2013 cch basic principles ch12

Chapter 12

Property Transactions: Treatment of Capital and

Section 1231 Assets

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CCH Federal Taxation Basic Principles 2 of 24

1. Capital Assets—Defined

2. Determination of Capital Gains and Losses

3. Steps to Determine Taxable Income

4. Section 1231 Assets

5. Determining Section 1231 Gains and Losses

6. Recap of the Rules

7. Recap of the Rules—Applying the Loss Limitation

8. Computing Casualty and Theft Losses

9. Netting Personal-Use Casualty/Theft Gains/Losses

Chapter 12 Exhibits

Chapter 12, Exhibit Contents A


10. Personal Casualty and Theft Losses

11. Casualty and Theft Losses

12. Section 1245 Depreciation Recapture

13. Section 1250 Depreciation Recapture

Chapter 12 Exhibits

Chapter 12, Exhibit Contents B


Capital Assets—Defined

Code Sec. 1221 defines capital assets by stating what they are not.

“Capital assets” generally refer to any property other than:

1. Ordinary income property (inventory, receivables, creative works created by the taxpayer) 2. Depreciable business property (buildings and machinery)3. Non-depreciable business property (land)

Thus, capital assets would include investment property such as stocks and bonds, and personal use assets such as cars, principal residences, household furnishings and jewelry. (Note: Paintings, manuscripts, and other creative works are capital assets if created by someone other than the taxpayer).

Chapter 12, Exhibit 1


Determination of Capital Gains and Losses

Long-term capital gains are taxed up to 15% (0% for individuals in the 10% and 15% tax brackets), except for:

Collectibles gains, which are taxed up to 28%

Section 1202 gains, which are taxed up to 28% (sale of small business stock held more than 5 years).

Un-recaptured Section 1250 gains, which are taxed up to 25%.

Chapter 12, Exhibit 2a


Step One

Group gains or losses into 4 baskets and determine the net amount in each basket.

1) Short-term gains/losses.2) 28% long-term gains/losses.3) 25% long-term gains (you will not have losses in this basket).4) 15% long-term gains/losses (including 1231 LT

capital gains)

Chapter 12, Exhibit 2b



Step Two Long-term net losses from the 28% basket are netted

first against gains from the 25% basket and then against gains from the 15% basket.

Long-term net losses from the 15% basket are netted first against gains from the 28% basket and then against gains from the 25% basket.

Short-term net losses are also netted against long-term net gains (starting with the 28% basket).

Short-term net gains reduce net losses from the 15% or 28% baskets.

Chapter 12, Exhibit 2c



Steps to Determine Taxable Income

If the result is a net short-term capital gain, the amount is included in ordinary income.

If the result is net long-term capital gains, the gains are taxed at the applicable capital gains rates (i.e., each basket’s rate).

If the result is a loss (short-term or long-term), up to $3,000 ($1,500 married filing separately) may be deducted for AGI. The excess can be carried forward indefinitely.



Code Sec. 1231 Assets.

Generally, business assets held over 12 months fall under the category “Section 1231.” These assets include depreciable personal and real property and land used in a business.

Examples include delivery trucks, the portion of a car’s basis allocable to business transportation, the portion of a principal residence used for a home office, factory, office computers, land, warehouses, office buildings, apartment buildings, and rental houses.

Section 1231 Assets



Gains entering into this calculation represent amounts remaining after applying the recapture rules of Sections 1245 and 1250.

Step One (the first netting)

Net all business casualty & theft gains and losses.

If the result is a net loss, the losses are ordinary losses (FOR AGI) and gains are included in ordinary income.

If the result is a net gain, the net gain is combined with other section 1231 gains and losses.

Determining Section 1231 Gains and Losses



Step Two (the second netting)

Net remaining 1231 gains and losses (including net casualty & theft gains from the first netting)

If the result is a net loss, the losses are ordinary losses (deducted FOR AGI) and gains are included in ordinary income.

If the result is a net gain, the net gain generally treated as a long-term capital gain. (It could be treated as ordinary income to the extent of unrecaptured Section 1231 net losses from the past 5 years).


Determining Section 1231 Gains and Losses


Recap of the Rules

1. Net each category.

2. If the long-term capital shows a gain after offsetting any net short-termcapital losses (STCLs) treat the net amount as a net long-term capital gain(LTCG) subject to a maximum 15% or 28% tax rate, depending on whichbasket survives the netting.

3. If the short-term capital shows a gain after offsetting any net LTCLs, treatthe net amount as a net STCG subject to the ordinary marginal tax rate.

4. If the Code Sec. 1231 column total shows a net loss, treat the net amountas an ordinary loss, deductible for AGI, without the $3,000 limitation. Donot offset it against net long-term or short-term capital gains.

5. If the Code Sec. 1231 column total shows a net gain. Treat as ordinaryincome to the extent of Code Sec. 1231 net losses for the previous five years that have not been recaptured. The remainder of the gain is treated aslong-term capital gain.



Recap of the Rules—Applying the Loss Limitation

Only $3,000 may be deducted each year for the aggregate of “net” short-term and “net” long-term capital losses. Short-term capital losses are used up first, then long-term capital losses beginning with the highest “baskets.”

Unused STCLs and LTCLs are carried forward indefinitely and retain their identity as short term or long term.

Remember, that STCLs and LTCLs on the sale of personal use property such as a principal residence or a car used for commuting, are NEVER deductible, and NEVER carried forward.



Computing Casualty and Theft Losses

“Basis” = Cost minus accumulated depreciation (if any).

““ means “reduce” or “reduced.”

FMV = fair market value.

Nature of the

Casualty:

Gain or Loss from Casualty:

Personal-Use: Business-Use:

Reimbursements, less: Reimbursements, less:

If total destruction or theft: Lower of basis or FMV Basis

If partial destruction: Lower of Basis or FMV Lower of Basis or FMV

Result: = “Realized” gain or loss = “Recognized” gain or loss

*Gain is recognized to the extent that insurance reimbursements exceed adjusted basis.



Netting Personal-Use Casualty/Theft Gains/Losses

Combine casualty/theft gains and losses less $100 per event, on personal-use property.

If a net gain, both gains and losses are capital gains and capital losses. Recall that the losses had been reduced by $100 per event but are NOT reduced by the 10% AGI floor.

If a net loss, the net amount is treated as an ordinary itemized deduction, having been reduced by $100 per event AND to be further reduced by the 10% AGI floor.



Personal Casualty and Theft Losses

If a personal use gain: = “Tentative” casualty gain

If a personal use loss: Reduce by $100 per event to get:

“tentative” casualty loss.

If all personal use tentative gains and losses net to a GAIN:

The result is a net casualty gain that gets capital gains treatment.

If all tentative gains and losses net to a LOSS:

Reduce by 10% AGI (applied once to all events’ combined net loss.) Any loss remaining is deductible “from” AGI



Casualty and Theft Losses

Type of deduction “From” AGI “For” AGI

Type of gain Capital (Ch. 12) Sec 1231 (Ch. 12)

Personal Use Business Use



Section 1245 Depreciation Recapture

Purpose – To prevent taxpayers from taking ordinary depreciation deduction and then receiving long term capital gain treatment through Section 1231.

Type of Property – Section 1245 is a subcategory of Section 1231. It includes depreciable personal property.



Ordinary income is recognized to the extent of total depreciation taken (not to exceed recognized gain).

Excess recognized gain is treated as Section 1231 gain.

All losses are treated as Section 1231 losses. There is no recapture of depreciation as ordinary income when there is a recognized loss.





Purpose – To prevent taxpayers from receiving the full benefits of accelerated depreciation and long term capital gain treatment through Section 1231.

Type of Property – Section 1250 is a subcategory of Section 1231. It includes depreciable real property.



General Rule (applies to MACRS property)

Unrecaptured Section 1250 gain is taxed up to 25%. Only gain on property held over 12 months is included (i.e. only applies to long-term gain)

Excess recognized gain is treated as Section 1231 gain and taxed up to 15%.




Pre-1981 Acquisitions

For nonresidential and residential real property, the following rules apply:

Excess depreciation is ordinary income (exception for residential real property - excess depreciation recapture is zero for pre-1976 time period).

Remaining unrecaptured depreciation is in the 25% basket. Remaining gain is in the 15% basket.

Chapter 12, Exhibit 13c



ACRS Acquisitions


Excess depreciation is ordinary income. For nonresidential real property, if accelerated depreciation was taken, total depreciation is recaptured as ordinary income.

Remaining unrecaptured depreciation is in the 25% basket. Remaining gain is in the 15% basket.

Chapter 12, Exhibit 13d



MACRS Acquisitions


Unrecaptured depreciation is in the 25% basket. Remaining gain is in the 15% basket.

Chapter 12, Exhibit 13e


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