58.a. $41,032 cost recovery; $358,968 adjusted basis of building.
58.b. $11,032 § 1231 gain.
59.b. AGI $461,108.
60.a. $9,300 § 1250 gain; $61,700 § 1231 gain.
60.b. $71,000 § 1245 gain.
61. $19,000 ordinary gain.
62. $1,000 ordinary gain.
63. No recognized gain or loss; $38,000 charitable contribution.
64. The entire $453,000 gain is ordinary income due to § 1245 depreciation recapture.
65. Brown has $4,500 § 1245 ordinary income; Emily has a $4,500 qualifying dividend.
66. The corporation’s gain is all ordinary income due to § 1239. Eli’s basis is $45,000.
67. $45,000 ordinary income.
68. $1,236 refund for 2003.
69. AGI is $272,982; taxable income is $256,206; tax refund is $4,383.
DISCUSSION QUESTIONS 1. Meredith has a zero tax basis for the supplies because she has already deducted their cost. Therefore, she has a gain of $1,000 from selling them. The supplies are not a capital asset because § 1221 specifically defines supplies as not a capital asset. Meredith has an ordinary gain from disposition of the supplies. p. 14-4
2. James is in the business of selling antique toy trains. Therefore, the toy trains are inventory and not a capital asset. The person who sold the trains at the garage sale held them as either a personal use asset or an investment asset. In either situation, the assets were capital assets. p. 14-4
3. Natasha is probably not in the trade or business of making loans. Therefore, she has made a loan in connection with an investment activity since she clearly intended to receive repayment of the loan plus interest. In the year the loan is worthless, she has a nonbusiness bad debt for the $4,000 principal of the loan. The $4,000 is treated as a short-term capital loss. p. 14-8
4. Anwar has a loss on a worthless security held for investment. The date of worthlessness is deemed to be the last day of the taxable year. However, since that is still in the same year he purchased the bonds, he did not hold them more than one year and he has a short-term capital loss of $12,000. p. 14-9
5. Mubsin was the grantee of the option and, since he exercised the option, the $10,000 option price is added to the $112,000 cost of the property to determine Mubsin’s adjusted basis for the property. The property is not a capital asset because Mubsin will hold it for use as rental property. He would have to determine how much of this basis is allocable to the land and how much is allocable to the building to determine his basis for depreciation. p. 14-11
6. Since Charles is a holder, the patent has not been reduced to practice, and he has given up all substantial rights in the patent, the $37,000 gain ($40,000 amount realized – $3,000 adjusted basis) is automatically a long-term capital gain. pp. 14-11 to 14-13
7. The lease was a personal use asset for the student and, therefore, a capital asset. However, the payment was in lieu of rent, a non-deductible personal expense of the student. Therefore, the payment is not a capital loss. Lease cancellation payments received are treated as an exchange for the lessee, but not lease cancellation payments made. p. 14-15
8. A former owner’s holding period is tacked on to the present owner’s holding period if the transaction is nontaxable and the former owner’s basis carries over to the present owner. Here, the value of the property was less than Juan’s (the donor) basis at the time of the gift. Miguel’s (the donee) holding period will not be known until Miguel sells the property. If Miguel sells the property for more than Juan’s basis, Juan’s holding period will tack on to Miguel’s. If Miguel sells the property for less than its fair market value at the date of gift ($7,000), Miguel’s holding period will start at the date of the gift.
p. 14-16 and Examples 24 and 25
9. Byron should sell enough stock to generate a $10,000 long-term capital gain. This will reduce his 2004 net capital loss to $3,000 and that $3,000 will be a for AGI capital loss deduction. pp. 14-26 to 14-27
10. The corporation may not reduce its 2004 taxable income by the net short-term capital loss. The corporation may carry over (three years back and five years forward) the loss and offset it against capital gains of the carryover year(s). p. 14-29
11. Until a potential § 1231 asset has been held more than one year, it is an ordinary asset because potential § 1231 assets do not qualify as capital assets and ordinary asset is the “default” category. p. 14-32
12. The taxpayer is in the racehorse business and the racehorse is a depreciable asset of that business. Since the racehorse has been held 24 months or longer, it is a § 1231 asset. p. 14-32
13. Personal use property is a capital asset. When personal use property casualty gains exceed personal use property casualty losses, the excess gain is treated as a capital gain. p. 14-33
14. If there is a net § 1231 gain of $45,000, some or all of the gain may be treated as ordinary income to the extent of § 1231 lookback losses. p. 14-35 and Concept Summary 14-6
15. The tax issues that Sally must properly handle are:
Should the two casualty items be netted against one another?
If the items are netted, what type of gain or loss results from the netting?
How are the results of the netting integrated with Sally’s other gains and losses (if any)?
Should Sally postpone the gain by reinvesting in similar property?
pp. 14-35, 14-36, and Chapter 13
16. Section 1231 has no effect on whether or not realized gain or loss is recognized. Instead, § 1231 merely dictates how such recognized gain or loss is classified (ordinary, capital, or § 1231) under certain conditions. p. 14-33
17. Since the property was used in a trade or business and held more than a year, it was a § 1231 asset. Disposition by condemnation (unlike disposition by casualty or theft) is not subject to any special netting rules. The loss is a § 1231 loss initially. Personal use property condemnation gains and losses are not subject to the § 1231 rules, but the property here was business use property. p. 14-33
18. The factors that will influence whether any of the 2004 net § 1231 is treated as long-term capital gain are:
What is the amount of the 2001 net § 1231 loss?
What is the amount of the 2002 net § 1231 gain, and after reducing the 2001 net § 1231 loss by the 2002 net § 1231 gain, does any of the 2001 net § 1231 loss remain?
If any of the 2001 net § 1231 loss remains, what is the amount of the 2003 net § 1231 gain, and after reducing the remaining 2001 net § 1231 loss by the 2003 net § 1231 gain, does any of the 2001 net § 1231 loss remain?
If any of the 2001 net § 1231 loss remains, what is the amount of the 2004 net § 1231 gain?
After reducing the 2004 net § 1231 gain by the remaining 2001 net § 1231 loss, does any of the 2004 net § 1231 gain remain?
pp. 14-33 to 14-35
19. The machine would have to be sold for more than the amount that was paid for it. p. 14-38
20. To properly handle this transaction, Sylvia must determine the following:
The tax status of the property (§ 1231 asset, capital asset, or ordinary asset).
The applicability of § 1245 depreciation recapture.
The outcome of the § 1231 netting process.
Both assets are § 1231 assets. Section 1245 depreciation recapture causes the entire gain of $2,510 ($40,000 – $37,490) to be taxed as ordinary income since the selling price does not exceed the $100,000 original cost of the asset. Since the loss of $14,490 ($23,000 – $37,490) on the other asset is the only § 1231 gain or loss, there is a net loss of $14,490 that is treated as an ordinary loss. Consequently, Sylvia is partially correct, the $2,510 gain from one of the items does offset the $14,490 loss from the other item. However, these transactions are reported separately from her 2004 business income. The $11,980 net loss is deductible for adjusted gross income on her 2004 tax return. pp. 14-30, 14-35, and 14-38
21. Section 1245 depreciation recapture generally applies to § 1231 assets; in this case depreciable equipment held more than one year. This asset was held one year or less; so it was an ordinary asset rather than a § 1231 asset. Since the asset is ordinary, the gain from disposition is also ordinary and § 1245 does not apply. pp. 14-30 and 14-38
22. All of the gain is subject to § 1245 depreciation recapture because nonresidential real estate acquired after 1980 and before 1987 for which accelerated depreciation was used is subject to § 1245 depreciation recapture. p. 14-40
23. The unrecaptured § 1250 gain is related to the depreciation taken on the property and requires that the property be sold at a recognized gain. The greater the portion of the sales price that relates to the land, rather than to the building, the smaller the recognized gain from disposition of the building will be. The issues raised include the following:
The original cost of the land and the building.
The portion of the sales price related to the land and to the building.
The depreciation taken on the building.
24. Section 1250 depreciation recapture would not apply to an asset acquired in 2000 because straight-line depreciation would have to be used for the building. Section 1250 depreciation recapture only applies when there is an excess of accelerated depreciation over straight-line depreciation. However, a portion of the recognized gain from disposition of the building may be taxed at a maximum of 25% because of the unrecaptured § 1250 gain rules. pp. 14-42 and 14-43
25. The amount in the 2003 additional depreciation column is negative because the straight-line depreciation exceeded the accelerated depreciation. As the holding period of the depreciable property gets longer, yearly straight-line depreciation of the original cost begins to exceed yearly declining balance depreciation. p. 14-43
26. The gain would be an ordinary gain due to § 1250. All depreciation is recaptured if the property is purchased and disposed of in one year or less. p. 14-42
27. Property qualifies as residential rental housing only if at least 80 percent of the gross rental income is rental income from dwelling units. p. 14-43
28. Abigail’s maximum unrecaptured § 1250 gain is the amount of the depreciation she took on the real estate. If the $45,000 recognized gain is less than the depreciation taken, that would be the maximum. She would have no § 1250 depreciation recapture because she acquired the real estate after 1986. Therefore, only straight-line depreciation was taken on the property. pp. 14-44 to 14-46
29. The § 1245 depreciation recapture potential carries over to the donee. p. 14-46
30. The § 1245 depreciation recapture potential does not carry over to the beneficiary. p. 14-46
31. The distribution of the truck is a taxable transaction for the corporation. All of the gain is § 1245 gain because the truck is a § 1231 asset and the fair market value is less than the original cost. p. 14-48
32. The distribution of the truck is a taxable transaction for the corporation. All of the gain is ordinary gain due to § 1239 because the shareholder is a related taxpayer and will use the truck in a business. Therefore, the truck is depreciable by the shareholder and § 1239 makes all the gain of the transferor ordinary gain. p. 14-48
PROBLEMS 33. All the assets are capital assets because they do not fit any of the items listed in § 1221 as not capital assets. The antique truck is a “collectible.” Therefore, the $12,000 loss ($35,000 sale price – $47,000 basis) is a long-term capital loss that would first be netted against any 28% long-term capital gain. The Blue Growth Fund $11,000 gain ($23,000 sale price – $12,000 basis) is a long-term capital gain that is potentially taxable at 5% and/or 15%. The Orange Bonds are sold for a $7,250 gain ($42,000 proceeds – $750 interest income – $34,000 basis). The gain is a long-term capital gain potentially taxable at 5% and/or 15%. The sale of the Green stock results in a $2,000 ($11,000 sale price – $13,000 basis) short-term capital loss because the stock was held one year or less. The $750 interest income is includible in Eric’s gross income. pp. 14-4 and 14-21 to 14-24
34. Sara is in the trade or business of being an artist. Her artworks are not capital assets, but are ordinary assets instead. Since she has a zero tax basis for the art that was sold, her ordinary income is $173,000. p. 14-5
35. By the close of business on the day Brenda purchases the shares, she must designate them as held for investment. The $55 ($200 – $145) per share gain would be long-term capital gain if she sells the shares after holding them more than a year.
Willis, Hoffman, Maloney, and Raabe, CPAs
5191 Natorp Boulevard
Mason, OH 45040
March 17, 2005
Ms. Brenda Reynolds
200 Morningside Drive
Hattiesburg, MS 39406
Dear Ms. Reynolds:
The purpose of this letter is to discuss the rules for purchases of stock by a securities dealer such as yourself. Your co-workers are incorrect that a securities dealer may never have a long-term capital gain from the sale of stock. The tax law allows you to designate stock you purchase as being held for investment. You must make this designation by the end of the business day on which the stock is acquired. I suggest you check with your supervisor on how this “designation” is normally done at your firm. I am sure it is a relatively simple procedure.
As long as you continue to hold the designated shares for investment until you sell them, the shares will be a capital asset. When you sell them at $200 per share, your $55 per share gain will be long-term capital gain if you have held the shares for more than one year.
Thank you for the opportunity to be of service. Please telephone me if you have additional questions.
Michelle Brown, CPA
36. Because Gerald has sold more than five lots, he has potential ordinary income equal to 5% of the selling price of each lot. Gerald has a total recognized gain of $228,000. This is classified as $3,000 ordinary gain and $225,000 long-term capital gain. The computations are shown below:
Selling price (10 X $30,000) $300,000