Ch14 - 2015

Chapter 14
Property Transactions: Capital

Gains and Losses, 1231, and
Recapture Provisions
Comprehensive Volume
2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Big Picture (slide 1 of 3)

Maurice has come to you for tax advice regarding his
investments.
He inherited $750,000 from his Uncle Joe and, following
the advice of a financial adviser, made the following
investments 9 months ago.
$5,000 for 100 shares of Eagle Company stock.

$50,000 for a 50% interest in a patent that Kevin, an
unemployed inventor, had obtained for a special
battery he had developed to power green cars.
To date, Kevin has been unable to market the battery to an auto
manufacturer or supplier.

$95,000 to purchase a franchise from Orange, Inc.
$200,000 in the stock of Purple, a publicly held bank
that does not pay dividends.
At one time, the stock had appreciated to $300,000, but now
it is worth only $210,000.
Maurice is considering unloading this stock.
$50,000 in tax-exempt bonds.

The interest rate is only 3%.
Maurice is considering moving this money into taxable
bonds that pay 3.5%.
$100,000 for a 10% limited partnership interest in a

real estate development.
Lots in the development are selling well.

Maurice read an article that talked about the
beneficial tax rates for capital assets and dividends.
He really liked the part about costless capital gains,
although he did not understand it.
Maurice has retained his job as a toll booth operator

at the municipal airport.
His annual compensation is $35,000.
Respond to Maurices inquiries.

Read the chapter and formulate your response.
Taxation of Capital
Gains and Losses
Capital gains and losses must be separated
from other types of gains and losses for two
reasons:
Long-term capital gains may be taxed at a lower
rate than ordinary gains
A net capital loss is only deductible up to $3,000
per year
Proper Classification of
Gains and Losses
Depends on three characteristics:
The tax status of the property
Capital asset, 1231 asset, or ordinary asset
The manner of the propertys disposition

By sale, exchange, casualty, theft, or condemnation
The holding period of the property

Short term and long term
Capital Assets
(slide 1 of 6)
1221 defines capital assets as everything

except:
Inventory (stock in trade)
Notes and accounts receivables acquired from the
sale of inventory or performance of services
Realty and depreciable property used in a trade or
business (1231 assets)
Capital Assets
(slide 2 of 6)
1221 defines capital assets as everything except

(contd):
Certain copyrights; literary, musical, or artistic
compositions; or letters, memoranda, or similar property
Taxpayers may elect to treat a sale or exchange of certain musical
compositions or copyrights in musical works as the disposition of a
capital asset
Certain publications of U.S. government

Supplies of a type regularly used or consumed in the
ordinary course of a business
Capital Assets
(slide 3 of 6)
Thus, capital assets usually include:

Assets held for investment (e.g., stocks, bonds,
land)
Personal use assets (e.g., residence, car)
Miscellaneous assets selected by Congress
Capital Assets
(slide 4 of 6)
Dealers in securities
In general, securities are the inventory of securities
dealers, thus ordinary assets
However, a dealer can identify securities as an
investment and receive capital gain treatment
Clear identification must be made on the day of
acquisition
10
Capital Assets
(slide 5 of 6)
Real property subdivided for sale

Taxpayer may receive capital gain treatment on the
subdivision of real estate if the following requirements are
met:
Taxpayer is not a corporation

Taxpayer is not a real estate dealer
No substantial improvements made to the lots
Taxpayer held the lots for at least 5 years
Capital gain treatment occurs until the year in which the

6th lot is sold
Then up to 5% of the revenue from lot sales is potential ordinary
income
That potential ordinary income is offset by any selling expenses
from the lot sales
11
Capital Assets
(slide 6 of 6)
Nonbusiness bad debts

A nonbusiness bad debt is treated as a short-term
capital loss in the year it becomes completely
worthless
Even if outstanding for more than one year
12
Sale or Exchange
Recognition of capital gains and losses
generally requires a sale or exchange of assets
Sale or exchange is not defined in the Code
There are some exceptions to the sale or
exchange requirement
13
Sale or ExchangeWorthless Securities and

1244 Stock (slide 1 of 2)
A security that becomes worthless creates a
deductible capital loss without being sold or
exchanged
The Code sets an artificial sale date for the securities on the
last day of the year in which worthlessness occurs
Section 1244 allows an ordinary deduction on

disposition of stock at a loss
The stock must be that of a small business company
The ordinary deduction is limited to $50,000 ($100,000 for
married individuals filing jointly) per year
14
Sale or ExchangeWorthless Securities

(slide 2 of 2)
Worthless securities example:

Calendar year taxpayer purchased stock on
December 5, 2013
The stock becomes worthless on April 5, 2014
The loss is deemed to have occurred on December
31, 2014
The result is a long-term capital loss
15
Sale or Exchange
Retirement of Corporate Obligations
Collection of the redemption value of
corporate obligations (e.g., bonds payable) is
treated as a sale or exchange and may result in
a capital gain or loss
OID amortization increases basis and reduces gain
on disposition or retirement
16
Sale or ExchangeOptions
(slide 1 of 2)
For the grantee of the option, if the property subject

to the option is (or would be) a capital asset in the
hands of the grantee
Sale of an option results in capital gain or loss
Lapse of an option is considered a sale or exchange
resulting in a capital loss
For the grantor of an option, the lapse creates

Short-term capital gain, if the option was on stocks,
securities, commodities or commodity futures
Otherwise, ordinary income
17
Sale or ExchangeOptions
(slide 2 of 2)
Exercise of an option by a grantee

Increases the gain (or reduces the loss) to the
grantor from the sale of the property
Gain is ordinary or capital depending on the tax
status of the property
Grantee adds the cost of the option to the basis

of the property acquired
18
The Big Picture - Example 13
Options (slide 1 of 4)
Return to the facts of The Big Picture on p. 14-1.
On February 1, 2014, Maurice purchases 100 shares
of Eagle Company stock for $5,000.
On April 1, 2014, he writes a call option on the stock,
giving the grantee the right to buy the stock for $6,000
during the following six-month period.
Maurice (the grantor) receives a call premium of $500 for
writing the call.
19
If the call is exercised by the grantee on August 1,

2014, Maurice has $1,500 of short-term capital gain
from the sale of the stock.
$6,000 + $500 $5,000 = $1,500
The grantee has a $6,500 basis for the stock.

$500 option premium + $6,000 purchase price
20
Assume that Maurice decides to sell his stock prior to exercise
for $6,000 and enters into a closing transaction by purchasing
a call on 100 shares of Eagle Company stock for $5,000.
Because the Eagle stock is selling for $6,000, Maurice must pay a call
premium of $1,000.
He recognizes a $500 short-term capital loss on the closing

transaction.
$1,000 (call premium paid) $500 (call premium received)
On the actual sale of the Eagle stock, Maurice has a short-term

capital gain of $1,000
$6,000 (selling price) $5,000 (cost)
21
Assume that the original option expired unexercised.

Maurice has a $500 short-term capital gain equal
to the call premium received for writing the option.
This gain is not recognized until the option expires.
The grantee has a loss from expiration of the

option.
The nature of the loss will depend upon whether the
option was a capital asset or an ordinary asset.
22
Sale or ExchangePatents
When all substantial rights to a patent are
transferred by a holder to another, the transfer
produces long-term capital gain or loss
The holder of a patent must be an individual,
usually the creator, or an individual who purchases
the patent from the creator before the patented
invention is reduced to practice
23
Patents (slide 1 of 2)
Kevin transfers his 50% rights in the battery

patent to the Green Battery Co.
In exchange, he receives $1 million plus $.50 for
each battery sold.
24
Patents (slide 2 of 2)
Assuming Kevin has transferred all substantial rights,
Kevin automatically has a long-term capital gain.
Both the $1 million lump-sum payment and the $.50 per
battery royalty qualify (less his basis in the patent).
Kevin also had an automatic long-term capital gain when
he sold 50% of his rights in the patent to Maurice.
Whether Maurice gets long-term capital gain

treatment on the transfer to Green Battery will depend
on whether he is a holder (see the discussion below
and Example 15).
25
Holder Of A Patent (slide 1 of 2)

Return to the facts of The Big Picture on p. 14-1 and
continuing with the facts of Example 14
Kevin is clearly a holder of the patent

He is the inventor and was not an employee when
he invented the battery.
26
Holder Of A Patent (slide 2 of 2)

When Maurice purchased a 50% interest in the patent, he
became a holder if the patent had not yet been reduced to
practice.
Since the patent was not being manufactured at the time of the
purchase, it had not been reduced to practice.
Consequently, Maurice is also a holder.

He has an automatic long-term capital gain or loss if he transfers his
50% interest to Green Battery Co.
Maurices basis for his share of the patent is $50,000, and his
share of the proceeds is $1 million plus $.50 for each battery
sold.
Thus, Maurice has a long-term capital gain even though he has
not held his interest in the patent for more than one year.
27
Sale or ExchangeFranchises, Trademarks, and

Trade Names (slide 1 of 3)
The licensing of franchises, trade names,
trademarks, and other intangibles is generally
not considered a sale or exchange of a capital
asset
Therefore, ordinary income results to transferor
Exception: Capital gain (loss) may result if the
transferor does not retain any significant power, right,
or continuing interest
28

Significant powers, rights, or continuing
interests include:
Control over assignment

Quality of products and services
Sale or advertising of other products or services
The right to require that substantially all supplies
and equipment be purchased from the transferor
The right to terminate the franchise at will, and
The right to substantial contingent payments
29

When the transferor retains a significant power, right,
or continuing interest, the transferees noncontingent
payments are ordinary income to the transferor
The franchisee capitalizes the payments and amortizes
them over 15 years
Whether the transferor retains a significant power,

right, or continuing interest, contingent payments are
ordinary income for the franchisor and an ordinary
deduction for the franchisee
30
Sale of Franchise
Return to the facts of The Big Picture on p. 14-1
Maurice sells for $210,000 to Mauve, Inc., the

franchise purchased from Orange, Inc., nine months
ago.
The $210,000 received by Maurice is not contingent, and
all significant powers, rights, and continuing interests are
transferred.
The $115,000 gain ($210,000 proceeds $95,000 adjusted
basis) is a short-term capital gain because Maurice has held
the franchise for only nine months.
31
Sale or Exchange
Lease Cancellation Payments
Lessee treatment
Treated as received in exchange for underlying leased
property
Capital gain results if asset leased was a capital asset (e.g., personal
use )
Ordinary income results if asset leased was an ordinary asset (e.g.,
used in lessees business and lease has existed for one year or less
when canceled)
Lease could be a 1231 asset if the property is used in lessees
trade or business and the lease has existed for > a year when it is
canceled
Lessor treatment
Payments received are ordinary income
Considered to be in lieu of rental payments
32
Holding Period
(slide 1 of 3)
Short-term
Asset held for 1 year or less
Long-term
Asset held for more than 1 year
Holding period starts on the day after the

property is acquired and includes the day of
disposition
33
Holding Period
(slide 2 of 3)
Nontaxable Exchanges
Holding period of property received includes holding period of former
asset if a capital or 1231 asset
Transactions involving a carryover basis

Former owners holding period tacks on to present owners holding
period if a nontaxable transaction and basis carries over
Certain disallowed loss transactions

Under several Code provisions, realized losses are disallowed.
When a loss is disallowed, there is no carryover of holding period.
e.g., Related party losses, sale or exchange of personal use assets
Inherited property is always treated as long term no matter

how long it is held by the heir
34
Holding Period
(slide 3 of 3)
Short sales
Taxpayer sells borrowed securities and then repays the
lender with substantially identical securities
Gain or loss is not recognized until the short sale is closed
Generally, the holding period for a short sale is determined
by how long the property used for repayment is held
If substantially identical property (e.g., other shares of the same
stock) is held by the taxpayer, the short-term or long-term character
of the short sale gain or loss may be affected
35
Holding Period
Assume that Maurice purchased the Purple

stock on January 15, 2013.
If he sells it on January 16, 2014, Maurices
holding period is more than one year.
If instead Maurice sells the stock on January 15,
2014, the holding period is exactly one year, and
the gain or loss is short term.
36
Tax Treatment of Capital

Gains and Losses (slide 1 of 7)
Noncorporate taxpayers
Capital gains and losses must be netted by holding
period
Short-term capital gains and losses are netted
Long-term capital gains and losses are netted
If possible, long-term gains or losses are then netted
with short-term gains or losses
If the result is a loss:

The capital loss deduction is limited to a maximum deduction
of $3,000
Unused amounts retain their character and carryforward
indefinitely
37

Noncorporate taxpayers (contd)
If net from capital transactions is a gain, tax
treatment depends on holding period
Short-term (assets held 12 months or less)
Taxed at ordinary income tax rates
Long-term (assets held more than 12 months)

An alternative tax calculation is available using preferential
tax rates
38

Noncorporate taxpayers (contd)
Net long-term capital gain is eligible for one or
more of five alternative tax rates: 0%, 15%, 20%,
25%, and 28%
The 25% rate applies to unrecaptured 1250 gain and is
related to gain from disposition of 1231 assets
The 28% rate applies to collectibles
The 0%/15%/20% rates apply to any remaining net
long-term capital gain
Under the American Taxpayer Relief Act of 2012, the 20% rate
applies beginning in 2013 when the taxpayers regular tax
bracket is 39.6%
39

Income Layers for Alternative Tax on Capital Gain Computation
40

Collectibles, even though they are held long term, are
subject to a 28% alternative tax rate
Collectibles include any:
Work of art
Rug or antique
Metal or gem
Stamp
Alcoholic beverage
Historical objects (documents, clothes, etc.)
Most coins
41

Qualified dividend income paid from current or acc.
E & P is eligible for the 0%/15%/20% long-term
capital gain rates
After determining net capital gain or loss, qualified
dividend income is added to the net long-term capital gain
portion of the net capital gain and is taxed as 0%/15%/20%
gain
If there is a net capital loss, it is still deductible for AGI
Limited to $3,000 per year with the remainder of the loss carrying
over
In this case, the qualified dividend income is still eligible to be
treated as 0%/15%/20% gain in the alternative tax calculation
It is not offset by the net capital loss
42

The alternative tax on net capital gain applies only if
taxable income includes some net long-term capital
gain
Net capital gain may be made up of various rate layers
For each layer, compare the regular tax rate with the alternative tax
rate on that portion of the net capital gain
The layers are taxed in the following order:

25% gain, 28% gain, the 0% portion of the 0%/15%/20% gain, the
15% portion of the 0%/15%/20% gain, and then the 20% portion of
the 0%/15%/20% gain.
This allows the taxpayer to receive the lower of the

regular tax or the alternative tax on each layer of net
capital gain
43
Qualified Dividend Income

After holding the Purple stock for 10 months,

Maurice receives $350 of dividends.
If Purple is a domestic or qualifying foreign
corporation, these are qualified dividends eligible
for the 0%/15%/20% tax rate.
44

Gains and Losses - Corporate Taxpayers
Differences in corporate capital treatment
There is a NCG alternative tax rate of 35 %
Since the max corporate tax rate is 35 %, the alternative
tax is not beneficial
Net capital losses can only offset capital gains (i.e.,

no $3,000 deduction in excess of capital gains)
Net capital losses are carried back 3 years and
carried forward 5 years as short-term losses
45
1231 Assets
(slide 1 of 4)
1231 assets defined

Depreciable and real property used in a business or
for production of income and held >1 year
Includes timber, coal, iron, livestock, unharvested
crops
Certain purchased intangibles
46
1231 Assets
(slide 2 of 4)
1231 property does not include the following:

Property not held for the long-term holding period
Nonpersonal use property where casualty losses exceed
casualty gains for the taxable year
Inventory and property held primarily for sale to customers
Copyrights, literary, musical, or artistic compositions and
certain U.S. government publications
Accounts receivable and notes receivable arising in the
ordinary course of a trade or business
47
1231 Assets
(slide 3 of 4)
If transactions involving 1231 assets result in:

Net 1231 loss = ordinary loss
Net 1231 gain = long-term capital gain
48
1231 Assets
(slide 4 of 4)
Provides the best of potential results for the

taxpayer
Ordinary loss that is fully deductible for AGI
Gains subject to the lower capital gains tax rates
49
Special Rules For

Certain 1231 Assets (slide 1 of 2)
Casualty gains and losses from 1231 assets
and from long-term nonpersonal use capital
assets are determined and netted together
If a net loss, items are treated separately
1231 casualty gains and nonpersonal use capital asset
casualty gains are treated as ordinary gains
1231 casualty losses are deductible for AGI
Nonpersonal use capital asset casualty losses are deductible
from AGI subject to the 2% of AGI limitation
If a net gain, treat as 1231 gain
50
Special Rules For

Certain 1231 Assets (slide 2 of 2)
The special netting process for casualties & thefts
does not include condemnation gains and losses
A 1231 asset disposed of by condemnation receives
1231 treatment
Personal use property condemnation gains and losses

are not subject to the 1231 rules
Gains are capital gains
Personal use property is a capital asset
Losses are nondeductible

They arise from the disposition of personal use property
51
General Procedure for

1231 Computation (slide 1 of 3)
Step 1: Casualty Netting
Net all recognized long-term gains & losses from casualties
of 1231 assets and nonpersonal use capital assets
If casualty gains exceed casualty losses, add the excess to the other
1231 gains for the taxable year
If casualty losses exceed casualty gains, exclude all casualty losses
and gains from further 1231 computation
All casualty gains are ordinary income
Section 1231 asset casualty losses are deductible for AGI
Other casualty losses are deductible from AGI
52

Step 2: 1231 Netting
After adding any net casualty gain from previous step to
the other 1231 gains and losses, net all 1231 gains and
losses
If gains exceed the losses, net gain is offset by the lookback
nonrecaptured 1231 losses from the 5 prior tax years
To the extent of this offset, the net 1231 gain is classified as
ordinary gain
Any remaining gain is long-term capital gain
If the losses exceed the gains, all gains are ordinary income
Section 1231 asset losses are deductible for AGI
Other casualty losses are deductible from AGI
53

Step 3: 1231 Lookback Provision
The net 1231 gain from the previous step is
offset by the nonrecaptured net 1231 losses for
the five preceding taxable years
To the extent of the nonrecaptured net 1231 loss, the
current-year net 1231 gain is ordinary income
The nonrecaptured net 1231 losses are those that have not
already been used to offset net 1231 gains
Only the net 1231 gain exceeding this net 1231 loss
carryforward is given long-term capital gain treatment
54
Lookback Provision Example

Taxpayer had the following net 1231 gains
and losses:
2012
2013
2014
$ 4,000 loss
$10,000 loss
$16,000 gain
In 2014, taxpayers net 1231 gain of $16,000

will be treated as $14,000 of ordinary income
and $2,000 of long-term capital gain
55
Section 1231 Netting Procedure
56
Depreciation Recapture
(slide 1 of 3)
Assets subject to depreciation or cost recovery

may be subject to depreciation recapture when
disposed of at a gain
Losses on depreciable assets receive 1231
treatment
No recapture occurs in loss situations
57
(slide 2 of 3)
Depreciation recapture characterizes gains that

would appear to be 1231 as ordinary gain
The Code contains two major recapture provisions
1245
1250
58
(slide 3 of 3)
Depreciation recapture provisions generally

override all other Code Sections
There are exceptions to depreciation recapture
rules, for example:
In dispositions where all gain is not recognized
e.g., like-kind exchanges, involuntary conversions
Where gain is not recognized at all

e.g., gifts and inheritances
59
1245 Recapture
(slide 1 of 3)
Depreciation recapture for 1245 property

Applies to tangible and intangible personalty, and
nonresidential realty using accelerated methods of
ACRS (placed in service 1981-86)
Recapture potential is entire amount of accumulated
depreciation for asset
Method of depreciation does not matter
60
1245 Recapture
(slide 2 of 3)
When gain on the disposition of a 1245 asset

is less than the total amount of accumulated
depreciation:
The total gain will be treated as depreciation
recapture (i.e., ordinary income)
61
1245 Recapture
(slide 3 of 3)
When the gain on the disposition of a 1245

asset is greater than the total amount of
accumulated depreciation:
Total accumulated depreciation will be recaptured
(as ordinary income), and
The gain in excess of depreciation recapture will
be 1231 gain or capital gain
62
1245 Recapture Example

(slide 1 of 2)
On January 1, 2014, Jake sold for $26,000 a machine

acquired several years ago for $24,000. He had taken
$20,000 of depreciation on the machine.
Amount Realized
$26,000
Adj. Basis-Cost
$24,000
Acc. Depr.
-20,000
4,000
Realized Gain
$22,000
Sec. 1245 Ordinary Income
20,000
Sec. 1231 Gain
$ 2,000
63
1245 Recapture Example

(slide 2 of 2)
Same as previous example except Jake sold

the machine for $18,000.
Amount Realized
Adj. Basis-Cost
$24,000
Acc. Depr.
-20,000
Realized Gain
Sec. 1245 Ordinary Income
Sec. 1231 Gain
$18,000
4,000
$14,000
14,000
$
-0-
The 1231 gain is $0 because the selling price ($18,000) does

not exceed the original purchase price ($24,000).
64
Observations on 1245
(slide 1 of 3)
Usually total depreciation taken will exceed

the recognized gain
Therefore, disposition of 1245 property usually
results in ordinary income rather than 1231 gain
Thus, generally, no 1231 gain will occur unless
the 1245 property is disposed of for more than its
original cost
65
(slide 2 of 3)
Recapture applies to the total amount of

depreciation allowed or allowable regardless
of
The depreciation method used
The holding period of the property
If held for < the long-term holding period the entire
recognized gain is ordinary income because 1231 does
not apply
66
(slide 3 of 3)
Section 1245 does not apply to losses which

receive 1231 treatment
Gains from the disposition of 1245 assets
may also be treated as passive activity gains
67
1250 Recapture
(slide 1 of 3)
Depreciation recapture for 1250 property

Applies to depreciable real property
Exception: Nonresidential realty classified as 1245
property (i.e., placed in service after 1980 and before
1987, and accelerated depreciation used)
Intangible real property, such as leaseholds of

1250 property, is also included
68
1250 Recapture
(slide 2 of 3)
Section 1250 recapture rarely applies since only the

amount of additional depreciation is subject to
recapture
To have additional depreciation, accelerated depreciation
must have been taken on the asset
Straight-line depreciation is not recaptured (except for property
held one year or less)
Depreciable real property placed in service after 1986 can

generally only be depreciated using the straight-line
method
Therefore, no depreciation recapture potential for such property
1250 does not apply if the real property is sold at a loss

69
1250 Recapture
(slide 3 of 3)
The 1250 recapture rules also apply to the

following property for which accelerated depreciation
was used:
Additional first-year depreciation [ 168(k)] exceeding
straight-line depreciation taken on leasehold
improvements, qualified restaurant property, and qualified
retail improvement property.
Immediate expense deduction [ 179(f)] exceeding straightline depreciation taken on leasehold improvements,
qualified restaurant property, and qualified retail
improvement property.
70
Real Estate 25% Gain

(slide 1 of 4)
Also called unrecaptured 1250 gain or 25%

gain
25% gain is some or all of the 1231 gain treated
as long-term capital gain
Used in the alternative tax computation for net
capital gain
71

(slide 2 of 4)
Maximum amount of 25% gain is depreciation

taken on real property sold at a recognized
gain reduced by:
Certain 1250 and 1245 depreciation recapture
Losses from other 1231 assets
1231 lookback losses
Limited to recognized gain when total gain is

less than depreciation taken
72

(slide 3 of 4)
Special 25% Gain Netting Rules

Where there is a 1231 gain from real estate and that gain
includes both potential 25% gain and potential
0%/15%/20% gain, any 1231 loss from disposition of
other 1231 assets
First offsets the 0%/15%/20% portion of the 1231 gain
Then offsets the 25% portion of the 1231 gain
Also, any 1231 lookback loss

First recharacterizes the 25% portion of the 1231 gain
Then recharacterizes the 0%/15%/20% portion of the 1231 gain
as ordinary income
73

(slide 4 of 4)
Net 1231 Gain Limitation

The amount of unrecaptured 1250 gain may not exceed
the net 1231 gain that is eligible to be treated as longterm capital gain
The unrecaptured 1250 gain is the lesser of
The unrecaptured 1250 gain, or
The net 1231 gain that is treated as capital gain
Thus, if there is a net 1231 gain, but it is all recaptured by

the 5 year 1231 lookback loss provision, there is no
surviving 1231 gain or unrecaptured 1250 gain
74
Related Effects of Recapture

(slide 1 of 8)
Gifts
The carryover basis of gifts, from donor to donee,
also carries over depreciation recapture potential
associated with asset
That is, donee steps into shoes of donor with
regard to depreciation recapture potential
75

(slide 2 of 8)
Inheritance
Death is only way to eliminate recapture potential
That is, depreciation recapture potential does not
carry over from decedent to heir
76

(slide 3 of 8)
Charitable contributions
Recapture potential reduces the amount of
charitable contribution deductions that are based
on FMV
77

(slide 4 of 8)
Nontaxable transactions
When the transferee carries over the basis of the transferor,
the recapture potential also carries over
Included in this category are transfers of property pursuant to the
following:
Nontaxable incorporations under 351

Certain liquidations of subsidiary companies under 332
Nontaxable contributions to a partnership under 721
Nontaxable reorganizations
Gain may be recognized in these transactions if boot is

received
If gain is recognized, it is treated as ordinary income to the extent
of the recapture potential or recognized gain, whichever is lower
78

(slide 5 of 8)
Like-kind exchanges and involuntary

conversions
Property received in these transactions have a
substituted basis
Basis of former property and its recapture potential is
substituted for basis of new property
Any gain recognized on the transaction will first

be treated as depreciation recapture, then as 1231
or capital gain
Any remaining recapture potential carries over
79

(slide 6 of 8)
Installment sales
Recapture gain is recognized in year of sale
regardless of whether gain is otherwise recognized
under the installment method
80

(slide 7 of 8)
Property Dividends
A corporation generally recognizes gain on the
distribution of appreciated property to shareholders
Recapture applies to the extent of the lower of the
recapture potential or the excess of the propertys
FMV over its adjusted basis
81

(slide 8 of 8)
Sales between related parties

Sales of depreciable assets between related parties
can cause the total gain to be recognized as
ordinary income
Applies to related party sales or exchanges of property
that is depreciable in hands of transferee
82
Refocus On The Big Picture (slide 1 of 3)

Maurice is correct that certain capital gains and
dividends are eligible for preferential tax treatment
Tax rates of 0%, 15%, or 20% may apply rather than
regular tax rates.
You then discuss the potential tax consequences of

each of his investments.
Purple stock and Eagle stock- To qualify for the beneficial
tax rate, the holding period for the stock must be longer
than one year.
From a tax perspective, Maurice should retain his stock
investments for at least an additional three months and a day.
To be eligible for the costless capital gains, his taxable income
should not exceed $36,900 for 2014.
The dividends received on the Purple stock are qualified
dividends eligible for the 0%/15%/20% alternative tax rate.
83

Patent - Since he is a holder of the patent, it will
qualify for the beneficial capital gain rate regardless
of the holding period if the patent should produce
income in excess of his $50,000 investment.
However, if he loses money on the investment, he will be
able to deduct only $3,000 of the loss per year (assuming
no other capital gains).
Tax-exempt bonds.
The after-tax return on the taxable bonds would be less
than the 3% on the tax-exempt bonds.
In addition, the interest on the taxable bonds would
increase his taxable income, possibly moving it out of the
desired 15% marginal tax rate into the 25% marginal tax
rate.
84

Franchise rights.
The franchise rights purchased from Orange, Inc., probably require the
payment of a franchise fee based upon sales in the franchise business.
Maurice should either start such a business or sell the franchise rights.
Partnership interest.
The tax treatment related to his partnership interest depends on whether
he is reporting
His share of profits or losses
Ordinary income or ordinary loss, or
Recognized gain or loss from the sale of his partnership interest

Capital gain or capital loss.
You conclude your tax advice to Maurice by telling him that

his investments should make economic sense.
There are no 100% tax rates.
For example, disposing of the bank stock in the current market could
be the wise thing to do.
85
If you have any comments or suggestions concerning this

PowerPoint Presentation for South-Western Federal
Taxation, please contact:
Dr. Donald R. Trippeer, CPA
trippedr@oneonta.edu
SUNY Oneonta
2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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Chapter 14

Property Transactions: Capital

The Big Picture (slide 1 of 3)

$5,000 for 100 shares of Eagle Company stock.

The Big Picture (slide 2 of 3)

$50,000 in tax-exempt bonds.

$100,000 for a 10% limited partnership interest in a

The Big Picture (slide 3 of 3)

Maurice has retained his job as a toll booth operator

Respond to Maurices inquiries.

The manner of the propertys disposition

The holding period of the property

1221 defines capital assets as everything

1221 defines capital assets as everything except

Certain publications of U.S. government

Thus, capital assets usually include:

Real property subdivided for sale

Taxpayer is not a corporation

Capital gain treatment occurs until the year in which the

Nonbusiness bad debts

Sale or ExchangeWorthless Securities and

Section 1244 allows an ordinary deduction on

Sale or ExchangeWorthless Securities

Worthless securities example:

For the grantee of the option, if the property subject

For the grantor of an option, the lapse creates

Exercise of an option by a grantee

Grantee adds the cost of the option to the basis

The Big Picture - Example 13

The Big Picture - Example 13

If the call is exercised by the grantee on August 1,

The grantee has a $6,500 basis for the stock.

The Big Picture - Example 13

He recognizes a $500 short-term capital loss on the closing

On the actual sale of the Eagle stock, Maurice has a short-term

The Big Picture - Example 13

Assume that the original option expired unexercised.

The grantee has a loss from expiration of the

The Big Picture - Example 14

Kevin transfers his 50% rights in the battery

The Big Picture - Example 14

Whether Maurice gets long-term capital gain

The Big Picture - Example 15

Holder Of A Patent (slide 1 of 2)

Kevin is clearly a holder of the patent

The Big Picture - Example 15

Holder Of A Patent (slide 2 of 2)

Consequently, Maurice is also a holder.

Sale or ExchangeFranchises, Trademarks, and

Sale or ExchangeFranchises, Trademarks, and

Control over assignment

Sale or ExchangeFranchises, Trademarks, and

Whether the transferor retains a significant power,

The Big Picture - Example 16

Return to the facts of The Big Picture on p. 14-1

Maurice sells for $210,000 to Mauve, Inc., the

Holding period starts on the day after the

Transactions involving a carryover basis

Certain disallowed loss transactions