Chapter 7

Capital Gains and

Other Sales of
Property

If a client asks in any but an extreme

case whether, in your opinion, his sale
will result in capital gain, your answer
should probably be, I dont know, and
no one else in town can tell you.
-- James L. Wood

McGraw-Hill/Irwin
McGrawHill/Irwin

Copyright 2013 by the McGraw-Hill

Companies, Inc. All rights reserved.
TheMcGrawHillCompanies,Inc.2008

LO #1 Terms & Tax Forms

Basis of property purchased is the cost of
the asset including cash, debt
obligations, and other property or
services included in acquiring the asset.
Basis of assets transferred by inheritance
are valued at the FMV of the property at
the date of death or FMV on the alternate
valuation date if an estate return is being
filed and the estate income is reduced by
the valuation.
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LO #1 Terms & Tax Forms

Basis of property transferred to a
taxpayer from a spouse or former
spouse incident to a divorce settlement,
is the same as the spouses or former
spouses adjusted basis before the
transfer.
Assets transferred by gift can be valued
at FMV or basis of the donor depending
if the FMV is < or = > basis.
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LO #1 Terms & Tax Forms

Adjusted basis is the cost of the asset
less any accumulated depreciation.
The difference between the amount
realized from the sale and the adjusted
basis of the asset;
Amount realized > adjusted basis = gain
Amount realized < adjusted basis=(loss)

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LO #1 Terms & Tax Forms

The nature of tax reporting for gains and
losses on the sale of property depends
primarily on the use of the asset rather
than on the asset form.

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LO #1 Terms & Tax Forms

Form 4797 Sales of Business Property
Use to report any and all gains or losses
from sale or liquidation of business property.
The form has four parts to it and is very
detailed to include all possible situations
involving property used in a business

Schedule D Capital Gains and Losses

Use to report any and all gains or losses
from sale of property held for investment.

Form 8949 Started in 2011

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LO # 2 Classifying Assets
Ordinary Asset
Ordinary income property is any asset
that is not a capital asset.
Capital Asset (1221)
Any asset used for personal purposes
or investment.
Eight exceptions to this definition

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LO # 2 Classifying Assets
1231 Business Asset
Depreciable or nondepreciable property
used in a trade or business
Held for more than one year

Any business asset disposed of within

one year of acquisition is an ordinary
income asset and is taxed to the
taxpayer at ordinary tax rates.

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LO # 3 Ordinary Assets
Inventory and accounts receivable are not
ordinary income assets unless they are sold
outside the normal course of business.
Sale of business property held less than one
year.
Gains are taxed at the taxpayers regular rate
There is no preferential tax treatment

Losses are fully deductible

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LO #4 Capital Assets
Tax treatment depends on holding
period of the asset. Assets must be held
for more than one year for preferential
tax treatment.
Exceptions:
Property received through a gift or nontaxable
exchange generally has same holding period as
the transferor.
Property acquired through inheritance is always
considered long-term property.

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LO #4 Capital Assets
Long term capital gain rates:
0% or 15% for most capital assets
25% rate for depreciable real property used
in a trade or business ( 1250)
28% rate for collectibles and gains on
1202 (Qualified Small Business Stock)
property.

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LO #4 Capital Assets
All short-term gains and losses are
netted.
All long-term gains and losses are
netted.
The resultant gain or loss determines
the deductibility of a loss and the tax
rate used for gain.

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LO #5 1231 Business Assets

Recall that 1231 assets are those
used in a trade or business that are
held for > 1 year.
Gains and losses from the sale of
1231 assets are netted before tax
rates are applied.
A net 1231 gain is taxed as a longterm capital gain subject to recapture
provisions
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LO #5 1231 Business Assets

Recapture provisions apply to
depreciation taken as a deduction in
prior years.
Depreciation recapture rules are
designed to transform some or all of
the 1231 gain into an ordinary gain.

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LO #5 1231 Business Assets

Net 1231 gains receive preferential tax
rate treatment
Net 1231 losses are treated as
ordinary losses not subject to
deductibility limit provisions of $3,000
per year.

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LO #5 1231 Business Assets

1245 applies to personal trade or
business property and is a subset of
1231 property
Tax rate to recapture the depreciation
portion of a gain is taxed at ordinary rates
Remaining gain, if any, is taxed at
preferential rates.

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LO #5 1231 Business Assets

1250 applies to buildings residential
or nonresidential (commercial) and is a
subset of 1231 property
The amount of capital gain
attributable to depreciation previously
taken is taxed at the 25% rate up to
the depreciation amount considered
unrecaptured.
Remaining gain, if any, is taxed at
preferential rates
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LO # 6 Special Types of Sales

Sales of stock purchased as blocks of
stock at different prices and/or dates are
valued either using specific identification
or the first-in, first-out method for
determining basis.

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LO # 6 Special Types of Sales

A mutual fund pools resources from various
investors and purchases shares of stock in a
portfolio
Form 1099-DIV is the form sent annually to
individual investors in the mutual fund to
record dividends, capital gains, and
distributions from the fund for the year.
Capital gains distributions from mutual funds
are reported on Schedule D (or directly on
Form 1040 if Schedule D is not required to be
filed).
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LO # 6 Special Types of Sales

Three methods to calculate the basis of
shares in a mutual fund purchased throughout
a period
First-In, First-Out assumes first shares
purchased are the first shares sold.
Specific Identification assumes that the shares
sold can be identified with a specific purchase.
Average Basis Calculate the average of shares
purchased for a period and use an average to
determine the cost basis of shares sold.

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LO # 6 Special Types of Sales

Worthless securities are treated as
losses from a sale or exchange of a
capital asset on the last day of the
taxable year.
Declaration of bankruptcy is not sufficient to
indicate worthlessness.
Often difficult to pinpoint exactly when a
security becomes worthless to determine a
sale date for long-term versus short-term
treatment.
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LO # 6 Special Types of Sales

Sales of assets given as gifts:
FMV<donors adjusted basis at time of gift
Use donors adjusted basis for a gain
Use FMV for a loss
Special provision, if the sell price is between the
adjusted basis and the FMV, there is no gain or
loss on the sale.

FMV=>donors adjusted basis at time of gift

Use donors adjusted basis for a gain or loss

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LO # 6 Special Types of Sales

Basis to beneficiaries is the FMV at the
date of death or alternate valuation date
(AVD applies only if valuing the asset
reduces the overall estate amount).
The holding period is always considered
long-term
Example: Property inherited with a basis of
$3,000 is sold six months later for $4,000.
The $1,000 gain is considered long-term
and qualifies for preferential tax treatment.
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