Calculate basis
Calculate basis
Depreciation
Find gain or loss
Can you take gain or loss
Is it above or below the line
Is it ordinary or capital
GENENERAL BASIS
§1001(a) provides that gain or loss shall be the difference between the amount realized from a sale of property and the tax payer adjusted basis sold.
§1001(b) amount realized defined. Includes cash and fair market value.
§1011 states that adjusted basis means basis as proved in 1012, which is cost basis.
Mortgaged Property
On a non-recourse mortgage, the amount borrowed is included to determine basis (CRANE). When the mortgaged property is sold the mortgage amount is included in the amount realized. (CRANE).
DEATH BASIS
Under §1014, the basis to the estate is the FMV of the property at the time of death.
BASIS FOR GIFTS
§1015 (a) donees basis as the same as the donors basis at the time of the gift. (for gain on sale of gift). For loss, the donees basis is the donor’s basis or the FMV at the date of the gift, whichever is lower (§1015 (a)). Taft v. Bowers.
CAPITAL IMPROVEMENTS
This falls under §1016, you increase the basis by the amount of the expense, and you decrease it by depreciation.
DEPRECIATION
The depreciation tables are on page XV. §167 explains the eligible property. Includes exhaustion, wear, and tear on property used in trade or business or held for the production of income. Useful life must be definite and predictable. Not for land because that is indefinite life. It is limited to the taxpayers basis. §167(c) allows you to deduct depreciation from basis.
Under §168 (b), you have declining balance and straight line. Under declining balance method, the rate is 40%. Use declining balance until the amount would be lower than straight line, then switch to straight line. Look at the classification of the property under (e), to find how property is going to be treated, then go to (c) to find the applicable recovery year. Don’t forget to look at (d) to find the applicable convention. Look to (f) for property to which this article is not applicable, then look to (g) for alternative methods.
§179 deduction. Can only take the first year. Must be §1245 property used in a trade or business. Limited by §179(b)(2) & (3).
Capital Assets
§1221 tells you what a capital assets isn’t. §1222 divides capital assets into short term (held for one year or less) and long term (held for more than one year). You must hold the property more than one year to benefit from the reduced rate.
DEDUCTIONS
§161 and §162 (trade or business expense). Under §163, you get interest deduction. You can only deduct personal interest under §163(h), for trade or business or home equity loan. Look for limitations on deduction under §163 (j). You can deduct start-up expenditures under §195.
Under §262, you cannot deduct personal expenses. No deductions will be allowed for capital expenditures under §263. If you are repairing the property to continue the properties opertions for the duration of its expected life, it is not a capital expenditure. If you are lengthening the expected life, it is a capital expenditure.
You can take depreciation deduction under §167. Capital expenditures can be deducted through depreciation.
ALIMONY PAYMENTS
§71 gross income includes amount received as alimony or separate maintenance payments. Under §215, the payor gets a deduction for the payments. Look to §71(f) for front end loading. Look at Reg§1.71-1T. Alimony payments must be cash. §61(a)(8) says you can take alimony above the line. §1041 says transfer of property between spouses has no tax consequences.
§71(f): Figure out recapture in year two first. If the payment in the second year exceeds the payment in the third year by $15K, then there is recapture of that excess in the third year. If the alimony payments in the first year exceeds the average of the payment in the second and third year by more than $15K , that excess amount is also recaptured in the third year. If either spouse dies, there is no recapture under §71(f)(5)(A)(i).
Example: First Year - $80K 1. Take the third year payment and add $15K to it = $45K
Second Year - $80K 2. Take the second year payment and subtract it from the $45K=$35K
Third Year - $30K 3. There is a $35K recapture of the year two excess in year three.
4. As the payment for the first year ($80K) exceeds the average of the second
Year(as reduced by the second year recapture) and the third year. This is the average of $45k and $30K = $37.5k then add $15K = $52.5K. There is an additional $27..5K ($80K less $52.5) recapture from year one in year three. Thus the total excess alimony payments form year one and year two is $62.5K and that amount is recaptured in year three. The payor spouse must include the recapture amount in this GI, the payee can deduct.
§1041 – there is no gain or loss for transfer of property subsequent to a divorce.
ANNUITIES
If you paid $20k for $5k a year for life expectancy which is 25 years, you are getting $125,000. The $20k is your basis, so you should only be taxed on $105k. You have three options: 1) first $20k is not taxable; 2) first $105k is income; and 3) part is taxable and part is not. Take the annuitants investment and divide it buy the aggregate of the payments to be received (# of payments X amount of annual payment). The result is an exclusion factor. Take that fraction and multiply the annual payments. That amount is the return of capital, so subtract this number from the payment to find the amount that is taxed. Under §72(b) if the annuitant dies early, he can deduct his full un-recovered amount on his tax return. If he lives too long, he must include the entire amount in his GI.
Exclusion ratio: x = basis §72(c)(1)/ total payments (c)(3) . Multiply this ration by the payment.
ACCOUNTING METHODS
§441 – taxable year is the taxpayer’s annual accounting period, if it is a calendar year or a fiscal year. §446 is methods of accounting, which can be cash method or accrual method. §451 tells you when the gross income will be included in gross income. §461 – general rule for taxable year of deductions. §465 – deduction limited to the amount of risk.
ALTERNATIVE MINIMUM TAX
§56(b)
FLOW CHART FOR LOSSES
§165 see if the loss fits in here. If yes, go to §267 to look for a roadblock. Look at §162 for t or b, or §212 for production of income. Look to see if it is an ordinary loss or capital loss. §1221, 1231, 1245. Always look at §1245 before §1231.
DETERMINING GAIN
§1001(a) is realized. 1001(c) is recognized. Then look at basis, §1012 (cash basis), §1014 (step up basis for death benefits), §1015 (gift basis)(Reg. 1.1015-4), §1016 (adjustment to basis)(got to §263 [capitalization] or §168 [depreciation]). Then go to §1031(c) which is like kind and exchange (tax shelter). Watch out for exchange of property and cash (boot). See Reg 1.1013 (d)(2), how to do like kind exchanges when boot or cash involved. See if it is an ordinary or capital.
MISCELLANEOUS
§465 – non-qualified non-recourse debt is not included in your basis if it is not at risk.
Part-gift/part sale = look at Reg 1.100-1(e). Then go to Reg1.1015-4 for basis.
Depreciation
§168(e) calssifies property. §168(d)(1) sends you to 168(d)(4).
When taking §179, don’t forget to reduce “dollar limitation” by §179(b)(2).
INSTALLMENT METHOD
Can only be used for cash accounting method. The essence of 453 is how much is taxed and how much is returned to basis.
Formula (453 c ): Income recognized (x)/ Payment in the first year = Gross profit (selling price – adjusted basis)/ Total Contract Price. Take the fraction and multiply it by the payment. That is the amount that you will pay in taxes, the leftover is allocated to basis. Good example on page 1418.
280A
280A(a) – generally no deductions are allowed with respect to residence. Exceptions under (c), (c)(1) says that business deductions will be allowed, but check the list. This deduction is limited by (c)(5). It creates a fraction. It is gross income (c)(5)(A) over (B)(i) and (B)(ii). (B)(i) are deductions like 163(h) and 164 (these are things you could take even if not used for trade or business). (B)(ii) are deductions like 162 (things attributable to the business) and this should be multiplied by X/365. (5) you can’t have deductions that exceed your gross income. You can only deduct a certain amount this year and can carry the rest over till the next year.
Example: Income from Rent $10,000 e(2) = days rented/365 x regular allowed deductions
Property Tax $ 1,000 Regular deductions = tax and interest
Interest on Mort. $ 1,000 Subtract this number from the income to get “N”, which you
Utilities $2,000 will use later.
Depreciation $ 3,000 Under ( c )(5), days rented/total pers. days + days rented x expenses.
Multiply this ratio by the business expenses (utili. & deprec)
Days rented 100 Subtract that total of the two from “N” and this gives you the
Days personal 20 max amount you can deduct. (remember about carryover next year)
LIMITS ON PASSIVE ACTIVITY LOSSES AND CREDITS
Divide the income by sources. Three categories: 1) active; 2) portfolio; and 3) passive. Passive activity loss is not deductable. Look at (d)(1), passive activity loss is the amount by which the aggregate losses from all passive activities for the taxable year exceed the aggregate income from all passive activities for the taxable year. Look at (e)(1) to see certain incomes that are not treated as income from passive activity. Under (f), you can carry over passive losses that you couldn’t take the year before. Look at (g) if you dispose of your entire interest in a passive activity. Look at (j) for special rules.
PRACTICE PROBLEM #2
Karent’s AB in the old machine is $100k (1012, Crane, & Tufts)
Issue #1 – The $1k istallation is a capital expenditure under (263)(1.263(a)(2)), (Indopco)
Issue#2 - $4k adjustment expense is a capital expense because it extens the life, adds to the value, or changes the property use.
Issue #3 - $300 repair – This is a business deduction under (162), (1.162-4), and this deduction is taken above the line under (62).
Issue $4 – Depreciation of the item under (167)(168)
· Go to (179) and then to (1245) to seeif it is 1245 property – if it is, then you can take the 179 deduction first before anyk depreciation
· You get a new AB when you add on the $4k (1016, 1012, 263), which is $104k.
· Subtract the 179 deduction and begin the depreciation.
Issue #5 – You have a new AB after depreciation – now we look to (1031) because we may have an exchange of like-kind property.
· Karen is receiving a new machine ($130k) and a realease of $60k of debt, so her amount realized is $190k.
· The other person is getting $75k for the old machine (FMV), $25k in cash, and a note for the remainder for $90k which equals $190,000.
· Next, figure out the net fair market value
Karen $75k (FMV of old machine) Other party $130k (new machine)
$60 (mortgage) $0
$15 (net FMV) $130k (net FMV)
· At this point, the other party needs $115k to make up the difference – it got $25k of cash, so now they need $90k to make up the difference.
· Now figure out the gain or loss – AR for Karen is $190k ($130k + $60k) and her AB is figured to be $63 (old basis) plus $25 (cash she paid out) plus $90k (her new note) equals $178k.
· $190k minus $178 = $12 of gain (1001(c))
Issue #6 – Now we look at (1031), look at each side seperatly
· Like kind property transfer (1.1031 (a)(2))
· Now look for Karent’s boot – she has $60k of potential boot (from release of debt) which may be washed.
· Under (1.1031 (b)(1)(c)), you wash this boot by taking on another obligation or money (she took on a $90, note and paid $25 cash) she may wish this here
· Other party’s AR is $75k (FMV of old machine they are taking), $25k (cash received from Karen), and $90k (note from Karen)
· Other party’s boot is $25 (cash received) and $90k (new note) for a total of $115k, can they wash this?
· So Karen has no gain at all under (1031)(a).
Issue #7
What is Karen’s basis on this new machine?
· Formula is Old basis – loss released from + recognized gain – recognized loss
· So Karent’s old basis as adjusted (1016) is $63k + $90k (new liability) + $25K )cash paid out) minus $60k (relieved loss) + $0 (recognized gain) minus $0 (recognized loss) = $118k (new basis).
Issue #8
Is this gain/loss capital or ordinary?
Go to §1221 and §1245, go to §1245 first.
· Look for recapture under 1245 for this type of problem.
CAPITAL GAINS OR LOSSES
Go to §1221, defines a capital asset. §1222 says that it must be a “sale or exchange” to be a capital asset. §1211(b), capital losses are limited to the gains on such exchanges less $3k. §1231 deals with business property, if it is depreciable business property, go to §1245 first, it trumps 1231. §1245 (a)(3) is the definition of §1245 property. Whatever gain exceeds the adjusted basis is ordinary gain, anything below that or equal to that is a capital gain. $200 gain from 1245 property, with a basis of §100. $100 is ordinary gain, and the other $100 is capital gain (1245 a 1). Losses are governed by §1231, this is hotchpot. If the capital gains exceed losses than everything is capital. If losses exceed gains, then everything is ordinary.
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