November 16, 2012

CONCEPTS IN FEDERAL TAXATION

CHAPTER 11: PROPERTY

DISPOSITIONS

ADMINISTRATIVE

AttendanceResearch project

Due November 19th

Midterm 2Regrade policyConcerns?

HW Problems:Assignment #12Chapter 11P#24, 27, 28, 52, 55

Extra problems: #44, 57

HOMEWORK PROBLEMS

Tuyen is negot iat ing the sa le of her lake f ront property near Wabasha. Ni ls i s off er ing:

Cash of $10,000 A parcel of land near Red Wing valued at $5,000 with an adjusted bas is of $3,000 A sk i boat valued at $9,000 wi th an adjusted bas is of $15,000 Insta l lat ion of new heat ing and a i r condi t ioning in Tuyen’s Rochester res idence

(Ni l ’s labor and equipment costs are valued at $4,500) Payment of $2,000 in real estate taxes due on the property Assumption of the $120,000 balance of the mortgage on the property Payment of the $900 in attorney fees and $50 in fi l ing fees to complete the

transact ion In addi t ion, Tuyen is off er ing to transfer her pontoon boat and outboard motor to Ni ls . The boat and motor have a fa i r market value of $8,500 and an adjusted bas is of $10,000. Also, she would assume the $3,000 mortgage balance on the Red Wing real estate Tuyen’s brother te l ls her she should not accept an off er of less than $150,000 for the Wabasha property. Wri te a letter to Tuyen expla in ing how much she would real ize i f she accepts Ni ls ’ off er as presented.

#24

Adjusted basis irrelevant for determination of amount realized Look at FV

Determination of amount realized by Tuyen:Cash receipt $ 10,000Value of parcel of land near Red Wing 5,000Ski boat value 9,000Value of heating and air conditioning installation 4,500Real estate taxes owed by Tuyen, paid by Nils 2,000Mortgage assumed by Nils 120,000Tuyen’s fees ($900 + $50) 950Less:Value of boat and motor transferred to Nils (8,500)Mortgage assumed on the Red Wing land (3,000)Amount realized$139,950

#24

$139,950 < $150,000 suggested by Tuyen’s brotherWhether she accepts/declines the deal depends on if

she deems the $139,950 to be a fair selling price or not

#24

During the current year, James sells some land he purchased in 2007 as an investment. He had paid $4,000 in cash and borrowed $22,000 to buy the land. He had paid legal fees of $440 and commissions of $560 on the purchase. He sells the land on October 1 to DeWayne, who gives James 200 shares of Aardvark common stock with a fair market value of $9,600 (DeWayne had paid $3,700 for the stock) and assumes James’s debt on the land, which is $20,800 at the time of sale. James pays legal fees of $400 and $1,800 of commissions on the sale. DeWayne pays legal fees of $575 and commissions of $980 related to the purchase. In addition, DeWayne agrees to pay the property taxes of $800 on the land for the entire year. Assume you are a staff accountant in a CPA fi rm. Write a memorandum to your supervisor explaining James’s gain or loss on the land sale, James’s basis in the common stock received, DeWayne’s gain or loss on the transaction, and DeWayne’s basis in the land.

#27

James’ gain on land:Gross sales price ($9,600 + $20,800 + $600) $ 31,000

Stock, debt assumption, property taxes

Less: Selling expenses ($400 + $1,800) (2,200)

Legal fees & commission

Amount realized $ 28,800AB ($4,000 + $22,000 + $440 + $560) (27,000)

Cash, debt, legal fees, commission

Realized gain on sale $ 1,800 $800 property taxes x 9/12 year = $600

James’s portion of property taxes

#27

James’ basis in the 200 shares of Aardvark stock is its fair market value $9,600

#27

DeWayne’s realized gain on transaction: Gross sales price (stock) $ 9,600Less: Adjusted basis (3,700)Realized gain $ 5,900

#27

DeWayne’s basis in the land: Gross sales price $ 31,000

Stock, debt assumption, property taxes

Plus: Expenses paid to acquire land ($575 + $980) 1,555

Legal fees & commission

Basis $ 32,555 

#27

Additional Considerations:

DeWayne’s payment of James’ property taxes of $600 [$800 x (9 ÷ 12)] is part of the agreed upon selling price of the property

The remaining $200 ($800 - $600) of property taxes Dewayne pays is a deductible property tax

#27

Elvira owns an offi ce building, and Jared Partnership owns an apartment building. Each property is encumbered by a mortgage. Elvira and Jared Partnership agree to exchange their properties and mortgages, with any diff erence to be paid in cash. The fair market values, mortgages, and adjusted bases for the properties are as follows: 

Jared PartnershipElvira’s Building Building

Fair market value $ 220,000 $ 250,000Mortgage debt 80,000 150,000Adjusted basis 100,000 175,000  a. Write a letter to Elvira explaining who wil l have to pay cash to complete the exchange, the amount of her gross sell ing price, and the amount of gain or loss she wil l realize on the exchange.

#28

Elvira’s Jared’sBuilding Building

Diff erenceFair market value $ 220,000 $ 250,000 $ 30,000Mortgage debt (80,000) (150,000) (70,000)Equity in building $ 140,000 $ 100,000 $ (40,000)

Jared Partnership will need to pay Elvira $40,000 cash to complete the exchange

#28

Elvira realizes a gross selling price of $220,000: Cash received from Jared $ 40,000Value of building received 250,000Mortgage assumed by Jared 80,000Less: Assumption of Jared’s mortgage (150,000)Gross selling price $ 220,000

#28

Elvira’s gain realized on the exchange is $120,000: Gross selling price $ 220,000Less: Adjusted basis (100,000)Realized gain $ 120,000

#28

b. Write a letter to Jared Partnership explaining who will have to pay cash to complete the exchange, the amount of the gross selling price of its property, and the amount of gain or loss it will realize on the exchange.

Jared Partnership will need to pay Elvira $40,000 to complete the exchange (determined in part a)

Jared realizes a gross selling price of $250,000: Value of land received $ 220,000Mortgage assumed by Elvira 150,000Less: Assumption of Elvira’s mortgage (80,000)Less: Cash paid to Elvira (40,000)Gross selling price $ 250,000

#28

Jared’s gain realized on the exchange is $75,000: Gross selling price $ 250,000Less: Adjusted basis (175,000)Realized gain $ 75,000

#28

During August 2009, Madeline invests $400,000 in Qual Company, Inc., buying 100,000 shares of stock. Her broker tells her this will be an excellent investment because the securities are qualified small business stock. He predicts the stock will triple in value over the next three years. At the end of 2011, Madeline’s shares are valued at $700,000. Madeline is encouraged. She decides to cash out of this investment in December 2012 if the stock continues to appreciate. Madeline comes to you for advice. Write a letter advising her what she should do.

#52

If the stock triples in value as predicted by her stockbroker, Madeline will realize a gain of $800,000 ($400,000 x 3 = $1,200,0000) - $400,000 on sale in

December 2012 Madeline’s investment can be qualified small

business stock only if she holds it for 5 yearsIndividuals may exclude 50%, 75%, or 100% of the realized

gain on qualified small business stock depending on timeframe

By not holding the stock 5 years, Madeline will be taxed at 15% on the $800,000 gainShe will pay $120,000 ($800,000 x 15%) in tax on the gain

if she sells the stock in December 2012

#52

If she purchases other qualified small business stock costing at least $1,200,000 (the selling price) within 6 months of the sale, she can defer the entire gain on the stock and the holding period of the new stock will include the time she held the Qual Company stockIf she buys replacement stock, the basis of the replacement

stock is reduced by any gain not recognized on the sale

#53

If Madeline holds the stock until after August 2014, the stock will be qualifi ed small business stock (>5 years)She can exclude 75% of any gain on the sale

If she can still sell the stock for $1,200,000 at this time, she can exclude $600,000 of the gain75% x $800,000 = $600,000

The remaining gain is taxed at 28% (assuming she in in the 28% or higher tax bracket)$200,000 x 28% = $56,000

By holding the stock an additional 1½ years, she will save $64,000 ($120,000 - $56,000) in taxes

#52

Madeline should not sell the stock until after August 2014 if she expects the stock to maintain its value

If the stock price is expected to drop before this time, she may want to consider selling in December 2012

For example, if the stock is projected to be worth only $750,000 in August 2014, she will have a $350,000 ($750,000 - $400,000) gain on the sale

She excludes $262,500 of the gain ($350,000 x 75%) and pays a tax of $24,500 ($87,500 x 28%) on the $87,500 of gain remaining after the exclusion

Her realization net of tax is $725,500 ($750,000 - $24,500)

If she sells the stock in December 2012, her realization net of tax is $1,080,000 ($1,200,000 - $120,000)

The decision to sell the stock in December 2012 or hold it until after August 2014 is dependent on what the price of the stock is expected to be in the future

#52

Neila sells 500 shares of Bolero Corporation stock for $10,500 and pays $500 in sales commissions on September 23 of the current year. She acquired the stock for $4,700 plus $300 in commissions fi ve years ago. Neila owns the following securities in December of the current year. 

Number Purchase Market Security of Shares Date Basis Value Rondo Corporation 200 2/13/09 $ 3,000 $ 6,000Hartley, Inc. 300 4/11/11 11,000 5,000Flescher Company 400 7/18/12 24,000 20,000 Write a memorandum to Neila recommending an optimal year-end tax-planning strategy for her capital gains and losses.

#55

Neila realizes a $5,000 [($10,500 - $500) - ($4,700 + $300)] long-term capital gain on the Bolero Corporation stock sale

When a taxpayer is in a net capital gain position prior to the end of the tax year, the normal strategy is to take losses on capital assets to off set the capital gain

Neila should sell some of her securities that currently have unrealized losses

#55

If Neila sells the Hartley Inc. shares, she will realize a $6,000 long-term capital loss$5000 FV - $11,000 basis

This will change her net capital gain/loss position to a $1,000 ($5,000 - $6,000) net capital loss

Selling the Flescher Company stock will result in a $4,000 short-term capital loss$20,000 FV - $24,000 basis

Because of the $3,000 capital loss deduction limitation, Neila should sell only 200 of the Flescher shares$2,000 short-term loss on the sale$3,000 net capital loss ($2,000 + $1,000)

#55

Alternative Solution:

Neila could sell the 400 Flescher shares$4,000 loss

She would then need to sell 200 of the Hartley Inc. shares, which would produce a $4,000 loss$6,000 loss x 2/3 = $4,000

Netting the $4,000 loss on the Flescher shares and the $4,000 loss on the Hartley shares with the $5,000 gain on the Bolero Corporation stock sale results in a net capital loss of $3,000, which is the maximum amount she can deduct

#55

Rollie has the following capital gains and losses during the current year: Short-term capital gain $ 3,000Collectibles gain 4,000Long-term capital gain 11,000Long-term capital loss 6,000 Rollie is married and has a taxable income of $145,000 before considering the eff ect of his capital gains and losses. What is the eff ect of Rollie’s capital gains and losses on his taxable income and his income tax liability?

EXTRA PROBLEMS—#44

Rollie has a $3,000 short-term capital gain and a $9,000 long-term capital gain: Short-term capital gain $ 3,000 Long-term capital gain $ 11,000Long-term capital loss (6,000)Collectibles gain 4,000Net long-term capital gain $ 9,000

EXTRA PROBLEMS—#44

The capital gains are added to gross income, increasing his taxable income to $157,000$145,000 TI + $3,000 STCG + $9,000 LTCG

The short-term capital gain is taxed at Rollie’s 28% marginal tax rate

The net long-term capital gain consists of an adjusted net capital gain of $5,000 ($9,000 - $4,000) and a $4,000 collectibles gain:

28% marginal rate = $3,000 28% rate gain = $4,000Adjusted net capital gain = $9,000 - $4,000 = $5,000

EXTRA PROBLEMS—#44

The $5,000 adjusted net capital gain is taxed at 15%

The $4,000 collectibles gain is taxed at 28% (equal to the marginal tax rate)

Rollie’s income tax liability increases by $2,710: Tax on short-term capital gain - $3,000 x 28%

$ 840Tax on adjusted net capital gain - $5,000 x 15% 750Tax on collectibles gain - $4,000 x 28%

1,120Tax on capital gains$2,710

EXTRA PROBLEMS—#44

Opal’s neighbor, Jilian, persuades her to invest in Schaake Corporation, a new venture, on March 4, 2011. Opal pays $15,000 for 3,000 shares of common stock. On February 6, 2012, Schaake Corporation declares bankruptcy and closes its doors forever. Opal never receives a return on her investment or a reimbursement of her original investment. What are the tax consequences to Opal?

EXTRA PROBLEMS—#57

Opal realizes a $15,000 long-term capital loss on the worthless securities in 2012

Opal is deemed to have realized the loss on the last day of the tax year in which the security is determined to be worthless (2012)

The realized loss is equal to the basis of the worthless security

The stock is long-term because the holding period is more than 12 months March 4, 2011, through December 31, 2012

Opal can deduct only $3,000 of the loss, unless she has capital gains to off set some or all of the $15,000 capital loss

EXTRA PROBLEMS—#57

I. All gain/loss are categorized as:A. OrdinaryB. CapitalC. Section 1231D. Personal use

II. Realized gain/lossA. Gross sales price – selling expensesB. Gross sales price:

i. Cashii. FMV property receivediii. FMV services receivediv. Amount of seller’s expenses paid by buyerv. Amount of seller debt assumed by buyer

IMPORTANT CONCEPTS

III. Capital gains/lossesA. Definition: a property that is NOT:

i. Inventory itemii. Receivableiii. Real/depreciable property used in trade/businessiv. Copyrights, etc.v. U.S. government publications (don’t worry about this one)

B. Capital gain/loss netting procedurei. Classify as ST or LTii. Identify gains from collectibles, qualified small business stock

and unrecaptured section 1231iii. Net within categories

a. Collectibles and qualified small business stock are netted with LT

iv. If LT & ST are opposite, keep nettingv. Otherwise, stop netting and treat LT and ST separately

IMPORTANT CONCEPTS

vi. Adjusted net capital gains are taxed at maximum 15%a. Adjusted NCG = NLTG – (28% rate gain + unrecaptured 1231 gain) + eligible

dividend incomeb. 28% rate gain = net collectibles gain + (qualified small business stock gain –

NSTL – LTL carryover)

vii. Net collectible gains taxed at maximum 28%viii. Unrecaptured 1231 taxed at maximum 25%ix. $3,000 capital loss limit

a. Corporations can’t deduct capital losses against other types of income and get no tax break on capital gains

IV. Capital gain exclusion on qualified small business stock

A. QualificationsB. Relief for gains (talked about losses in chapter 7)C. Defer gain if replaced

IMPORTANT CONCEPTS

V. Capital gains/losses—planning strategiesA. Net capital gain position

i. Sell assets with unrealized loss

B. Net capital loss positioni. Optimize at $3,000 net capital loss

C. Worthless securitiesi. Deemed to occur on last day of tax year

D. Basis of securities soldi. Specific identificationii. FiFO

IMPORTANT CONCEPTS

VI. Section 1231 gains/lossesA. Definition

i. Real or depreciable property used in a trade/business and held for more than 1 year

ii. Timber, coal, iron oreiii. Cattle or horses held more than 2 yearsiv. Other livestock held more than 1 yearv. Crops in the field

B. Netting procedure:i. Net gain = LTCGii. Net loss = ordinary lossiii. Lookback recapture rule (applies only to gains)

IMPORTANT CONCEPTS

VII. Depreciation recaptureA. Only applies to gains on property dispositionsB. Section 1245 recapture

i. Full recaptureii. Applies to peronalty

C. Section 1250 recapturei. Partial recapture of excess depreciation over SLii. Real estate using MACRS will not have any 1250 recapture

since already using SL

D. Section 1245 and 1250 propertiesi. Apartment buildings always 1250ii. Nonresidential realty depends on when it is placed in serviceiii. Look at table 11-2

IMPORTANT CONCEPTS

VIII.Unrecaptured section 1250 gainA. Gain that would be ordinary if using Section 1245B. Taxed at maximum 25%

IMPORTANT CONCEPTS