12/7/2012 (c) William P. Streng 1
Chapter 8 p.609
Capital Gains & Losses
§1(h)(1)(C) provides for (1) a preferential 15%
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 losses;
2)Short term capital gains and losses;
3)Net LTCG or net LTCL against STCG or
STCL to obtain net capital gain.
4)If net capital gain (§1222(11)) is produced a
preferential rate is imposed for that income.
12/7/2012 (c) William P. Streng 2
Varying capital gains
rates – Individuals p.611
1) Usual rate for net LTCG is 15% (20% in
2013).
2) Gain from small business stock – 14%.
3) Low ordinary income tax bracket of 15% -
then cap. gains rate of zero. §1(h)(1)(B).
4) Collectibles (art, rugs, etc.) – 28% on gain.
See §1(h)(4).
Cap. gain tax rates for corporations – 35%
(same as the rate on ordinary income).
§1201.
12/7/2012 (c) William P. Streng 3
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 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. §1212(b).
12/7/2012 (c) William P. Streng 4
Definition of a Capital
Asset p.615
§1221(a) specifies 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;
accounts or notes receivable; supplies used in
the ordinary course of business; and, certain
other items.
12/7/2012 (c) William P. Streng 5
Depreciable Property
Treatment
1) Not a capital asset - §1221(a)(2).
2) But, property 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).
4) But, if applicable gain is attributable to prior
depreciation, this deduction can be
recaptured as ordinary income. §1245.
12/7/2012 (c) William P. Streng 6
Policy for/against LTCG
Treatment p.616
1) Realized capital gains are accumulated over
several years but bunched into one year
when “realized” and to be recognized.
2) To reduce the “lock-in” effect.
3) To reduce impact of inflation (but consider
13 months vs. 13 year holding period).
4) 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?
12/7/2012 (c) William P. Streng 7
Limitation on Capital Loss
Deductibility p.618
Individuals may deduct only $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.
12/7/2012 (c) William P. Streng 8
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.
12/7/2012 (c) William P. Streng 9
Mark-to-Market Treatment
§475 p.623
Securities dealers are required to mark-to-
market securities not treated as inventory or
held for investment.
Treatment as if sold at end of the year – gain or
loss as ordinary gain/loss.
Cf., §1236 (p. 623) permitting a securities dealer
to segregate securities into an investment
account treated as capital assets.
12/7/2012 (c) William P. Streng 10
Biedenharn Realty v. U.S.
P.624
Was taxpayer selling property held primarily
for sale (i.e., inventory) and, thereby, producing
ordinary income?
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.
12/7/2012 (c) William P. Streng 11
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 5th Circuit position is that this is
a question of fact.
Therefore, subject to the “clearly erroneous”
standard of review.
12/7/2012 (c) William P. Streng 12
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.
12/7/2012 (c) William P. Streng 13
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)?
12/7/2012 (c) William P. Streng 14
Corn Products case
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 assure price of product when
eventually acquired. Was profit from corn
futures contracts capital gain? No.
12/7/2012 (c) William P. Streng 15
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. 8th Cir.: All stock was capital asset.
Taxpayer asserts Corn Products permits
ordinary business (loss) treatment.
Holding: motivation for purchase not relevant.
Corn Products involved inventory exception.
12/7/2012 (c) William P. Streng 16
Source of Supply cases
p.642
Booth Newspapers – buys stock in paper
manufacturing corp. to assure source of supply
and then sold at a loss. Is the stock a substitute
for newsprint supply?
See Reg. §1.1221-2(c)(5)(ii).
What if airline hedges against an increase in
price of jet fuel? Should it constitute a source of
supply substitute?
12/7/2012 (c) William P. Streng 17
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.
12/7/2012 (c) William P. Streng 18
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.
12/7/2012 (c) William P. Streng 19
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).
12/7/2012 (c) William P. Streng 20
What Tax Basis for the
Life Tenant? P.650
§1001(e) – Where life tenant sells 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.
12/7/2012 (c) William P. Streng 21
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?
12/7/2012 (c) William P. Streng 22
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.
12/7/2012 (c) William P. Streng 23
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.
12/7/2012 (c) William P. Streng 24
WWWWW
wwww
Top Related