two gain = $450,000 (x1231 gross profit) $100,0000 (amount collected) = $45,000. $1,000,000 (contract price) As a result, the total reported in the year of sale is $295,000 ($250,000 ordinary income $45,000 1231 gain; in the following year, $45,000 (all 1231 gain). All of the 1231 gain is 25% gain since all "25% gain" must be recognized before any "15% gain." (See pp. 17-15 through 17-36.) 17-44 B's basis in the warehouse is $38,500 ($45,000 $6,500). So, when it is sold for $62,000, B's gain is $23,500. If B has no 1231 losses, the entire $23,500 is a long-term capital gain. The first $6,500 is 25% gain and the remaining $17,000 is 15% gain. (See pp. 17-15 and 17-23.) 17-45 Since V's 1250 recapture is $2,000, the unrecaptured 1250 gain is $3,000. Since the asset was held more than 12 months, the unrecaptured 1250 gain is 25% gain and the remaining $3,000 is 15% gain. The short-term capital loss first offsets the 25% gain, so V's "net capital gain" of $3,000 is 15% gain. (See pp. 17-15 and 17-23.) 17-46 a. 1250 recapture--ordinary income 1231 gain of ($30,000 $4,500): To extent of unrecaptured losses (2005 in this case)--ordinary income Excess over recapture--treat as long-term capital gain (15% gain) b. $ 4,500 $12,000 $13,500 $7,500 ordinary loss deduction under 1231, all in year of sale, since there were no other 1231 gains or capital gains. (See Exhibit 17-1 and pp. 17-11 through 17-34.) 17-47 Sales price Cost Depreciation allowed Straight-line depreciation Depreciation recapture 1231 gain or (loss) Land $100 140 0 0 n/a* (40) Building $110 100 30 20 10 30 Machine $ 90 125 25 n/a 0 (10) Machine $105 100 30 n/a 30 $ 5 *There is no depreciation or depreciation recapture related to land. (See Examples 1 through 12 and pp.17-3 through 17-26.) 17-48 a. Since there is only one casualty or theft involving 1231 assets and business capital assets, there is no netting. Since the result of the theft was a loss, it is not included in the 1231 netting process, but is deducted in full as an ordinary deduction of $425 (adjusted basis). The equipment is sold at a gain of $1,250. All of this gain is 1245 depreciation recapture. The land and building are sold at a gain of $17,500. Since straight-line depreciation was used for the building, there is no 1250 recapture, and all of the gain is 1231 gain. The net result of these three transactions is ordinary income of $825 ($1,250 $425) and a net 1231 gain of $17,500. This $17,500 is treated as a long-term capital gain. (See Examples 1 through 12 and pp. 17-4 through 17-34.) This problem deals with the 1231 lookback rule. It becomes an issue when a taxpayer has 1231 gains in some years and 1231 losses in other years. In this case, the equipment involves a $180,000 loss and the real estate involves a $460,000 gain. b. c. 17-49 a. Solutions to Problem Materials 17-11 b. c. A $460,000 1231 gain that is treated as a long-term capital gain in 2011 and a $180,000 1231 loss that is treated as an ordinary deduction in 2012. A 1231 loss of $180,000 that is treated as an ordinary deduction in 2011 and a 1231 gain that is treated as ordinary income of $180,000 under the lookback rule and as a long-term capital gain of $280,000 ($460,000 $180,000) in 2012. A net 1231 gain of $280,000 that is treated as a long-term capital gain. The lookback rule can be avoided only by (1) selling the gain assets first, followed by the loss assets in a later year or (2) waiting more than five years. (See Exhibit 17-1 and pp. 17-8 through 17-12.) 17-50 a. Section 1245 recapture is $600 (lesser of $600 realized gain or $2,600 depreciation from the lawn tractor); 1250 recapture is $600 (lesser of $44,000 gain or $600 excess depreciation from the apartment); other ordinary deduction for loss of scooter is $1,750 because casualty losses exceed gains. There is no recapture on the disposition of the spray painter because it was sold at a loss. $43,100. This is the remaining gain on the apartments ($44,000 $600 = $43,400) and a loss on the spray painter [$500 = ($1,400 $600 = $800) = ($300)]. $40,700. This is the $1,000 gain on the LM Corp, the $3,400 loss on the silver ingots, and the $43,100 net 1231 gain. This is a 15% gain. ($1,300) loss on PL, Inc. Ordinary income: 1245 recapture $ 600 1250 recapture 600 Other: casualty (1,750) Capital gains and losses: NLTCG(L) (including 1231 gain) $40,700 NSTCG(L) (1,300) Total/difference (15% gain) 39,400 Overall change in A.G.I. $38,850 b. c. d. e. (See pp. 17-2 through 17-36.) 17-51 G's gain is as follows: 1250 gain of $1,500, unrecaptured 1250 gain (25% gain) of $6,000, and 15% gain of $1,000. The $4,000 gain on the stock is a 15% group gain and the $5,000 loss on the gold is a 28% group loss. Combining the three, since the net 28% group loss first offsets the net 25% group gain, G has a net capital gain of $6,000, $1,000 of which is 25% gain and $5,000 of which is 15% gain, in addition to the ordinary income of $1,500. (See pp. 17-7 and 17-19.) C's gain is as follows: 1250 gain of $1,800, unrecaptured 1250 gain (25% gain) of $6,000, and 15% gain of $1,250. The $3,000 loss on the stock is a 15% group loss and the $4,000 gain on the land is a 15% group gain. Combining the three, since the net 15% group loss first offsets the net 15% group gain, C has a net capital gain of $8,250, $6,000 of which is 25% gain and $2,250 of which is 15% gain, in addition to the ordinary income from depreciation recapture of $1,500. Since C has taxable income of $121,900, his ordinary income is $113,650. The tax on 113,650 ($23,180) is calculated using the regular rates, $2,250 is taxed at 15% ($338), and $6,000 is taxed at 25% ($1,500) for a total tax of $25,018. (See pp. 17-7 and 17-19.) O and P can exclude $500,000 of the $522,000 gain on the sale of their residence. Their gain on the sale of the 1250 property was $116,000 ($26,000 of which was 1250 recapture and $30,000 of which was unrecaptured 1250 gain). The remaining 1231 gain of $60,000 is 15% group gain. So, O and P's taxable income is calculated as follows: Ordinary income ($45,200* $10,100 $15,000 $26,000) 25% Gain Group ($56,000 $26,000) 15% Gain Group ($22,000 residence gain $16,000 stock gain $60,000) Adjusted Gross Income Itemized deductions Exemption deductions ($3,700 (2011) 2) Taxable Income $ 96,300 30,000 98,000 $224,300 (23,400) (7,400) $193,500 17-52 17-53 17-12 Chapter 17 Property Transactions: Dispositions of Trade or Business Property The gross income tax on this income is the regular tax on $65,500 ($193,500 $30,000 $98,000 = $65,500), plus the capital gains tax. Tax on $65,500 Plus: 25% $30,000 Plus: 15% $98,000 $ 8,975 7,500 14,700 $31,175 *It is assumed that this is net of the deduction for of the self-employment tax. (See p. 17-7 and 17-17.) 17-54 This problem illustrates how 1245 and 1231 can apply to the asset if it is sold at a gain when the gain exceeds the depreciation recapture, and only 1231 applies to losses. a. Section 1231 applies. If the amount realized on the sale of an asset is less than its adjusted basis, a loss results and 1231 applies to the loss. b. Sections 1245 and 1231 apply. If the amount realized is greater than the original cost of the asset, the gain exceeds the depreciation that has been allowed. The gain is ordinary under 1245 to the extent of the depreciation allowed and is 1231 gain to the extent of any excess. c. Section 1231 applies. The way this question is presented, the answer is the same as the answer to (a). If the second relationship were reversed (i.e., X greater than T and T greater than Z), all of the gain would be ordinary income under 1245. d. Section 1245 applies. Because the property is sold at a gain (T greater than Z) and because the sales price is less than the depreciation allowed (the gain being less than the depreciation allowed), the gain is all ordinary income under 1245. (See Examples 8 through 10 and pp. 17-7 through 17-19.) 17-55 a. b. Section 1231 applies. If the amount realized is less than the adjusted basis, there is no depreciation recapture and the loss is a 1231 loss. Sections 1231 and 1250 apply. If the sales price exceeds the cost of the asset, there is a gain, and if the depreciation claimed exceeds straight-line depreciation, there is a 1250 recapture. When the sales price exceeds the original cost, the total gain exceeds the 1250 recapture, so part of the gain is 1231 gain. Section 1231 applies. If straight-line depreciation is claimed, there is no 1250 recapture, and any gain or loss is covered under 1231. Section 1250 applies. Where there is a gain, but the amount of the gain is less than the recapture potential (i.e., depreciation claimed less straight-line depreciation), all of the gain is ordinary income (i.e., depreciation recapture). c. d. (See Examples 11 through 14 and pp. 17-7 through 17-24.) 17-56 a. The depreciation reductions are determined using the tables for residential rental property, beginning February 11, 2009. Since the property was converted from personal use, the basis for depreciation (and determining loss) is the lesser of adjusted basis or fair market value on the date of conversion. The depreciation deductions are as follows: 2009 2010 2011 $85,000 3.182% $85,000 3.636% $85,000 3.636% 11.5/12 Total depreciation $2,705 3,091 2,962 $8,758 b. Since the property is sold at a gain, the original basis, reduced by the depreciation allowed, is used to determine the gain as follows: Sales price Less: Adjusted basis ($110,000 $8,758) Gain realized $ 104,500 (101,242) $ 3,258 The entire $3,258 realized gain will be recognized as a 1231 gain (25% group). The unrecaptured 1250 gain is $8,758. (See pp. 17-2 through 17-10 and 17-17 through 17-24.) Solutions to Problem Materials 17-13 17-57 a. The depreciation deductions, assuming no part was expensed under 179, are as follows: 2008 $14,500 20% 2009 $14,500 32% 2010 $14,500 19.20% 2011 $14,500 11.52% 0.5 Total depreciation $ 2,900 4,640 2,784 835 $11,159 b. The computer is listed property. In 2011, when the computer is converted to personal use, the excess of the depreciation under MACRS and that under the alternative system (five-year life, straight-line) must be recaptured. Therefore, Z must report ordinary income of $3,909 ($11,159 $7,250) in 2011. Had Z sold the computer system, the gain would be determined as follows: Sales price Less: Adjusted basis ($14,500 $11,159) Gain realized ( 1245 ordinary income) $ 5,400 (3,341) $ 2,059 (See pp. 17-7 through 17-19). TAX RESEARCH PROBLEMS Solutions to the Tax Research Problems (17-58 17-59) are contained in the Instructor's Resource Guide and Test Bank for 2012. ...
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This note was uploaded on 02/05/2012 for the course ACCT 110 taught by Professor Smith during the Spring '11 term at Adrian College.

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