Taxchapter10.docx

Taxchapter10.docx

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Taxchapter10

Chapter10

Property:

Dispositions

SOLUTIONSMANUAL

DiscussionQuestions:

1.[LO1]Compareandcontrastdifferentwaysinwhichataxpayertriggersarealizationeventbydisposingofanasset.

Arealizationeventfortaxpurposesiscreatedinmanyways.Virtuallyanydisposalwillresultinasaleorotherdisposition.Theseincludeasale,trade,gifttocharity,disposaltothelandfill,ordestructioninanaturaldisaster.Inasaleortrade（exchange）,thetaxpayerreceivessomethingofvalueinreturnfortheasset.Incontrast,acharitablecontribution,disposal,ordestructionfromanaturaldisastergenerallyresultsinalossofanyremainingbasisintheassetwithoutcompensation（unlessreimbursedbyinsurance）.

2.[LO1]PotomacCorporationwantstosellawarehousethatithasusedinitsbusinessfor10years.Potomacisasking$450,000fortheproperty.Thewarehouseissubjecttoamortgageof$125,000.IfPotomacacceptsWydenInc.’soffertogivePotomac$325,000incashandassumefullresponsibilityforthemortgageontheproperty,whatamountdoesPotomacrealizeonthesale?

Whenthepropertydisposedofissubjecttoaliabilityandthebuyerassumestheliability,thereliefofdebtincreasestheamountrealized.Thus,Potomac’samountrealizedconsistsof$450,000,whichiscashof$325,000plus$125,000reliefofdebt.Thisassumesthatthebuyerhypotheticallytransferscashtothesellerinordertopayoffthemortgage.

3.[LO1]MontanaMaxsellsa2,500-acreranchfor$1,000,000incash,anotereceivableof$1,000,000,anddebtreliefof$2,400,000.Healsopayssellingcommissionsof$60,000.Inaddition,Maxagreestobuildanewbarnontheproperty（cost$250,000）andspend$100,000upgradingthefenceonthepropertybeforethesale.WhatisMax’samountrealizedonthesale?

Anythingreceivedbythesellerduringasaleorexchangeisincludedintheamountrealized.Mostdispositionsresultincashtotheseller.However,amountrealizedincludes,butisnotlimitedto,cash,thefairmarketvalueofanyotherpropertyreceived（e.g.marketablesecuritiesorasimilarasset）,orreliefofdebt.Inaddition,sellingexpensesreducetheamountrealized.Therefore,Max’samountrealizedincludesthe$1,000,000ofcash,$1,000,000notereceivable,reliefofdebtof$2,400,000,andisreducedbysellingcommissionsof$60,000（sellingexpensesreducetheamountrealized,S.C.Chapin,CA-8,50-1USTC¶9171）.Anythingthesellergivesupinthetransactionisaddedto

thebasisofthepropertygivenupandisnotconsideredpartoftheamountrealized.Therefore,thebarnandfenceimprovementsarenotconsideredpartofMax’samountrealized.Note,however,thatmakingtheseimprovementsdecreaseshisrealizedgainbyincreasingMontanaMax’sadjustedbasisinthepropertyduetotheimprovements.

4.[LO1]Hawkeyesoldfarmingequipmentfor$55,000.Itboughttheequipmentfouryearsagofor$75,000,andithassinceclaimedatotalof$42,000indepreciationdeductionsagainsttheasset.ExplainhowtocalculateHawkeye’sadjustedbasisinthefarmingequipment.

Hawkeyewillcalculateitsadjustedbasisinthefarmingequipmentbyreducingthehistoricalcostbyanycostrecoverydeductionstaken—namely,depreciation.Therefore,Hawkeye’sadjustedbasisis$33,000（$75,000less$42,000）.Thetaxadjustedbasisisusuallydifferentthanthebookadjustedbasis.Thisisbecausemostassetsuseadifferentrecoveryperiod,costrecoverymethod（e.g.doubledecliningbalance）,andconvention（e.g.half-year）fortaxthanforbookpurposes.SeeChapter9forhowthesedifferencesarise.Duetothedifferenceincostrecoverydeductions,theadjustedbasisislikelydifferentunlesstheassetisfullydepreciatedforbothbookandtaxpurposes.

5.[LO1]Whenataxpayersellsanasset,whatisthedifferencebetweenrealizedandrecognizedgainorlossonthesale?

Therealizedgainorlossissimplytheamountrealizedlesstheadjustedbasisoftheassetsold.Everysaleordispositionresultsinarealizedgainorloss（unless,ofcourse,theamountrealizedisequaltotheadjustedbasis）.Mostrealizedgainsorlossesbecomerecognizedgainsorlossesandareincludedonthetaxpayer’staxreturnandincreases（ordecreasesinthecaseofaloss）thetaxpayer’staxableincomeandsubsequenttax.However,therearesomerealizedgainsorlossesthatareexcludedfromincomeordeferredtoalatertimeperiod.

6.[LO2]Whatdoesitmeantocharacterizeagainorloss?

Whyischaracterizingagainorlossimportant?

Onceagainorlossisrecognized,ataxpayermustdeterminehowtherecognizedgainorlossaffectsthetaxpayer’staxliability.Thecharacterdependsonacombinationoftwofactors:

purposeoruseoftheassetandholdingperiod.Thepurposeoruseoftheassetisimportantbecausethelawdoesnottreatallassetsequally.Thegeneralusecategoriesare:

（1）tradeorbusiness,

（2）fortheproductionofincome（rentalactivities）,（3）investment,and（4）personal.Basedonthesecriteria,wecancategorizeanassetintooneofthreegroups:

（1）ordinary,

（2）capital,or（3）section1231.Characterizingthegainorlossisimportantbecauseallgainsandlossesarenotequal.Ordinarygainsandlossesaretaxedatordinaryincomerates,regardlessoftheholding

period.Capitalgainsonassetsheldformorethanayearreceivepreferentialrateswhilecapitalgainsonassetsheldforoneyearorlessdonot.Section1231gainsandlossesreceivethebestofbothworlds—thegainsbecomelong-termcapitalgainsandthelossesbecomeordinary.However,toqualifyasa1231asset,theassetmustbeusedinatradeorbusinessformorethanayear.

7.[LO2]Explainthedifferencebetweenordinary,capital,and§1231assets.

Anordinaryassetisanassetthatisheldforsaleintheordinarycourseofataxpayer’sbusiness（e.g.inventory）orarisesfromsalesintheordinarycourseofbusiness（e.g.accountsreceivable）.Capitalassetsareheldforinvestment（expectingappreciation）orarepersonal-useassets（e.g.ataxpayer’spersonalbelongings）.A§1231assetsisusedinatradeorbusinessorfortheproductionofincomeandisheldformorethanoneyear.Anassetthatisusedinatradeorbusinessorfortheproductionofincomeandisheldforoneyearorlessisanordinaryasset.Gainsonpersonalusepropertyarecapitalgainswhilelossesarenon-deductible.

8.[LO2]Discussthereasonswhyindividualsgenerallyprefercapitalgainsoverordinarygains.Explainwhycorporatetaxpayersmightprefercapitalgainsoverordinarygains.

Individualtaxpayersprefercapitalgainsbecausetheycanbetaxedatpreferentialrates.Long-termcapitalgainsaretaxedatpreferentialrates（5or15%）.Short-termcapitalgainsaresimplytaxedatordinaryrates.Capitalgainscanoffsetcapitallosses,whileordinarygainscannot.Additionally,individualtaxpayerscanoffset$3,000ofnetcapitallossesagainstordinaryincomeandcarrytheremainingcapitallossforwardindefinitely.

Eventhoughcorporatetaxpayersaretaxedatthesamerateonordinaryincomeandcapitalgains,theyprefercapitalgainsbecausecapitalgainscanoffsetcapitallosses.Capitallossescannotbeusedtooffsetordinaryincome.Corporatetaxpayerscancarrycapitallossesbackthreeyearsandforwardfiveyears.However,afterthecarrybackandcarryforwardperiodsexpire,capitallossesexpireandareworthless.

9.[LO2]DakotaConradownsaparceloflandhewouldliketosell.Describethecircumstancesinwhichthesaleofthelandwouldgenerate§1231gainorloss,ordinarygainorloss,orcapitalgainorloss.AlsodescribethecircumstanceswhereDakotawouldnotbeallowedtodeductalossonthesale.

TheparceloflandcouldqualifyasacapitalassetifitisheldbyDakotaasaninvestment（e.g.thepurposeforholdingthelandisforexpectedappreciationinvalue）.Thelandcouldqualifyasa§1231assetifDakotausesitinatradeorbusinesssuchasasole-proprietorshiporfortheproductionofincome（arentalproperty）andheusesitforthesepurposesformorethanoneyear.Theland

couldbeordinaryincomepropertytoDakotaifitisheldinatradeorbusinessorfortheproductionofincomeforoneyearorlessorifitisconsideredtobeinventory（forexampleareal-estatedealer）.Thelosswouldbenon-deductibletoDakotaifheheldthelandforpersonal-usepurposes.

10.[LO2]Lincolnhasusedapieceoflandinherbusinessforthepastfiveyears.Thelandqualifiesas§1231property.ItisunclearwhetherLincolnwillhavetorecognizeagainorlosswhensheeventuallysellstheasset.Sheasksheraccountanthowthegainorlosswouldbecharacterizedifshedecidestosell.Heraccountantsaidthatselling§1231assetsgivessellers“thebestofbothworlds.”Explainwhatheraccountantmeansby“thebestofbothworlds.”

Anassetqualifiesasa§1231assetifusedinatradeorbusinessorheldfortheproductionofincomeformorethanoneyear.Thetaxtreatmentissometimesdescribedasreceiving“thebestofbothworlds”becauseiftheyresultingains,thegainwillreceivecapitalgaintreatmentandiftheyresultinlossesthelosswillreceiveordinarylosstreatment.Capitalgainsarepreferablebecausetheyaretaxedatapreferentialrate（fornon-corporatetaxpayers）andcanoffsetcapitallosseswhichcannotalwaysbeoffsetagainstordinaryincome.Ordinarylossesarepreferredtocapitallossesbecausetheyoffsetordinaryincomeinthecurrentyearratherthanbeingaccumulatedtooffsetfuturecapitalgains.

11.[LO3]ExplainCongress’srationalefordepreciationrecapture.

Thepurposeofdepreciationrecaptureistotreatthegainonthesale