Chapter 8 p.609 Capital Gains & Losses 1(h)(1)(D) provides for (1) a preferential (maximum) 20% rate for net capital gains & (2) special treatment (for individuals) for net capital losses. 1222 specifies a netting process of: 1) Long term capital gains and LT losses; 2) Short term capital gains and ST losses; 3) Net LTCG or net LTCL against STCG or STCL to obtain net capital gain (or loss). 4) If net capital gain ( 1222(11)) is produced a preferential rate is imposed for that income. 12/5/2013 (c) William P. Streng 1
Varying capital gains rates Individuals p.611 1) Maximum rate for net LTCG is 20% (in 2013 & thereafter; previously 15%). 2) Gain from small business stock (50% exclusion, but 100% through 2013). 3) If ordinary income tax bracket of 25% - then cap. gains tax rate of zero. 1(h)(1)(B). 4) Collectibles (art, rugs, etc.) 28%. 1(h)(4). Cap. gain tax rates for corporations 35% (same as rate on ordinary income). 1201(a)(2). 12/5/2013 (c) William P. Streng 2
Net Capital Losses 1211(b) p.612 Net capital loss can offset ordinary income up to $3,000 per year for an individual. For individuals the excess losses can be carried forward to offset future capital gains or to offset ordinary income up to $3,000 for any subsequent year, until exhausted (or until death). 1212(b). Value of a $3,000 ordinary loss deduction to a 40% taxpayer = $1,200. 12/5/2013 (c) William P. Streng 3
Definition of a Capital Asset p.615 1221(a) defines the term capital asset as property held by the taxpayer (whether or not connected with his trade or business), but does not include eight specified items: e.g., inventory; depreciable property ( 1221(a)(2)); copyrights, etc. (note impact in the charitable contributions deductions context); accounts or notes receivable; supplies used in the ordinary course of business; and, certain other items. 12/5/2013 (c) William P. Streng 4
Depreciable Business & Real Property p.615 1) Not a capital asset - 1221(a)(2). 2) But, if property is used in the trade or Business, see 1231(a)(3)(A)(i)) can produce 1231 gain. See p. 615. 3) Net 1231 gains are treated as long term capital gains. 1231(a)(1)(A). Loss as ordinary. 4) But, if applicable gain is attributable to prior depreciation, this deduction can be recaptured as ordinary income. 1245. 12/5/2013 (c) William P. Streng 5
Policy for/against LTCG Treatment p.616 1) Realized capital gains are accumulated over several years but bunched into one year when realized and required to be recognized. 2) To reduce the lock-in effect. Defined as? 3) To reduce impact of inflation (but consider 13 months vs. 13 year holding period). 3) To encourage capital investment. But, the benefit of tax deferral is realized. Alternative: base the tax rate on the actual holding period for the specific asset? 12/5/2013 (c) William P. Streng 6
Limitation on Capital Loss Deductibility p.618 Individuals may deduct $3,000 per year of capital losses against his/her ordinary income. 1211(b) specifies this treatment. Objectives of this limitation: 1) Preclude cherry-picking of losses (and deferral of gain recognition). 2) Limit the impact of these losses on tax revenues derived by U.S. Treasury Dept. Cf., treatment of corporations. 12/5/2013 (c) William P. Streng 7
Bielfeldt v. Commr. Trader Status P.620 See 1221(a)(1) specifies that property held primarily for sale to customers is not eligible for status as a capital asset. Losses to a dealer are deductible as ordinary losses; not if a trader. What distinction between a dealer and a trader? Dealer realizes gain from sales commissions; trader realizes gain from market speculation. Cf., floor specialist treatment. Here, no inventory of securities. 12/5/2013 (c) William P. Streng 8
Mark-to-Market Treatment 475 p.623 Securities dealers are required to mark-tomarket any securities it holds not (1) treated as inventory or (2) held for investment. Treatment as if sold at end of the year the accrued gain or loss is treated as ordinary gain/loss. Cf., 1236 (p. 623) permitting a securities dealer to segregate securities into an investment account treated as capital assets. 12/5/2013 (c) William P. Streng 9
Biedenharn Realty v. U.S. P.624 Was taxpayer selling property held primarily for sale (i.e., inventory) and, thereby, producing ordinary income? More than a liquidation? Factors for making this determination: 1) Frequency and substantiality of sales. 2) Improvements streets, utilities, etc. 3) Solicitation and advertising efforts. 4) Brokerage activities attributable to owner. Held: Dealer status and ordinary income. 12/5/2013 (c) William P. Streng 10
What Standard of Review? P.630 Is the ultimate question of dealer status a question of law or a question of fact? See (p.630) that 5 th Circuit position (in Byram case) is that this is a question of fact. Therefore, subject to the clearly erroneous standard of review. FRCP Rule 52(a). 12/5/2013 (c) William P. Streng 11
Condominium Conversion p.631 Apartment building was converted from rentals into condominium units. Should the sale of the units be treated as capital gain? In Gangi case held units not held primarily for sale but, rather, a liquidation of their investment. Partly attributable to disintegration in the business relationship between two partners. Here, (1) limited advertising and (2) improvements were not made for the primary purpose of sale. 12/5/2013 (c) William P. Streng 12
What is the Relevance of Agency Status? P.633 Should a contract with a real estate agency to sell lots in a property immunize the owner from dealer status? How far can the owner go in improving property before becoming a dealer? Consider this technique: Sell land (at high price) for installment note to controlled corporation which then further develops the land and realizes (limited) ordinary income on sales. What about sale to an LLC (not treated as a corporation for FIT purposes)? 12/5/2013 (c) William P. Streng 13
Corn Products case Hedging p.635 What is a capital asset (further defined)? Consider the tax treatment of a futures contract acquired to protect against the cost of inventory (necessary to be integrated into a final finished product). In Corn Products long futures contracts were acquired so as to assure the pricing of product when eventually acquired. Was profit from corn futures contracts capital gain? No. 12/5/2013 (c) William P. Streng 14
Arkansas Best Corp. Capital Loss p.638 Is capital stock in a corporation always a capital asset? Here corporate shareholder sold stock of bank and claimed an ordinary loss deduction. Tax Court had held that stock acquired during problem phase was exclusively for business purposes. 8 th Cir.: All stock was a capital asset. Taxpayer asserts Corn Products permits ordinary business (loss) treatment. Holding: motivation for purchase not relevant. Corn Products involved the inventory exception. 12/5/2013 (c) William P. Streng 15
Source of Supply cases p.642 Booth Newspapers buys stock in paper manufacturing corp. to assure a source of supply and stock is then sold at a loss. Is the stock a substitute for newsprint supply? See Reg. 1.1221-2(d)(5)(i). What if airline hedges against an increase in price of jet fuel? Should the hedge contract constitute a source of supply substitute? 12/5/2013 (c) William P. Streng 16
Substitutes for Ordinary Income p.642 Hort, p. 642 payment by tenant for cancellation of a real estate lease. Ordinary income or cap. gain? Taxpayer received payment for cancellation of lease. Property received from father s estate with lease. Tenant payment of $140x for lease cancellation. Owner claimed loss on the lease termination. IRS says all is includible as ordinary income. Is this just a substitute for rent and, therefore, ordinary income? Court says yes. 12/5/2013 (c) William P. Streng 17
Premium Lease p.646 Can a lease have its own intrinsic value if it requires rental payments in excess of the current fair market value rent for the property? What income tax treatment if purchasing a property with a premium lease? Will additional consideration be paid for that property (assuming a creditworthy tenant)? 167(c)(2) specifies no allocation of tax basis to a lease when property is acquired. Therefore, only the physical property itself is depreciable. 12/5/2013 (c) William P. Streng 18
McAllister v. Commr. P.647 Individual (widow) transfers her life interest in a testamentary trust for receipt of a cash payment. She reports a capital loss of $8,790 (amount received less basis established under uniform basis rules). Amount received by her is actually an accelerated payment of her anticipated income stream? Was this like the Blair case or the Hort case? Held: Sale of entire property interest (capital) and not an income stream (treated as income). 12/5/2013 (c) William P. Streng 19
What Tax Basis for the Life Tenant? P.650 1001(e) Where life tenant sells his life interest the tax basis for the life interest is zero unless the remainderman sells at the same time, in which situation the tax basis is proportionately allocated. Capital gains treatment to the selling life tenant. Under uniform basis rules the original basis is allocated between the life interest and the remainder interest. Basis is gradually shifted from life tenant, based on life expectancy tables. 12/5/2013 (c) William P. Streng 20
Lottery Winnings Womack p.651 Taxpayer transfers entire remaining annual payments for winning lottery in exchange for a (discounted) lump sum amount. Does this amount constitute receipt of ordinary income or capital gain. Held: Payment was a substitute for ordinary income stream and, therefore, all constituted ordinary income. Lottery rights were never a capital asset. Does the term property not have its normal meaning here since all treated as income? 12/5/2013 (c) William P. Streng 21
Oil Payments P.G. Lake p.656 Corporation has a 7/8ths working interest in two oil and gas leases. Assigns a $600,000 oil payment (plus 3% interest payment) to its president to pay a debt owed to him. Corp. reported this transfer as a sale of property producing a $600,000 LTCG. Held: Proceeds were ordinary income (but, subject to depletion deduction). Treated as essentially a substitute for the future receipt of ordinary income. Right result? See next slide. 12/5/2013 (c) William P. Streng 22
Oil Payments & Code 636 p.659 636(a) carved-out production payment treated as a mortgage loan on the property (i.e., payment periodically by the oil producer for the property owner made to production payment holder). Not an economic interest to the recipient under production payment but to the seller (who gets depletion). Taxed periodically when payments actually made. 12/5/2013 (c) William P. Streng 23
WWWWW wwww 12/5/2013 (c) William P. Streng 24