Federal Income Taxation Chapter 5 Capital Appreciation

Transcription

1 Presentation: Federal Income Taxation Chapter 5 Capital Appreciation Professors Wells September 12, 2017

2 CH 2-4 Capital Appreciation Tax Basis Recovery p (a)(3) gross income includes gains derived from dealing in property; Reg (a) (sales less cost of goods sold). Reg (sales price less basis to determine gain ) determining the amount of gain (amount realized less tax basis) 1012 identifying cost basis - Should a person recover investment in a property without gross income inclusion? 2

3 Windfall Gains p.225 Eisner v. Macomber Discuss Facts Lay out majority and dissenting opinions Analyze opposing views and implications Who was right? 3

4 Helvering v. Bruun p.261 Landlord owns tenant s improvements to property at expiration of the lease. Gross income? Timing when improvements made? Periodically as lease runs? Expiration of the lease? At subsequent time of property sale? (& impact in interim?) Note Code 109 and 1019 (no GI inclusion and no basis adjustment). 4

5 Cottage Savings Assn. Loan Packages p.265 Facts: 1. Financial institution exchanges one group of residential mortgage loans with another financial institution for another package of residential mortgage loans. A swap of participation interests occurs. Long-term low interest mortgages had declined in value because of the significant increase in market interest rates. 2. Seller did not want to record the losses on its books (i.e., reporting for regulatory and financial accounting purposes). Issue: Does tax disposition event occur only if properties are "materially different"? Holding: This exchange does cause realized losses for federal income tax purposes. Cf., inclusion of income based merely on appreciation, i.e., an accretion to wealth. 5

6 Post-Cottage Savings p.274 Significant Debt Modifications Tax community became concerned that Cottage Savings created a hair-trigger realization event analysis. The Treasury Department responded with regulations under Is the modification of a debt a realization event? Reg (b) states a significant modification of a debt instrument is an exchange. Consider change in (1) term, (2) interest rate, (3) other (e.g., priority)? Exception for a unilateral option. 6

7 Deemed Realization: 1259 p.274 Gain or loss arises on the sale or exchange of a capital asset. See Code How postpone sale/gain recognition? - Short against the box : (1) owning securities, (2) borrow similar securities, (3) sell the borrowed securities (short), thereby terminating risk on investment; (4) then close transaction - deliver original shares. Short 100 shares Stock Lender Este Lauder Transaction Lauders $10 million Buyer Loan 100 shares Code 1259 gain on doing this transaction. Long 100 shares 100 shares of ABC Stock Basis $10,000 FMV $10 million The Box Shares 7

8 Non-recognition Rules p.277 Like-Kind Exchanges 1031 Under Code 1001(c) gain is recognized except as otherwise provided. Like-kind exchanges can enable gain recognition postponement - Code No gain recognition is required on a like-kind property exchange, except for the receipt by taxpayer of boot 1031(b). What is the rationale for this provision? valuation difficulty? lack of liquidity? 8

9 How Assure Exchange Status? 1031 does not permit deferral with receipt of cash and then reinvestment in a new property. How arrange exchange when one party is providing cash? - multi-party transactions; exchange facilities Cf., tenancy in common ownership arrangements 9

10 Alderson v. Commissioner p.277 Orange (Escrow Agent) 5/21/1957 Buena Park Pty acres (FMV=$172,871.40) + $19,000 Alloy 9/3/1957 $172, $191, /3/1957 Salinas Pty 9/3/1957 Salinas Pty acres (FMV=$190,000) Salinas Title (Escrow Agent) Delayed receipt of exchange property relying on creditworthiness of the exchanging party. A 1031 exchange? See 1031(a)(3) specifying 45 day and 180 day limits. What if interest charge equivalent credited to replacement property purchase? 10

11 Rev. Rul p.283 FACTS: Exchange of United States gold coins for African Krugerrand gold coins. Held: Not like kind. Like-kind exchange treatment permitted: 1) Different types of real estate? (PLR ). 2) Auto trade-ins? 3) Computer for a printer? See limits in 1031(a)(2). 11

12 Jordan Marsh Co. v. Commissioner p.285 FACTS: Sale of property for $2.3 John Marsh million and lease-back for 30 years. Taxpayer claims loss equal to difference between $2.3 million and adjusted basis. IRS: Claims that the sale-leaseback is a like-kind exchange subject to Section 1031(c) s prohibition on recognizing losses. Tax Court: Agreed with IRS. Second Circuit: Held not a like-kind exchange but a cash sale. 12

13 How is the Gain Potential Retained for Tax Purposes? Tax basis for replacement property is: 1) same as tax basis for property transferred; 2) decreased by boot received; 3) increased by gain recognized on the exchange. See 1031(d) providing for a transferred tax basis. 13

14 Like Kind Exchanges with No Boot Received Example One: Exchange of Property A worth 10x, basis 4x, for like-kind Property B, also fmv 10x. Inclusion of gain of 6x is postponed. Tax basis for the replacement property is 4x (to preserve the income tax potential on 6x deferred gain). Code 1031(d). 14

15 Like-kind Exchanges, cont. Boot Received Example Two: Transfer of Property A worth 10x (basis 4x, appreciated gain is 6x) in exchange for replacement Property B, fmv 8x, and additional cash is received of 2x (i.e., boot ). Code 1031(b) - 6x gain is realized. Gain is to be recognized to the extent of the 2x boot. Tax basis for replacement Property B (fmv 8x) is 4x (2x has been recognized; 4x is not recognized). Tax basis for 2x cash received is (obviously) 2x. 15

16 Like-kind Exchanges, cont. Boot Exceeds Gain Example Three: Transfer of Property A worth 10x (basis 4x; 6x appreciation) for replacement Property B, fmv 3x, plus cash (boot) received in the amount of 7x. Code 1031(b) - 6x gain is to be recognized (i.e., only to the extent of gain realized). Basis for Property B is 3x (all gain has been recognized). Basis for the cash is 7x. 16

17 Loss - Like-kind Exchange Provision Is Not Elective Example Four: Transfer of Property A worth 10x (basis 12x, i.e., loss property) for replacement Property B, fmv 10x (i.e., same FMV). No loss can be recognized. Code 1031(a). Basis for Property B received is 12x (i.e., the 2x loss potential is retained in the replacement property for future loss recognition when sold, unless subsequent appreciation). See Jordan Marsh Co. v. Commissioner. 17

18 Loss - Like-kind Exchange Provision Is Not Elective Example Five (loss exchange & boot received): Transfer of Property A worth 10x (basis 12x, i.e., loss property) for replacement Property B, fmv 8x, and 2x cash boot received by seller. No loss can be recognized. Code 1031(c). Tax basis for Property B is 10x (basis is reduced by 2x cash); 2x loss potential is retained (8x fmv for Property B); and, 2x tax basis for the cash received. 18

19 Like-kind Exchange Boot Received in Kind Example Six: Transfer of Property A worth 10x (tax basis is 4x, 6x appreciation) for (1) replacement Property B, fmv 8x and (2) other property (e.g., stock) worth 2x. Code 1031(b) - 6x gain is realized, but recognition of gain only to extent of the boot. Basis for Property B (fmv 8x) is 4x (2x of the 6x appreciation is recognized (& 4x gain potential) & 2x is tax basis for boot. 19

20 Like-kind Exchange Taxpayer Adds Cash Boot Example Seven: Transfer of both Property A worth 10x (basis 4x, with 6x appreciation) and 5x cash for acquiring replacement Property B with fmv 15x. Code 1031(a) - 6x gain is realized but no gain is to be recognized. Basis for (15x fmv) Property B is 9x (4x old basis plus 5x new cash from purchaser). 20

21 Involuntary Conversions p (a) Analysis Step One: 1033(a) applies to property that is the subject of an involuntary conversion (destruction, theft, seizure, requisition or condemnation) Step Two: Taxpayer receives 1. replacement property ( 1033(a)(1)) or 2. money ( 1033(a)(2)) that is used to purchase replacement property within 2 years of realization of any part of the gain ( 1033(h) extends to 4 years for federal disaster areas), Then, realized gain or loss is not recognized to the extent that the conversion proceeds are reinvested into replacement property. Basis per 1033(b): Substitute Basis Boot + Gain Recognized. 21

22 Sale of Home p excludes gain on sale of home of up to $250,000 ($500,000 for married filing jointly) The benefits of this exclusion arguably changes taxpayer behavior on where they have their wealth. Is this a good thing? The Tax Expenditure cost of this benefit is $17.5 billion. 22

23 Wash Sale Rules p (a) Analysis In the case of any loss claimed to have been sustained from any sale or other disposition of shares of stock or securities where it appears that, within a period beginning 30 days before the date of such sale or disposition and ending 30 days after such date, the taxpayer has acquired (by purchase or by an exchange on which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock or securities, then no deduction shall be allowed under section 165 unless the taxpayer is a dealer in stock or securities and the loss is sustained in a transaction made in the ordinary course of such business. 23

24 Deferred Sale: p.293 Bernice Patton Testamentary Trust v. U.S. FACTS: in 1995, Pattons sold two closely-held businesses for cash ($317,140) plus Seller s note ($507,424). Patton s basis was $299,322. Taxpayer used open transaction doctrine and reported gain of $17,818 (cash in excess of basis). Taxpayer note was reduced to $107,916, $23067 interest, and $2,914 default interest. Taxpayer ultimately received / was paid $14,116 (in 1995), $104,704 (in 1996), and $85,350 (in 1997) (total of $204,170). IRS contended that note had ascertainable value of $202,344 and thus created long-term capital gain in Fed. Cir.: Held that installment sale reporting was appropriate. How did court decide valuation of the note? 24

25 Deferred Sale: p.293 Bernice Patton Testamentary Trust v. U.S. Bernice Patton Testamentary Trust v. United States Sales price Cash (Year 1) 317,140 Note 507,424 Overall Amount Realized 824,564 Basis 299,322 Open Transaction Year 1 Calculation Later Years Amount Realized 317, ,170 Basis 299,322 Gain in Year 1 17, ,170 Year 1 Calculation Later Years Installment Sales Amount Realized 317, ,170 Basis 115, ,322 x (317,140/824,564) 184,198 Gain 202, ,140 x (525,242/824,564) 19,972 25

26 Installment Sales: 453 Supp. pp Hypo: Seller sells property worth $600x (Basis $400x) to Buyer in exchange for Buyer s debt instrument pays $100x per year over the next 7 years. AFR=4%. Seller elects the installment method. Tax Consequences to Seller / 483 computes original issue price of $600x. Gain of $200 is realized (see Treas. Reg (g)), but it is not recognized immediately if the installment method were elected. 2. Receive $100x Step One: Interest First of $24x ($600x x 4%). See Treas. Reg. 15.a.453-1(b)(2)(ii) Step Two: Compute Included Gain per 453(c) Included Gain = x Payment (other than interest) (200/600 * 76x) = $25.3 gain Remaining payment of $50.7 is return of basis A modifies the above results in certain events, including if debt instrument were pledged or if sale s price > $5 million. 26