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Chapter 21: Capital gains and losses.

WHAT iS IT?

When the income tax was originally created in 1913, capital gains were not distinguished from any other type of income. Legislators soon realized that treating capital gains in the same fashion as other sources of income was producing some inequities and moved to correct the problem. For this reason, gains from transactions involving capital assets have been afforded preferential treatment under the tax law for most of its history. Beginning with the 1921 tax year, capital gains have been taxed at a separate, and generally significantly lower, tax rate than other sources of "ordinary" income. In fact, with only a few exceptions, in every tax year since 1921, the capital gains tax rate has been lower than the highest marginal ordinary income tax rate. (1)

The reasoning behind the separate and lower tax rate was fairly simple. Capital gains generally represent appreciation that is earned over time; however, the annual appreciation is not taxed. By waiting until the capital asset is sold to tax the gain, the taxpayer reports a large sum of income in one year that may actually have been "earned" over a number of intervening years. The inclusion of the lump sum amount in the year of sale could force the taxpayer into higher marginal tax brackets and ultimately to a higher tax in the year of sale than would have been paid had the gain in the asset been subjected to tax on an annual basis.

In order to determine if a transaction qualifies for the more favorable capital gains tax rate, the key question to be answered is whether the asset--in the hands of the seller--is a "capital" asset. In characterizing whether an asset is a capital asset, the length of time the taxpayer held the asset is immaterial. (2)

Losses on sales of capital assets are also subject to special rules. Non-corporate taxpayers first offset capital gains with capital losses. However, to the extent capital losses exceed capital gains, non-corporate taxpayers may use up to $3,000 of net capital losses to offset other taxable income. (3) Excess capital losses for a particular year may not be carried back to offset capital gains or ordinary income in earlier years, but, rather, are carried forward to offset capital gains or ordinary income in future years. Non-corporate taxpayers may only carry forward excess capital losses from a given year to offset capital gains in future years and may do so for an unlimited period until the excess is used. (4)

Corporate taxpayers must also net capital losses with capital gains. (5) The excess capital loss may generally be carried back three years and carried forward five years. (6) Note that corporate taxpayers, unlike individuals, do not benefit from a special tax rate for capital gains. The net capital gain is treated as additional income and is taxed accordingly.

The characterization of whether an asset is capital or not is not elective. This is the source of a great deal of litigation. Obviously, non-corporate taxpayers with large gains will argue for treatment as a capital asset to receive the more favorable tax rates. On the other hand, taxpayers with large losses will vehemently fight for ordinary tax treatment since capital losses will likely take years to offset with capital gains and, even then, will be offsetting income at the lower capital gain tax rate.

WHAT IS--AND WHAT IS NOT--A CAPITAL ASSET?

In order for a transaction to be treated as a capital gain (or loss), the underlying asset must meet the definition as a capital asset. Like so many other parts of the U.S. tax law, a capital asset is defined by what it is not.

A capital asset is any property held by a taxpayer, whether or not connected with a trade or business, excluding the following categories of assets: (7)

1. stock in trade of the taxpayer or other property that would properly be classified as inventory at the end of a taxable year, or property held by the taxpayer for sale to customers in the ordinary course of the trade or business. (8)

2. depreciable or real property used in a trade or business. (9) However, capital gain status may still be given to such assets under IRC Section 1231.

3. a copyright, a literary, musical or artistic composition, or a letter or memorandum or similar property held by the creator of such work or certain subsequent owners. (10) Note that as a result of the Tax Increase Prevention and Reconciliation Act of 2005, taxpayers may elect to treat the sale or exchange of musical compositions or copyrights in musical works created by the taxpayer's personal efforts as the sale or exchange of a capital asset. This election is applicable to sales or exchanges of such assets in tax years beginning after May 17, 2006. The law is set to expire at the end of 2010.

4. accounts or notes receivable acquired in a trade or business in exchange for services provided or from the sale of inventory. (11)

5. a publication of the U.S. Government which is received from the U.S. Government or its agency at a price which is less than what it is offered for sale to the general public. (12)

6. any commodities derivative financial instrument held by a commodities derivatives dealer. (13)

7. any hedging transaction which is identified as such before the close of the day on which it was acquired, originated, or entered into. (14)

8. supplies of a type regularly used or consumed by the taxpayer in the ordinary course of a trade or business of the taxpayer. (15)

It would seem that, given these exclusions, it would be relatively simple from this point to determine whether an asset should be considered a capital asset. However, judicial interpretations have muddied the waters over the years. If there is any question about whether an asset is capital in nature or not, research should be done to determine if the courts have already addressed the issue.

Once it has been determined that the asset qualifies as a capital asset, the asset must be disposed of in a transaction that will be treated as a "sale or exchange" to obtain the favorable capital gains treatment. Although tax law does not specifically define a "sale or exchange," there are solid interpretations that are very consistent with what one would expect.

A "sale" is defined as a transfer of property for money or a promise to pay money. (16) A contract to sell shows the intent of the parties to enter into a transaction but not an actual transfer. When there is doubt as to whether a sale or transfer of property has occurred, factors that the courts use to make that determination include:

1. whether legal title has passed;

2. whether the purchaser has acquired an equity interest in the property;

3. whether the acquisition creates a present obligation to transfer legal title for an agreed upon consideration;

4. whether legal title is vested in the purchaser; and

5. whether the purchaser bears the risk of loss and has the benefits of ownership. (17)

An "exchange" is a transfer of property for other property. (18)

Example: Broad Street, Inc. owns a car that it wishes to swap for a computer system that is currently owned by Bullies, Inc. Assume these assets qualify as capital assets. The exchange of these dissimilar assets would constitute a taxable exchange of capital assets for which each company would need to determine its capital gain or loss.

With an exchange, taxpayers must take into account the "like-kind exchange" rules of IRC Section 1031. Although this will be covered in more detail in Chapter 30--Like-Kind Exchanges, exchanged property that is similar in nature may not result in the current recognition of gain or loss. The like-kind exchange rules require deferral of any gain or loss in these situations.

Certain events will create a statutory sale or exchange of a capital asset. The more common ones that may be encountered by taxpayers include:

* A nonbusiness debt of a noncorporate taxpayer that becomes worthless within the taxable year is treated as a loss from the sale or exchange of a capital asset held for not more than one year (i.e., a short-term capital loss). (19)

* A security that becomes worthless during the taxable year and which is considered a capital asset in the hands of the taxpayer is treated as a loss from the sale or exchange of a capital asset on the last day of the taxable year. (20) For this purpose, a security is:

(1) a share of stock in a corporation, (21)

(2) a right to subscribe for or to receive a share of stock in a corporation, (22) or

(3) a bond, debenture, note, or certificate, or other evidence of indebtedness issued by a corporation or government, with interest coupons or in registered form. (23)

* Distributions of property from a corporation to a shareholder if the distribution exceeds the shareholder's adjusted basis in the corporation's stock. (24)

Example: Bruce Rosen owns 500 shares of Bellyup, Inc., a publicly traded company. He originally purchased the stock three years ago for $6,000. During the current tax year, Bellyup, Inc. ceased operations, filed for bankruptcy, and was delisted from the securities exchange markets. Since there is no market for the stock and operations have ceased, Bruce may treat his $6,000 as a loss from the sale or exchange of the stock as of the last day of the taxable year.

Section 1231 Assets

Although one of the exclusions from the definition of a capital asset is depreciable or real property used in a trade or business, IRC Section 1231 may characterize the gain realized upon the sale or exchange of these assets as a capital gain. A "Section 1231 asset" is depreciable or real property that is used in a trade or business and is held for more than one year. (25)

If, in a single tax year, the gains from Section 1231 assets exceed the losses from Section 1231 assets, each Section 1231 asset sale is treated as either a long-term capital gain or loss. (26) If the losses from the disposition of Section 1231 assets exceed the gains, each Section 1231 asset sale is treated as ordinary income or loss. (27)

Example: During a tax year, Bermuda Shorts, Inc. sells a machine at a $5,000 gain, a truck at a $500 gain, and a car at a $3,000 loss. All of the assets are used in the trade or business and have been held for more than one year. (Ignore depreciation recapture issues, which will be discussed later in this chapter.) Since the Section 1231 gains exceed the Section 1231 losses, each gain and loss is treated as a separate long-term capital gain and loss.

It would appear that the taxpayer could obtain the best of both worlds under the rules for Section 1231. Properly timed, a taxpayer can create an ordinary loss in one year by selling Section 1231 assets at a loss and in the next year achieve long-term capital gain treatment for gain assets. For this reason, the amount treated as long-term capital gains under Section 1231 must be reduced by the amount of Section 1231 losses for the five previous tax years. (28)

Example: In 2008, Loose Ends, LLC sold a car at a $5,000 loss. The loss was properly identified and reported as an ordinary loss in 2008. In 2009, the company sold a computer at a $2,000 gain. Were it not for the loss recapture rules, the $2,000 gain could be treated as a Section 1231 long-term capital gain in 2009. Instead, the $2,000 is reported as ordinary income in 2009. The remaining $3,000 of "unrecaptured" Section 1231 losses will be carried forward for four more years.

AMOUNT OF GAINS AND LOSSES

The amount of gain or loss that is realized when a capital asset is sold or exchanged is the difference between the amount realized (AR) and the taxpayer's adjusted basis (AB) for the property. (29) As a formula, this is AR--AB = Gain.

The amount realized from a sale or exchange is equal to the sum of (a) money and (b) the fair market value of other property received in consideration for the transfer of the property. (30) The amount of debt assumed by the purchaser of the property is also considered as part of the amount realized by the seller. (31)

The taxpayer's adjusted basis in the property depends upon how the taxpayer acquired the property and whether it was subject to adjustments (either up or down) while owned by the taxpayer. Determining the adjusted basis is fully covered in Chapter 20--Basis.

Example: Richard Hart sells 500 shares of Alleycat Corp. for $10,000. He originally paid $6,500 for the stock. The amount realized from the sale is $10,000 and his adjusted basis is $6,500. Hart recognizes a gain of $3,500: the difference between the $10,000 Hart received and Hart's adjusted basis of $6,500.

HOLDING PERIODS

In an effort to distinguish between sales of capital assets that are held for long-term appreciation and those which are held for short-term speculation, taxpayers must determine their holding period for each capital asset that is sold. Congress decided that the more favorable capital gain treatment should be reserved for those taxpayers who seek long-term appreciation rather than those who may be attempting to benefit from quick turns in the market.

Under current law, the more favorable capital gains tax rate is applied to net long-term capital gains. A gain or loss is treated as long-term if the capital asset is held for more than one year. (32) If the capital asset is not held for more than one year, the gain or loss is treated as short-term. (33)

Example: John Hatch purchased 200 shares of Webster's, Inc. on July 31, 2008. If John sells the shares on or after August 1, 2009, any gain or loss will be treated as a long-term gain or loss.

The dates on which holding periods begin and end are not always clear. As a result, the IRS and the courts have specified a number of common capital assets and identified what begins and ends the holding period for each of these capital assets.

For transactions involving stocks and bonds traded over the counter or on an exchange, the holding period begins and ends on the "trade date": the date that the taxpayer enters into a binding contract to buy or sell the stock. (34) Most brokerage statements show the settlement date as the date of the transaction. The settlement date actually takes places as many as five dates after the "trade date." As a result, the settlement date is the wrong date to use to determine the holding period.

Example: Assume the same facts as above. John's trade date was July 31, 2008, even if the settlement date was August 3, 2008 (the date that happened to appear on John's brokerage statement). The settlement date is irrelevant in determining the start of John's holding period.

If the taxpayer has different lots of the same stocks or bonds that were acquired at different times, the "first-in, first-out" method applies unless the taxpayer specifically identifies the stock or bond that is to be sold. Taxpayers can identify a specific stock or bond if the taxpayer notifies the broker of the intent to sell a particular block of shares at the time the trade order is placed and, within a reasonable amount of time thereafter, the broker confirms the shares that were specifically identified to be sold in a written document. (35)

The holding period for property that is given in exchange for the performance of services (Section 83 property) begins "just after" the property is substantially vested. The holding period for Section 83 property begins at the earliest time the property is no longer subject to a substantial risk of forfeiture or is freely transferable. (36)

Property acquired from a decedent is treated as being held by the beneficiary for the one year long-term holding period, regardless of the length of time the property was actually held. (37) In order for this rule to apply, the basis of the property must have been determined based upon the fair market value of the property on either the date of the decedent's death or the alternate valuation date.

Holding periods may occasionally "tack." Tacked (sometimes referred to as tacked on) holding periods typically occur when a taxpayer acquires a property in a nonrecognition transaction, such as a like-kind exchange. (38)

A holding period will also tack in the case of property acquired by gift. (39) An exception to this rule applies when the property received by gift is sold at a loss. In this case, the donee's (recipient's) basis is the fair market value of the property on the date of the gift and not the transferor's basis. Since the donee's basis is no longer determined by reference to the transferor's basis, the holding period is deemed to begin on the date of the gift.

Example: Hal Stevens gave 1,000 shares of Stickershock.com to his son, Larry. Hal purchased the stock on October 31, 2008 for $10,000 and gave the stock to Larry on January 2, 2009 when the value had decreased to $6,000. On November 5, 2009, Larry sells the stock for $4,000. Since the stock is sold at less than the fair market value on the date of the gift, the holding period does not tack. As a result, Larry realizes a short-term capital loss of $2,000.

TAX IMPLICATIONS

Categories

Capital gains and losses come in a variety of types. The categorization process is so important that practically an entire IRC section is dedicated to it.

Each capital transaction is first divided into one of four types:

1. Short-term capital gain--a gain from a sale or exchange of property held for one year or less. (40)

2. Short-term capital loss--a loss from a sale or exchange of property held for one year or less. (41)

3. Long-term capital gain--a gain from a sale or exchange of property held for more than one year. (42)

4. Long-term capital loss--a loss from a sale or exchange of property held for more than one year. (43)

There are actually more than four categories to consider since there are different tax rates associated with long-term capital gains. Each long-term capital gain or loss that falls within different capital gains tax rates are grouped together in "rate gain baskets." See "Netting Capital Gains and Losses" which follows.

Once each transaction is divided into one of these four categories, the categories are combined as follows:

1. Net short-term capital gain--the excess of short-term capital gains over short-term capital losses in a given year. (44)

2. Net short-term capital loss--the excess of short-term capital losses over short-term capital gains in a given year. (45)

3. Net long-term capital gain--the excess of long-term capital gains over long-term capital losses in a given year. (46)

4. Net long-term capital loss--the excess of long-term capital losses over long-term capital gains in a given year. (47)

Obviously, for any given year, a taxpayer can only have two of these net amounts--one for short-term and one for long-term. However, certain taxpayers may have more than one type of long-term capital gain (i.e., more than one "rate gain basket") since there are a number of different long-term capital gains tax rates. If a taxpayer has both net short and long-term capital gains, no further netting is required. A "net capital gain" results if the taxpayer has net long-term capital gains in excess of net short-term capital losses for the year. (48)

Capital Gains Tax Rates

An individual's net capital gain is subject to taxation at a rate not to exceed the maximum capital gains rate. (49) This implies that there is one overall maximum capital gains rate. In reality, there are actually four that apply for tax years after 2003 and before 2011. (50) Each maximum rate applies to different types of gains or is dependent upon the taxpayer's overall tax bracket:

1. Taxpayers in the lowest two ordinary income tax brackets (currently 10% and 15%) will pay tax on their net capital gain at a maximum rate of 5% (0% for tax years 2008 through 2010). (51)

2. Taxpayers that have gains that are from the sale of Section 1250 assets pay a maximum rate of 25% (the "25-percent basket") on the unrecaptured depreciation (Section 1250 recapture is discussed later in this chapter). (52)

3. A maximum rate of 28% (the "28-percent basket") applies to sales of collectibles and the unexcluded gain from the sale of small business (Section 1202) stock. A collectible is any work of art, rug, antique, metal, gem, stamp, coin, alcoholic beverage, or any other property designated by the IRS. (53)

4. All other gains are subject to a maximum capital gains rate of 15% (the "15-percent basket").54

Example: Christopher and Jennifer White's taxable income for 2008 is $150,000. Of this amount, $50,000 represents net capital gain from stock sold during the year. They will compute their tax by using the ordinary tax rate brackets on the $100,000 of ordinary income and will add $7,500 (15% of $50,000) to this amount to determine their tax for the year.

For purposes of the maximum capital gains rate, the net capital gain is reduced by any amount the taxpayer elects to be treated as investment income for purposes of computing deductible investment interest expense. (55)

The capital gains rates apply for both regular tax and alternative minimum tax (AMT) liabilities. (56) However, the net capital gain for AMT purposes must be recomputed using any adjustments or preferences that are attributable to the gain.

Netting capital Gains and Losses

As mentioned above, long-term capital gains are subject to different maximum tax rates based upon the type of gain. Each type of gain must be grouped by tax rate into "rate gain baskets."

Based on the maximum capital gains rates described above, three rate gain baskets must be considered:

* 28-percent gain (collectibles and Section 1202 stock)

* 25-percent gain (unrecaptured Section 1250 gain)

* 15-percent gain (all other long-term capital gains)

Note that the 5% tax rate is simply an application of a lower tax rate to the 15-percent rate gain basket.

If one rate gain basket has a net loss, the loss is used to offset the net gain in the rate gain basket with the highest rate, then the next highest rate gain basket, etc. Therefore, if there is a loss in the 15-percent rate gain basket, the net loss is used to offset any gains in the 28-percent basket, then the 25-percent basket.

Short-term capital losses, including short-term capital loss carryovers, are first applied to reduce short-term capital gains. This results in a net short-term capital gain or loss for the year which can then be applied against the rate gain baskets starting with the one with the highest rate.

Example: Ryan Alcott had the following capital gains and losses during 2008.

* $5,000 short-term capital loss from the sale of stock

* $6,000 long-term capital loss from the sale of stock

* $10,000 unrecaptured Section 1250 gain from the sale of real estate

* $4,000 long-term capital gain from the sale of collectibles

Since Ryan has one amount in each rate gain basket, the netting process is as follows:

The $6,000 long-term capital loss offsets the $4,000 gain on the sale of collectibles (28-percent basket) and $2,000 of the unrecaptured Section 1250 gain (25-percent basket). The $5,000 short-term capital loss offsets $5,000 of the highest rate gain basket, in this case, the unrecaptured Section 1250 gain. The netting process leaves a $3,000 unrecaptured Section 1250 gain subject to a maximum tax rate of 25%.

Capital Losses

Taxpayers who have capital losses that exceed their capital gains in a given year must follow a special set of rules. For non-corporate taxpayers, losses from the sale of capital assets are allowed to the extent of capital gains plus up to $3,000 ($1,500 for married taxpayers filing separately) of excess losses. (57)

If the net capital loss for the year exceeds $3,000, an individual or other non-corporate taxpayer may carry the excess amount forward to future years until it is completely utilized. (58) Any capital loss that is carried forward to a future year will retain its original short or long-term character in that future year. Thus, a short-term capital loss carryforward will offset future short-term capital gains and a long-term capital loss carryforward will offset future long-term capital gains.

When both a net short-term capital loss and net longterm capital loss exist, the allowable $3,000 net capital loss is treated as an offset to the short-term capital loss first. (59)

Example: During the tax year, Jimmy Johnson incurred a short-term capital loss of $2,000 and a long-term capital loss of $15,000. His total net capital loss for the year is $17,000. Of this amount, only $3,000 is available to offset other income. Since the $3,000 first offsets the short-term capital loss, that loss is fully utilized during the year. He will utilize $1,000 of his current year long-term capital loss and carry forward a $14,000 long-term capital loss to the next taxable year.

The $3,000 limit has been the source of a great deal of controversy in recent history since there is currently no mechanism to adjust this amount for inflation. Especially in the early-2000s when the stock market took such a dramatic downturn, the $3,000 net capital loss limit has created a large number of taxpayers who have huge capital loss carryforwards with little ability to generate any future capital gains to utilize the losses.

Corporate taxpayers may only utilize capital losses to offset capital gains. (60) If capital losses exceed capital gains in a given year, the excess may be carried back three years and then forward up to five years. 0 The amount which may be carried back to a prior year is limited to an amount that does not create or increase a net operating loss in the carryback year. (62)

Recapture

Section 1245 Gains

A taxpayer who realizes a capital gain on the disposition of depreciable or amortizable (Section 1231) property used in a trade or business or held for investment must "recapture" all or part of the gain as ordinary income. (63) The logic behind depreciation recapture is reasonable. Taxpayers benefit from the deduction for depreciation as an offset to their ordinary income. The corresponding gain that may be created when the asset is sold should not be taxed at the favorable capital gains rate.

The amount that must be recaptured as ordinary income is the lesser of:

1. the total depreciation or amortization deductions allowed or allowable with respect to the property, or

2. the total gain realized.

If the total gain exceeds the amount that must be recaptured as ordinary income, the excess is treated as Section 1231 gain. If the gain is less than the total accumulated depreciation or amortization, the entire gain is recaptured as ordinary income.

The most common type of "Section 1245 property" is tangible or intangible personal property used in a trade or business. Buildings and their structural components (with limited exceptions) are not considered Section 1245 property. (64)

Example: Jones, Inc. sells a piece of machinery for $12,000. Jones originally purchased the equipment four years ago for $25,000. Over the four years, the company claimed depreciation deductions totaling $18,000, making the adjusted basis of the property $7,000 at the time of the sale. The company realizes a gain of $5,000 on the sale ($12,000--$7,000). Since the gain ($5,000) is less than the total depreciation deductions claimed ($18,000), the entire gain is recaptured as ordinary income.

Example: Multimedia, Inc. finds a deal on a conference room table and pays $2,000 for it. Over the next two years, the company claims $1,000 of depreciation deductions, lowering the adjusted basis of the table to $1,000. The company then sells the table for $3,500. The gain on the sale of the table is $2,500 ($3,500 $1,000). Since the gain ($2,500) exceeds the total depreciation deductions claimed ($1,000), the amount to be recaptured is limited to $1,000 and the remaining $1,500 gain is treated as long-term capital gain.

Taxpayers must watch the "allowed or allowable" clause in the tax law. This has been used by the IRS in the past to recapture income on sales of property for which no depreciation was claimed. For instance, if a taxpayer begins to depreciate a tangible property item used in the business but then fails to claim the depreciation deduction over the next few years, the IRS can assert that the amount to be recaptured as ordinary income is based upon the depreciation that was allowable even though not properly claimed or deducted.

Section 1250 Gains

Section 1250 property is generally real property (buildings and structural components) subject to depreciation. (65) Gains on the disposition of Section 1250 property are taxed as ordinary income to the extent of post-1969 allowances for depreciation that are in excess of what would have been available using the straight-line method for depreciation.

Gain recapture on Section 1250 property is becoming increasingly rare. Ever since the creation of the Modified Accelerated Cost Recovery System (MACRS) in 1987, almost all real property has been depreciated using the straight-line method.

Residential real property depreciated under the Accelerated Cost Recovery System (ACRS) is subject to recapture to the extent of accelerated depreciation claimed in excess of straight-line depreciation.

ACRS nonresidential real property is treated as Section 1245 property if it is not being depreciated using the straight-line method. Therefore, all depreciation on such a property would be subject to recapture.

Recapture on Section 1250 property is required only if a disposition of the property occurs. The following do not represent dispositions that would trigger recapture:

1. gifts (66)

2. transfers at death (67)

3. certain tax-free exchanges (68)

4. like-kind exchanges and involuntary conversions (69)

5. SEC and FCC transactions (70)

6. property distributed by a partnership to its partners (71)

7. transfers to a tax-exempt organization (72)

8. foreclosures (73)

As mentioned earlier, to the extent depreciation deductions are not recaptured under these rules, the unrecaptured gain from the sale of Section 1250 property is subject to a maximum capital gains tax rate of 25%. (74)

Example: Realty Plus, L.P. sells a shopping center for $3,000,000. The original purchase price of the property was $1,250,000 and over the years $400,000 of MACRS depreciation deductions have been claimed. The property's adjusted basis is $850,000 ($1,250,000-$400,000). Of the total gain of $2,150,000 ($3,000,000-$850,000), $400,000 is unrecaptured Section 1250 gain and will be taxed at a maximum rate of 25%. The remaining gain of $1,750,000 will be taxed as a long-term capital gain.

QUESTIONS AND ANSWERS

Question--Can losses from capital assets be used to offset Section 1231 gains?

Answer--Yes. Once the Section 1231 gains are identified as such (i.e., the 1231 gains exceed the 1231 losses for the year and all unrecaptured Section 1231 losses are used to recategorize the gain as ordinary income), the gains are treated as long-term capital gains and may be offset by capital losses from the sale or exchange of capital assets defined under Section 1221.

Question--During the year, Buckshot, Inc., a corporation, sold a truck used in the business (Section 1245 property) for $10,000. Buckshot originally paid $50,000 for the property but fully depreciated it over the years. Knowing that they had this gain, the company decided to sell some investments at a loss of $10,000 to offset the gain. Can the truck gain offset the stock loss?

Answer--Unfortunately, this scenario occurs far too often. The gain on the sale of the truck will be treated as ordinary income due to the depreciation recapture rules under Section 1245. The loss on the sale of the investments is a capital loss that can only offset capital gains. The $10,000 capital loss may be carried back three years and forward up to five years--but may still only be used to offset capital gains occurring in those years.

Question--What are the reporting requirements for capital gains and losses?

Answer--Taxpayers report their gains and losses from the sale or exchange of capital assets on Schedule D. Section 1231 property and properties subject to potential Section 1245 or 1250 recapture are reported on Form 4797.

CHAPTER ENDNOTES

(1.) The only exception occurred between 1988 and 1990 when the capital gains tax rate and the highest marginal ordinary income tax rate were both 28%.

(2.) Treas. Reg. [section]1.1221-1(a).

(3.) IRC Sec. 1211(b).

(4.) IRC Sec. 1212(b)(1).

(5.) IRC Sec. 1211(a).

(6.) IRC Sec. 1211(a).

(7.) IRC Sec. 1221(a).

(8.) IRC Sec. 1221(a)(1).

(9.) IRC Sec. 1221(a)(2).

(10.) IRC Sec. 1221(a)(3).

(11.) IRC Sec. 1221(a)(4).

(12.) IRC Sec. 1221(a)(5).

(13.) IRC Sec. 1221(a)(6).

(14.) IRC Sec. 1221(a)(7).

(15.) IRC Sec. 1221(a)(8).

(16.) Rogers v. Comm., 103 F.2d 790 (9th Cir. 1939).

(17.) Grodt & McKay Realty, Inc. v. Comm., 77 TC 1221 (1981).

(18.) Helvering v. William Flaccus Oak Leather Co., 313 US 247 (1941).

(19.) IRC Sec. 166(d).

(20.) IRC Sec. 165(g)(1).

(21.) IRC Sec. 165(g)(2)(A).

(22.) IRC Sec. 165(g)(2)(B).

(23.) IRC Sec. 165(g)(2)(C).

(24.) IRC Sec. 301(c)(3)(A).

(25.) IRC Sec. 1231(b)(1).

(26.) IRC Sec. 1231(a)(1).

(27.) IRC Sec. 1231(a)(2).

(28.) IRC Sec. 1231(c).

(29.) IRC Sec. 1001(a).

(30.) IRC Sec. 1001(b).

(31.) Treas. Reg. [section]1.1001-2.

(32.) IRC Secs. 1222(3), 1222(4).

(33.) IRC Secs. 1222(1), 1222(2).

(34.) Rev. Rul. 66-97 1966-1 CB 190.

(35.) Treas. Reg. [section]1.1012-1(c).

(36.) IRC Sec. 83(f).

(37.) IRC Sec. 1223(11).

(38.) IRC Secs. 1223(1), 1223(2).

(39.) Treas. Reg. [section]1.1223-1(b).

(40.) IRC Sec. 1222(1).

(41.) IRC Sec. 1222(2).

(42.) IRC Sec. 1222(3).

(43.) IRC Sec. 1222(4).

(44.) IRC Sec. 1222(5).

(45.) IRC Sec. 1222(6).

(46.) IRC Sec. 1222(7).

(47.) IRC Sec. 1222(8).

(48.) IRC Sec. 1222(11).

(49.) IRC Sec. 1(h)(1).

(50.) Beginning in 2011, there are schedule capital gains rates.

(51.) IRC Sec. 1(h)(1)(B).

(52.) IRC Sec. 1(h)(1)(D).

(53.) IRC Sec. 1(h)(5)(A).

(54.) IRC Sec. 1(h)(1)(C).

(55.) IRC Sec. 1(h)(2).

(56.) IRC Sec. 55(b)(3).

(57.) IRC Sec. 1211(b).

(58.) IRC Sec. 1212(b)(1).

(59.) IRC Sec. 1212(b)(2)(A).

(60.) IRC Sec. 1211(a).

(61.) IRC Sec. 1212(a)(1).

(62.) IRC Sec. 1212(a)(1)(A)(ii).

(63.) IRC Sec. 1245(a)(1).

(64.) IRC Sec. 1245(a)(3).

(65.) IRC Sec. 1250(c).

(66.) IRC Sec. 1250(d)(1).

(67.) IRC Sec. 1250(d)(2).

(68.) IRC Sec. 1250(d)(3).

(69.) IRC Sec. 1250(d)(4).

(70.) IRC Sec. 1250(d)(5).

(71.) IRC Sec. 1250(d)(6).

(72.) IRC Sec. 1250(d)(7).

(73.) IRC Sec. 1250(d)(8).

(74.) IRC Sec. 1(h)(1)(D).
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Publication:Tools & Techniques of Income Tax Planning, 3rd ed.
Date:Jan 1, 2009
Words:5987
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