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§ 61. GROSS INCOME
A. Gross income means all income from whatever source derived, unless excluded by law
Compensation for services, including fees, commissions, fringe benefits, and similar items GI derived from business Gains derived from dealings in property Interest Rents Royalties Dividends Alimony and separate maintenance payments Annuities Income from life insurance and endowment contracts Pensions Income from discharge of indebtedness Distributive share or partnership GI Income in respect of a decedent Income from an interest in an estate or trust
INCOME
Rent-free residence equal money equivalent to rent. Fair rental value of residence property is to be included in the taxpayers G.I. Assignable frequent flyer miles by ER to EE have value and are included in GI. FFM had a personal benefit and are included in GI unless there is a restriction. It would have been different had the EE paid for the 10 previous flights. The free flight would have been considered paid for. A donor who makes a gift of property on condition that the donee pay the resulting gift tax realizes TI to the extent that the gift taxes paid by the donee exceed the donor’s ADJB in the prop. Reg. 1.61-2(a)(1): Tips are considered compensation for past services (business related). They are not gifts Bargain purchase Basis is FMV Reg. §1.61-2(d)(2)(I) Windfall Earnings: Glenshaw Glass, are fully taxable. Win a cruise vacation (raffle tickets are a form of gambling and you can deduct the cost the ticket from the windfall. Gambling losses §165(d) HAIG-SIMONS INCOME; economic income for the year=consumption +[net change in worth (assets-liab)]. An increase in wealth may mean that you have income without realization. Even if you consume, it is taxable under FIT even though you cannot use it to pay the taxes.
PRIZES & AWARDS §74 Except as provided under §117, GI includes amounts received as prizes and awards. Was a prize received? At what amount is the taxpayer taxed at? FMV Reg. §20.2032. Is something else a better indicator of value; the basis could be from something other than source listed.
EXCEPTIONS Prizes transferred to charities §74(b) recipient was selected without any action on his part AND the recipient is not required to render substantial future services as a condition to receiving the prize AND the prize was transferred by the payor to an organization described in §170(c) pursuant to a designation made by the recipient
Employee achievement awards §74(c)(1) GI does not include the value of an employee achievement award (see §274(j)) if the cost to the employer of the EE award does not exceed the amount allowable as a deduction to the ER for the cost of the award.
QUALIFIED SCHOLARSHIPS §117 GI does not include any amount received as a qualified scholarship by an individual who is a candidate for a degree at an educational organization described in §170(b)(1)(A)(ii) They don't qualify as a gift and are not compensation for services
Qualified scholarships Qualified scholarship means any amounts received to be used for qualified tuition and related expenses Qualified tuition and related expenses means tuition and fees required for enrollment. Fees, books, supplies, and equipment required for course NO $ IS PERMITTED FOR ROOM & BOARD
Reg. §1.117-6(a)(3)(i)“A scholarship is an amount paid for the benefit of a person in the pursuit of study or research. The recipient must be a candidate for a degree at an educational institution.
Qualified tuition reduction--Employment related exclusion §117(d) Below the graduate level
MEALS AND LODGING §119 §162 & §274 for ER NONCASH compensation.; EE is not WEALTHIER Applies to owners of a EE’s that are also the owners Meals and Lodging are excluded from GI of EE if furnished to EE, spouse, dependents (§152 for dependent requirements) by the ER for the convenience of the employer IF: the MEALS are furnished on the business premises of ER §119(a)(1) OR in the case of lodging, the EE is required to accept lodging on the business premises of his ER as a condition of his employment §119(a)(2) Business premises: means the place of employment of the EE. Compare the distance from the lodging facilities to the place where the ER’s business was conducted
For the Convenience of the ER Must be furnished for a substantial noncompensatory business reason of the ER. EXAMPLES: Reg. §1.119-1(a)(2)(ii) meals furnished during working hours to have either EE available for emergency call during his meal period. CALL IT THE EMPLOYEE REQUIREMENT TEST. Must show that emergencies have actually occurred or are expected to occur and would result in the ER calling the EE to perform his job during his meal period.
WHEN MEALS & LODGING ARE INCLUDED AS INCOME Reimbursed meals/meals allowance. ER is not constrained in his eating choices Meals furnished before or after work are not considered for the convenience of the ER unless Reg. §1.119-1(d) of (f) where an EE was so busy during working hours that he could not take time to eat--that would be for the convenience of the ER COMPENSATORY reasons when the meals are furnished to promote the morale or goodwill, or attract prospective EE’s
§ 132 CERTAIN FRINGE BENEFITS §162 for ER
GI shall not include any fringe benefit, which qualifies as: Provided without compensatory intent
No-additional cost services §132(b)(1)--service provided by an ER to an EE for use by EE if:
(1) Such service is offered for sale to customers in the ordinary course of the line of business or the ER in which the EE is performing services, and (if not then its taxable)
(2) The ER incurs no substantial additional cost (some cost is acceptable)(factors considered which are not acceptable--including forgone revenue) in providing such service to the EE.
Nondiscriminatory --not only the highly compensated employee, applies here (§132 (j)(6)) §132 (h)(2)(A) defines employee for this section: (spouse and children §152, retired, disabled). Treated as being received by the EE. When benefit is extended to family, its considered an intra-family support & is non taxable. If the benefit is extended to a non-family member then it is viewed as a gift. Reciprocal agreement applies only to this section (§ 132(i)) Excess Capacity--no revenue lost by giving to EE rather than customer. STANDBY rather than RESERVED E.g. Conglomerate, airline is owned by a cruiseline--EE at cruiseline cannot deduct the free plane ride.
Qualified employee discount §132©(4)--discount on property or services limited to:
(A) Limited to the gross profit percentage offered to customers (sales – CGS) / (sales)=GP %
(B) Services 20% of the price at which they are offered to customers in the ordinary course of business of the ER. Is a TICKET to an event a service or property? For goods see GP %. It may be more than 20%
Nondiscriminatory --not only the highly compensated employee, applies here (§132 (j)(6)) §132 (h)(2)(A) defines employee for this section e.g. Rebates or discounts e.g. Even if EE works for a mfgr and the rebate is to be used at the retailer. e.g. Doesn’t apply to loans or investments Reg 1.132-3 p. 911 if discount goes below the cost, then the difference between cost and discount is taxable income. DOESN’T APPLY TO REAL PROPERTY.
Working Condition Fringe §132(d)--property or services--IS TUITION REIMBURSEMENT INCOME? YES ER gets a deduction.
GI shall not include any fringe benefit, which qualifies as: Provided without compensatory intent Can be discriminatory and still qualify for exclusion. (Car salesmen gets free demo to drive) Excludable from GI if the property or services provided to EE would have been deductible had the EE paid for such services or property himself (cannot be personal in nature). It’s a deduction under §162. EX. free parking is a working condition fringe--the non discrimination requirement doesn’t apply ex. subscriptions provided by ER/use of a company car/ bodyguard service/on the job training FREE PARKING; any parking provided to an employee on or near the business premises of the ER. INDEPENDENT GENERAL CONTRACTOR: Reg. §1.132-1(b)(2)(iv) includes them—don’t include in GI
De minimus fringe--the value of which is so small as to make accounting for it unreasonable/impracticable. The nondiscrimination requirement applies, except in the case of a company cafeteria
ex. Doughnuts, beverages, occasional (infrequent) sporting event tickets, or even a meal, photocopying Nondiscriminatory & line of business requirements DO NOT apply—too small to matter
OTHERS FRINGE BENEFITS
§79 Group term life insurance §106 disability & med. insurance ---no limit §127 education assistance up to $5250, doesn’t have to be job related §129 dependant care up to 5K/yr (but decreases 1 for 1 maximum amount )
BORROWING AND LENDING An individual is not taxed on the amount that he borrows on the theory that the obligation to repay the loan offsets the amount received. CHARACTER OF A LOAN DID TAXPAYER DERIVE AN ECONOMIC BENEFIT FROM THE LOAN? Was there a wash for tax purposes? That is was that the liability the same as the proceeds. If so, then, no income is REALIZED §1001. If the liability is less than the proceed then, the taxpayer realized an economic benefit in the way of increase net worth as if he sold the property at a profit. This is a taxable event.
A LOAN IS NOT INCOME The taxpayer is not taxed on the receipt of the principle amount and may not deduct the repayment of any amount except interest under §163 because the increase in cash is offset by an increase in liability. Types of debt Nonrecourse debt: a secured obligation for which the debtor is not liable. The lender’s only recourse for default is foreclosure on the property. Recourse debt: The debtor is personally liable whether or not secured by the property. Lender can garnish wages, impose liens on the other property.
MECHANICS Interest is includable in GI by lender §61(a)(4), and deductible by the borrower §163
CRANE RULE When property is transferred the amount of debt is to be added to the amount realized in calculating G/L under §1001 (difference between the FMV and AB to determine realized gain) regardless of whether it is recourse or nonrecourse BUYING PROPERTY: basis = cash outlay + Crane rule. SELLING PROPERTY: basis = cash rec’d + Crane rule. VALUE OF PROPERTY IS IRRELEVENT; TUFTS CASE
DISCHARGE OF INDEBTEDNESS §108 INCLUDED AS INCOME: The borrower must include in income the amount of the DISCOUNT (the amount owed less the amount paid to discharge the debt. §61(a)(12), DEBT FORGIVENESS, OR CANCELLATION. NOT A GIFT §102 Freed-up asset theory—is a taxable event
3rd party pays the debt If a 3rd party pays the debt instead of the debtor, or the creditor discharging the debt, the debt is satisfied, not discharged. DEBTOR THEN HAS INCOME FROM THAT SATISFACTION. Exception Payment of the child’s debt by parent is like a gift and not includable in GI under §102. There must be no economic consideration or legal consideration given for the gift.
Repayment by giving property: The transfer is a realization event and the amount realized is equal to the debt satisfied. Like a barter. §1001
EXCEPTIONS: §108(a)(1)(A) and (d)(2) A financially troubled taxpayer can exclude discharge of indebtedness income if the taxpayer has filed a BANKRUPTCY PETITION. If the taxpayer has not filed a bankruptcy petition, the taxpayer can still exclude the discharge of indebtedness income only to the extent of the taxpayer's §108(d)(3) INSOLVENCY at the time of the debt discharge. Taxpayer's liabilities exceed FMV of its assets. To what dollar amount is taxpayer insolvent?
DISPUTED DEBT OR CONTESTED LIABILITY ZARIN V. COMM. Under the contested liability doctrine, if the taxpayer in good faith disputes the amount of debt, the subsequent settlement of the dispute is treated as the amount of debt treated for tax purposes. The true amount of the debt is the amount for which it was settled. Zarin realized no income for tax purposes. Definition of debt is: §108(d)(1)(A) indebtedness that the taxpayer is liable for OR §108(d)(1)(B) subject to which the taxpayer hold property
§108(e)(5) Reduction to Purchase Price--Must be a disagreement as to Price The reduction does not occur: in a title 11 case OR when the purchaser is insolvent But for this § the reduction would be treated as income to the purchaser from discharge of indebtedness
MECHANICS When a debt becomes worthless, the lender has “sustained” a loss and is considered a bad debt loss §166. Under this §, a business bad debt is considered ORDINARY LOSS §1012 provided that the basis of property is the cost
§108(b)(5) If taxpayer first elects to reduce his basis in depreciable assets, the debt discharge amount is applied first to reduce the taxpayers tax attributes in the following order NOL and carryovers Capital losses and carry over Basis of the taxpayers assets; §1017 if txpr excludes discharge of indebtedness then he must reduce his basis. REASON—debtor used the debt to acquire these assets, and they should reflect the value of the debt. Compare with §102
10K bank 35K other. 40K of assets. (so far insolvent 5K). If Bank discharges 6; you have income of 1K.
DAMAGES COMPENSATION FOR INJURIES OR SICKNESS §104 COMPENSATORY damages are excludable PUNITIVE damages are NOT excludable. Damages received on account of loss of reputation ARE taxable. §104(a) §104 excludes from GI damages received from personal injury or physical sickness. Purpose is to make the P whole as before the injury. This exclusion applies to recoveries for medical expense, lost wages (amount over that is income) and pain and suffering. WHAT IS PERSONAL? Reg. §1.104-1(c) provides that a claim is a personal injury claim if it is a TORT TYPE CLAIM and not a contract type claim. invasion of privacy slander assault/battery breach of a promise to marry
A taxpayer can exclude damages received on account of a physical injury to his or her spouse. AMOUNTS EXCLUDED FROM INCOME §104(a)(1)Workers compensation acts as compensation for personal injuries or sickness §104(a)2 amounts from damages (other than punitive) received whether by suit or agreement and whether by lump sum or as periodic payments) on account of personal injury or physical sickness §104(a)(3) Amounts received through accident or health insurance for personal injuries or sickness. Wrongful death judgments Can exclude a recovery for emotional distress only if the distress is the byproduct of other physical injury or sickness (e.g. insomnia, headache, stomach disorders). If the emotional distress doesn’t result from any physical injuries or sickness, then the taxpayer can exclude from income the portion of the recovery that is for medical care attributable to emotional distress §104(a) Legal Fees allocable to any tax-exempt recovery are Nondeductible under §265(a)(1)
AMOUNTS INCLUDED AS INCOME Recovery for future lost earnings capacity are taxable if actually earned in the future. Damages to compensate for lost business profits – GI to recipient GLENSHAW GLASS Damages for fraud = GI to recipient ATTORNEY FEES; §265(a) =GI for nontaxable and taxable awards §212 if for K damages; it may be a business expense
ASSIGNMENT OF INCOME--INCOME SHIFTING §1(g) KIDDIE TAX §1(g) Net unearned income (investment income) of a child under 14 is taxed at the greater of the child’s tax rate or the parent’s rate. §1(g) applies to: §1(g)(2)(A) Child has not attained age of 14 by the end of the taxable year §1(g)(2)(B) either parent of the child is alive at close of the taxable year Has Net unearned income is the excess of twice the §63(c)(5) limited standard deduction or a person that is claim as a dependent by another. ALLOCABLE PARENTAL TAX Is the excess of tax imposed on the parent had the income §1(g)(4)(A) NET UNEARNED INCOME IS:
MECHANICS Tax is levied on the excess of $500 (plus either expenses or $500 of the standard deduction) NUI – 500 -500 Applies only to unearned income, interest or dividends
INCOME FROM PROPERTY HEVERING V. HORST, ‘A’ owes ‘B’ money. ‘A’ instructs ‘B” to pay ‘C’, ‘A’’s money. Court said that ‘A’ enjoys the ECONOMIC BENEFITS of the income to the same extent as if ‘A’ would have received the money as earnings. Father was liable to pay taxes on the interest that accrued on a bond coupon before it was given as a gift to his son. You can make a VALID GIFT or ASSIGNMENT of income producing property but, cannot gift or assign income. The property owner is the one who reports income generated by it, and gain on the sale. Was D claiming the transfer was payment for past services rather than a gift? Income under §61 and a deduction under §162 Was there a gift writing? Detached and disinterested generosity? What was the value of the work done? Reasonable Compensation? §162(a)(1) Was profit or property transferred? CAN GIVE AWAY THE TREE BUT NOT THE FRUIT EXAMPLES Assign as a gift, future earnings Assign as a gift, current earnings
SUSIE SALVATORE, The entire planning and timing of the transaction showed NO OUTRIGHT GIFT, but were merely a plan to assign income from property in order to avoid taxes on that income. There was no actual conveyance of the property. Cannot transfer the taxable gain unless he transfers effective ownership. Was there already an existing partnership? And the property transferred was a distributive share of partnership GI? Was there an explicit agreement to carry on a business for profit? Was there a long history of dealing with one another that looked like a partnership? Who was the owner at time of sale? Who paid the capital gains?
EFFECTIVE TRANSFER OF OWNERSHIP Was transfer timely and carried sufficient economic control that the sales would be treated as sale to the transferee rather than the transferor Have legal title
INEFFECTIVE TRANSFER OF OWNERSHIP §102 for transferee §262 for OR §1015 for basis
ONE TIME EXCLUSION §121 sale of home Basis §1012? How was the residence acquired? Gift/inheritance §1015 Purchase, use cost basis §1012? Divorce settlement §1041(a)? Holding period (§121(d)(3)(A)) for the transferee is the period the transferor owned the property.
INCREASING HOME’S BASIS Additions; bedroom, deck, garage, pool, fence Lawn & garden Alarm system, intercom system Electrical upgrades Built in appliances New water heater
Gain from the sale of a personal residence is excluded from GI if: During the 5-year period ending on the date of the sale or exchange the property was owned and used-occupied by the taxpayer as the taxpayers principle residence for periods aggregating 2 years or more (2 out of the last 5 yr. period).
LIMITATIONS 500K for joint filers; 250K single Only 1 sale every two years. 2 year period ending on the date of the sale or exchange. Reduced exclusion §121(c) if resident was not occupied for the required 2 yrs
Involuntary conversion §121(d)(5); destruction, theft, seizure, requisition, or condemnation of property is treated as the sale
HOME SALES §1034 No like-kind exchange because its personal property Applies only to primary residence, not summer home EX. Buy H 65K, sell FMV H2 100K: H2 must be less than 85K or the difference will be taxed H1 100K, H2 95K: 5K CG = new basis=100 Buy H1 65K, sell 85K, buy H2 100K: new basis = 100-(85-65)=80K
PERSONAL CASUALTY LOSS §165 Is it a personal casualty gain or Loss? Vs( business G/L—NOT SUBJECT TO $100 FLOOR) Is it a repair or a capital improvement? Is a gain or loss recognized from any involuntary conversion of property (can be a personal auto) arising from fire, storm, shipwreck, or other casualty, or from theft. Rev. Rul. Casualty is sudden, unexpected and unusual. Analyze the situation based on this criteria. cannot be progressive deterioration
Loss cannot exceed the taxpayers AB of the property. Loss reduces the taxpayers AB in the property.
Must be losses from property not connected with a trade or business Business losses are deducted to AB.
Valuation of the loss Cost of repairs to the property damaged is acceptable as evidence of the loss of value if the taxpayer shows that the repairs are necessary to restore the property to the original condition immediately before the casualty, the amount spent is not excessive, the repairs do not care for more than the damage suffered And the value of the property after the repairs does not exceed the value of the property before the casualty. Reg. §1.165-7(a)(2)(ii).
WHAT AMOUNT IS CONSIDERED CONSUMPTION? Part is consumption, part is loss that was not reimbursed, and the rest it the remaining value of the personal asset. Damage due to faulty driving Reg. §165-7(a)(3)(i) casualty loss is permitted if it’s due to the taxpayer's negligence. EX. negligent operation of an automobile. But, gross negligence (willful) is not permitted.
MECHANICS §165(h)(1) subtract $100 from the casualty loss How much is over 10% of AGI? itemized deductions BUSINESS CASUALTY LOSSES are not subject to 100 floor or 10% of AGI. Loss equals the decline in FMV of the damaged portion of the property as a result OR basis in the damaged portion. §165(a) a deduction is allowed—business loss =”other”
Casualty Gain §165(h)((2)(A) gain is treated as a CG
INVOLUNTARY CONVERSION §1033 May be the result of the destruction of property in whole or part, the theft, seizure, or requisition or condemnation of property. Or the threat on imminence of requisition or condemnation of property. IS A GAIN RECOGNIZED? Continuation of investment theory §1033 applies only to gains. Losses are not recognized by this § §1033 permits a taxpayer to ELECT out (compare with §1031), that is not to recognize some or all of the gain from the involuntary conversion/disposition of the property if the taxpayer “acquires property that is similar or related in service or use” within the requisite time. IF NOT RELATED? If the new property is not “similar or related in service or use” THEN MUST RECOGNIZE ENTIRE GAIN Is the original property rental property and the new property a residence?
THEN, HOW MUCH GAIN IS RECOGNIZED IF RELATED? Under §1033(a), the gain is recognized only to the extent that the amount realized upon conversion exceeds the cost of the new property.
WHAT IS THE CHARACTER OF THE GAIN? Was property used in a trade or business? §1231(a)(3)(ii)(I) Gain from the involuntary conversion of §1231 property Is a property used in a “trade or business” §1231 Was the property converted to rental use? §1231(b)(1) states that in order to be “property used in a trade or business”, the property must be held for more than one year. If less than a year then the gain is ordinary income. §1250 recapture §1250(a)(1) Recapture is limited to “additional depreciation.” §1250(b)(1) defines additional depreciation as the excess of the actual depreciation taken over straight-line method. This doesn’t apply because all post 1986 real property must use straight-line. No accelerated method can be used on real property.
§1245 recapture
TYPE of property Was the property transferred incident to divorce? §1041 Was it a Capital asset? §1221 If the property was a capital asset, then the gain was still §1231 gain under §1231(a)(3)(A)(ii)(II). This applies to gains from involuntary conversions of a capital asset held >1yr. Then, what is the holding period?
What is the new basis in the property? §1012
LIKE-KIND EXCHANGE §1031 If it’s not a like-kind exchange; take the value at date of exchange or transfer. The nonrecognition provision is MANDATORY. The Realization Doctrine: for a gain to be recognized, it must be realized. There must be a change in form ---sale Viewed as a continuation of the investment Land for personality is not like kind. Not a continuation of investment
Is it a like-kind exchange? §1031(a)(2) doesn’t apply to many types of property exchanges: PROHIBITED CATEGORIES: doesn’t apply to exchanges of inventory held primarily for sale doesn’t apply exchange of stock or bonds or indebtedness doesn’t apply to interests in partnerships doesn’t apply to trusts or beneficial interests doesn’t apply to contract rights or lawsuits
CODE; “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.” Look to the future use by the same person. REQUIREMENT: The form of the transaction is an exchange Both the property transferred and the property received are held either for productive use in a trade or business or for investment. The property is like-kind property IF: Real estate can only be exchanged for other real estate Personality can only be exchanged for other personality LIKE-KIND OR LIKE CLASS? Reg. 1.1031(a)-1 states that unimproved property and improved property are property of like-kind. Can have stock for property but not stock for stock. Like kind refers to the “nature and character of the property and not its grade or quality.” Reg. §1.1031(a). e.g. Trucks must be of the same class Computer for office equipment is in DIFFERENT business classes.
What is the AB of property? Land cannot be depreciated. Was it inherited? use §1014 for basis (equals FMV at DOD) Transfer between spouses incident to divorce §1041. Basis equals the transferor’s AB in the property. Was it a gift? use §1015 (basis equals the donors basis) Is it §1231 property? AB equals cost to capital improvements that extend its useful like and minus any capital expenditure take (e.g. depreciation §167 &§168) Gain is not eliminated but deferred. No stepped-up basis.
What is the amount REALIZED §1001(b)? It equals the FMV of his property at the time of exchange minus AB. This is the realized gain. Is any gain RECOGNIZED §1001(c) ? If property was held primarily for sale (then the property is not a capital asset §1221(1); and it is not §1231(b)(1)(B) property. If so, then must recognize all gain and is barred from nonrecognition--that is recognize as ordinary income. If BOOT is received then a gain is recognized to the lesser of: (1) the gain REALIZED (basis – FMV of that property) in the exchange or (ii) the FMV of the boot (CASH PLUS DEBT RELIEF) received. Losses are not recognized.
Basis in new property: Is equal to basis in property given up (+CRANE RULE) in the exchange, reduced by any amount of money received and increased by the amount of gain recognized. §1031(d) This gives person a new cost basis §1012; to be used for depreciation purposes §167.
SPECIAL PROVISION §2670(b) To qualify for a like-kind exchange, the taxpayer and the related party must not dispose of the like-kind property received in the exchange within a 2yr period following the date of the exchange. If disposition does occur then GAIN is RECOGNIZED.
OTHER NONRECOGNITION PROVISIONS §102 GIFTS & INHERITANCE §104 DAMAGES §108(a)(1)(A) DISCHARGE OF INDEBTEDNESS §117 QUALIFIED SCHOLARSHIPS §118 MEALS & LODGING FBO EMPLOYER §121 SALE OR PRINCIPLE RESIDENCE §1031 LIKE KIND EXCHANGES §1033 INVOLUNTARY CONVERSIONS §1041 TRANSFERS INCIDENT TO DIVORCE
REASON TO DEFER INCOME Seller may lack liquidity; no money to pay taxes now The value of property may fluctuate from yr to yr The realization requirement delays the imposition of tax until the property is sold.
PROPERTY USED IN A TRADE OR BUSINESS §1231 Business real estate or depreciable business property is excluded from the definition of capital assets. However, if business property qualifies as §1231 property & gains exceed losses, then each gain or loss is treated as though it were derived from the sale of LTC. They are NOT capital assets. §1221(2) Property Excluded: Property held less than a yr Inventory held primarily for sale to customers Intangible assets EX. acct./rec & acct./pay Casualty losses Casualty Gains are §1231 assets.
§1231 states that net gain from the disposition of such property is sometimes treated as LTCG LOSSES This § treat’s losses as ORDINARY and are fully deductible FOR AGI
MAIN HOTCHPOT gains Recognized gain from the sale or exchange of property used in a trade or business Recognized gain from the compulsory or involuntary conversion of Property used in a trade or business Any capital asset held greater than 1 yr. in connection with a trade or business entered into for profit.
1
MAIN HOTCHPOT losses §1231(a)(3)(B) includes losses on the destruction , theft or seizure or requisition or condemnation
SUBHOTCHPOT gains & losses §1231(a)94)(c) Includes gains and losses from an involuntary conversion arising from theft fire, storm, shipwreck, or other casualty
§1245 RECAPTURE This §1245(b) & §1250(d) applies to all DISPOSITIONS depreciable personal property. EXAMPLE Amortizable personal property; goodwill, patents §179 immediate expensing §1245(a)(2)(C) & §179(d)(10)
This provision causes gains to originally be treated as ORDINARY gains/income. Gains are to be treated as ordinary gains to the extent of depreciation taken on the property disposed of. §1231 gain only results when the property is disposed for more than its original cost. The excess of the sale price over the original cost is §1231 gain.
§1250 RECAPTURE §1250 property is depreciable REAL property Recaptured amount is OI §1250(a). Only the amount of “additional depreciation” is subject to recapture. Property placed in service after 1986 will not have §1250 recapture because it uses straight-line depreciation. §1250 (a)(1)(A)(ii) The excess of the amount realized, or the FMV over the ADJB SHALL BE TREATED AS GAIN WHICH IS ORDINARY INCOME.
REAL PROPERTY (LAND) SUBDIVIDED FOR SALE §1237 Is there a sale of a parcel of LAND §1237? This § does not apply to losses. A loss would be treated as an ordinary loss unless the property is considered a capital asset under §1221.
Was it a sale of INVENTORY? Any lot or parcel which is part of a tract of real property in the hands of a taxpayer other than a C-Corp shall NOT be deemed to be held primarily for sale to customers in the ordinary course of trade or business if: The tract or lot was not previously held for primarily for sale to customers in the ordinary course of a trade or business. No substantial improvement that substantially enhances the value of the lot
Sale of more than 5 parcels If more than 5 lots or parcels contained in the same tract or real property are sold or exchanged, gain from the sale or exchange of the 6th parcel shall be deemed to be gain from the sale to customers in the ordinary course of business to the extent of 5% of the selling price.
If the seller is NOT a dealer in property then §1237 allows real estate investors capital gain treatment if they engage in limited development activities. If they are not a corp No substantial improvements Must have held lots for 5 yrs.
What is the BASIS? Necessary improvements--that are NOT substantial improvements §1237(b)(2)(A) No improvements shall be deemed a SUBSTANTIAL improvement if the lot or parcel is held by the taxpayer for a period of 10yrs and IF: the improvements is for installation of sewer, drainage
What is the character of G/L Was it inventory? §1231 property? §1221 capital gain property?
INSTALLMENT SALES METHOD §453 §453(b) The term “installment sale” means a disposition of property where at least 1 payment is to be received after the close of the taxable year in which the disposition occurs. §453(b)(2) EXCEPTION: Installments sales do not include: any dealer disposition inventories of personal property
§453(c) defines installment method as a method in which the income recognized for any taxable year from a disposition is that portion of the payment received in that year which the gross profit realized bears to the total contract price. §453(d) ELECTION OUT: Election out must be made on or before the due date prescribed by law for filing the taxpayers return
§453(e) SECOND DISPOSITION BY RELATED PERSONS If property is disposed to a related person and before the person making the first disposition receives all payments, the related person disposes of the property, then the amount realized with respect to the second disposition shall be treated as received at the time of the second disposition by the person making the first disposition.
§453(e)(7)TAX AVOIDANCE Taxpayer cannot use the installment sales method under this section if the Secretary of the IRS establishes that neither the first disposition nor the second disposition had as its principle purpose the avoidance of FIT.
§453(i) RECOGNITION OF RECAPTURE INCOME IN THE YEAR OF DISPOSITION §453(i)(1)(A) states that any recapture income shall be recognized in the year of disposition §1250 & §1245. Recompute GI by subtracting depreciation from GP then dividing by the total contract price.
§453B GAIN OR LOSS DISPOSITION OF INSTALLMENT OBLIGATIONS-SALE OD REC’ If an installment obligation is satisfied at other than face value, distributed, sold or disposed of (gift), gain or loss shall result from the difference between the basis of the obligation and the amount realized or the FMV of the obligation at the time of distribution. see page 430 in code
MECHANICS Add up total payments to be rec’d minus ADJB = GP. GP/total proceeds = GP%. GP% X amount of PMT rec’d in that year.
Computation of DEPRECIATION on the property. §167-8 & §179 Depreciation is allowable when property is placed into service. When was this? Covert property to rental property. Land, inventory and personal items are not depreciable. Only buildings and equipment are capitalizable. Assign costs to building and land §179 ELECTION TO EXPENSE CERTAIN DEPRECIABLE BUSINESS ASSETS BONUS DEPR only applies to §1245 property which is property other than buildings (buildings are §1250 property). §179(d). Limit for 1999 is $19,000.
§168 DEPRECIATION Capital improvements: increase /prolong the life of the property greater than 1yr. Improvement/upgrade replacement, Repairs and maintenance Reg. §1.162-3 Incidental expenses do not produce a benefit beyond the current year Repairs and maintenance neither materially add to the value of the property nor prolong life. Only keep it in an ordinarily efficient operating condition. I.e. restore to original working condition. Cost to maintain the building. Prerequisites: §167(a) & 168(a) restrict the depreciation deduction to: Property used in a trade or business OR property held for the production of income
§168(e)(2)(B) describes what is not residential real property. NONRESIDENTIAL REAL PROPERTY has a class life (or recovery period) of 39 yrs. EX office bldg. §168(e)(2)(B) RESIDENTIAL RENTAL PROPERTY” if 80% or more of the gross rental income of the property is rental income from a dwelling unit. Dwelling unit means house or apt bldg. to provide living accommodations, but does not include a hotel or motel. The class life is less than 27.5yrs. Condominium is residential rental property to the owner if it is leased out.
RECOVERY METHOD Applicable *recovery method is straight-line, §168(b)(3)(A) Applicable *recovery period is 27.5 or 39 yrs. Applicable *convention is MIDMONTH, §168(d)(2). MID QUARTER convention applies to non-real property. EX .equipment 150% DDBM applies to 15 or 20yr prop 200% DDBM applies to all other property.
§1231 CHARACTERIZATION ON THE SALE OF DEPRECIABLE PROPERTY. Held > 1yr; not inventory sold in the ordinary course of business. Sale or exchange of depreciable property/or real estate used in a trade or business, net gains are treated as capital gains and net losses are treated as ordinary losses.
§1239 SALE OR EXCHANGE BETWEEN RELATED PARTIES (controlled entities >50%) No preferential tax treatment is permitted. So that you don’t sell a depreciated asset & re-depreciate it through a related company to offset a gain from the sale. Treated as ordinary income.
LIMITATION ON DEPRECIATION §280F Limitations on luxury automobiles p241 code Limitation where business use of property is not greater than 50%
DISALLOWANCE OF CERTAIN ENTERTAINMENT EXPENSES §274(d) §274(d)(4) with respect to any listed property (see §280F(d)(4))
NEW BASIS; §1016 Adjustments
DEDUCTIBLE INTEREST §163 §163(a); All interest is fully deductible unless, there is a code section which made it partially or wholly nondeductible--”personal interest §163(h)(1).” Must be legal owner Interest on a loan, even a car loan, secured by a residence is “QUALIFIED RESIDENCE INTEREST” §163(h)(4)(A) a qualified residence means principle residence and one other. §163(h)(A)(iii) residence not rented QUALIFIED RESIDENCE INTEREST is defined by §163(h)(3)(A) as either interest “acquisition indebtedness” or “home equity indebtedness.” §163(h)(2)(B)(i)(I) Acquisition Indebtedness must be used to build, construct, buy, or substantially improve (could be a substantial home improvement) a residence. 1,000,000 limitation; 500K married filing separately Home Equity indebtedness §163 (h)(3)(C) is secured by a qualified residence §163(h)(4)(A). The amount cannot exceed to FMV of the property. And cannot exceed $100,000 of debt. REFINANCING
LIMITATION: §163 (d) INVESTMENT INTEREST. §163(d)(3)(B)(i) states that qualified residence interest is not investment interest. Investment interest is interest paid on indebtness properly allocable to property held for investment. PROPERTY HELD FOR INVESTMENT: §163(d)(5)(A) is property that produces income as described in §469(e)(1). RENTS are not listed in this § Investment interest is deductible to the extent of Net Investment Income. (NII – NI expenses). No carry-over limitation. Carry forward indefinitely and subject to the same investment interest limitations Investment income =dividends BELOW THE LINE DEDUCTION
PERSONAL INTEREST is defined §163(h)(2) as all interest other than: Investment interest Passive activity interest Qualified residence interest Interest on tax liability
Is nondeductible under §163(h)(2)
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