Property Dispositions Student Notes PDF

**\*\*READ PAGES 11-1 -- 11-2 (ending after Example 11-1) & PAGES 11-5 -- 11-11 (ending after Example 11-6)\*\*** **LO 11-1 -- Dispositions** (P 11-32, P 11-35, Example 11-3 (adapted)) A. **Dispositions** 1. Every asset disposition (through sale, donation, trade, disposal, etc.) triggers a...

**\*\*READ PAGES 11-1 -- 11-2 (ending after Example 11-1) & PAGES 11-5 -- 11-11 (ending after Example 11-6)\*\*** **LO 11-1 -- Dispositions** (P 11-32, P 11-35, Example 11-3 (adapted)) A. **Dispositions** 1. Every asset disposition (through sale, donation, trade, disposal, etc.) triggers a realization event for tax purpose. 2. To calculate the amount of gain or loss taxpayers realize when they sell assets, they must determine the **[amount realized]** on the sale and their adjusted basis in each asset they are selling. 3. **Amount realized** a. The amount realized by a taxpayer from the sale or other disposition of an asset is everything of value received from the buyer [ **LESS any selling costs**]. b. Taxpayers typically receive cash when they sell property; they may also accept marketable securities, notes receivable, similar assets, or any combination of these items as payment. c. Taxpayers selling assets such as real property subject to loans or mortgages must increase their amount realized by the amount of [ **DEBIT relief**] (the buyer's assumption of the seller's liability increases the seller's amount realized). B. **Determination of Adjusted Basis** **(starting top of page 11-5)** 1. An asset's cost basis is the amount subject to cost recovery. 2. Initial basis is generally its cost. Exceptions apply for gifts, inherited property, and property converted from personal to business use. 3. The **adjusted basis** for determining gain or loss on the sale of the assets is the initial basis reduced by [ **DEPRECIATION** ] or other types of cost recovery deductions allowed (or allowable) on the property.  4. *Because businesses generally use more highly accelerated depreciation methods for tax purposes than they do for book purposes, the tax-adjusted basis of a particular asset is likely to be **[lower]** than the book-adjusted basis.* C. **Realized Gain or Loss on Disposition** 1. The amount of gain or loss taxpayers realize on a sale or other disposition of assets is simply the amount they realize minus their [ **ADJUSTED basis**] in the disposed assets. D. **Recognized Gain or Loss on Disposition** 1. Recognized gains or losses are gains (losses) that increase (decrease) taxpayers' gross income. 2. Taxpayers must report recognized gains and losses on their [ **TAX returns**]. 3. In certain circumstances taxpayers may be allowed to [ **defer** ]recognizing gains to subsequent periods, or they may be allowed to permanently [ **exclude** ] the gains from taxable income. **LO 11-2 -- Character of Gain or Loss** (P 11-39 (adapted), P 11-41, P 11-48) Taxpayer must determine the character or type of gain or loss recognized that affects the taxpayer's income tax liability. Every gain or loss is characterized as either **[ordinary]** or [ ] (long-term or short-term). The character of a gain or loss is important because gains and losses of different characters are treated differently for tax purposes.  A. **Ordinary Assets** 1. Assets created or used in a taxpayer's **[trade or]**. 2. Business assets held for less than a year. 3. **Examples of ordinary assets**---inventory, accounts receivable, machinery, and equipment if they have been used in business for one year or less. 4. If taxpayers sell ordinary assets at a gain, they recognize an ordinary gain that is taxed at **[\_\_\_\_\_\_\_\_\_\_\_\_ rates]**. 5. If taxpayers sell ordinary assets at a loss, they deduct the loss against other ordinary income. B. **Capital Assets** 6. Assets held for [ ] , for the production of income, or for **[personal use]**. 7. Qualification as capital asset depends on the purpose for which taxpayer uses the asset. 8. Both individual and corporate taxpayers prefer capital gains to ordinary income. C. **Section 1231 Assets** 9. Depreciable assets and land used in a trade or business held for more than one year 10. If the taxpayer recognizes a net §1231 gain, the net gain is treated as a **[long-term]**. 11. If the taxpayer recognizes a net §1231 loss, the net loss is treated as an [ **loss**]. 12. §1231 gains on individual depreciable assets may be [ ] as ordinary income under the depreciation recapture rules. D. **Depreciation Recapture\*** 1. Potentially applies to gains (but [ **losses**]) on the sale of depreciable or amortizable business property. 2. Recharacterizes the gain on the sale of a §1231 asset (all or a portion of the gain) from §1231 gain into [ **income**]. 3. The method for computing the amount of depreciation recapture depends on the type of §1231 assets the taxpayer is selling (personal property or real property).  **P 11-32** (LO 11-1) Rafael sold an asset to Jamal. What is Rafael's amount realized on the sale in each of the following alternative scenarios? a. Rafael received \$80,000 of cash and a vehicle worth \$10,000. Rafael also paid \$5,000 in selling expenses. b. Rafael received \$80,000 of cash and was relieved of a \$30,000 mortgage on the asset he sold to Jamal. Rafael also paid a commission of \$5,000 on the transaction. c. Rafael received \$20,000 of cash, a parcel of land worth \$50,000, and marketable securities of \$10,000. Rafael also paid a commission of \$8,000 on the transaction. **P 11-35** (LO 11-1) Lassen Corporation sold a machine to a machine dealer for \$25,000. Lassen bought the machine for \$55,000 and has claimed \$15,000 of depreciation expense on the machine. What gain or loss does Lassen realize on the transaction? **Example 11-3 (adapted)** (LO11-1) **Scrap-Happy owns a computer (five-year MACRS recovery period) that it purchased two years ago for \$1,200. For financial statement purposes, the computer depreciates over three years using the straight-line method, with no salvage value. What are the adjusted book and tax bases for the computer (after two years of depreciation)?** **Book** **Tax** ----------------- --------------------- --------- Cost Basis: \$1,200 Yr Dep. (HY): (400) Yr Dep.: [(400)] Adjusted Basis: \$ 400 **Scrap-Happy sells the computer for \$400. What is the realized gain or (loss) on the sale?** **P 11-39 (adapted)** (LO 11-2) Identify each of Green Corporation's following assets as an ordinary, capital, or §1231 asset. a. Five years ago, Green used its excess cash to purchase land as an investment. b. Two years ago, Green purchased a new warehouse. It uses these assets in its business. c. Manufacturing equipment Green purchased earlier this year. d. Inventory Green purchased 17 months ago that is ready to be shipped to a customer. e. Office equipment Green has used in its business for the past five years. f. 15,000 shares of stock in Blue Corporation that Green purchased three years ago because it was a good investment. g. Account receivable from a customer with terms 3/15 net 60. h. Machinery Green held for three years and then sold at a loss of \$10,000. **P 11-41** (LO 11-2) 1. In year 0, Longworth Partnership purchased a machine for \$40,000 to use in its business. In year 3, Longworth sold the machine for \$35,000. Between the date of the purchase and the date of the sale, Longworth depreciated the machine by \$22,000. a. What is the amount and character of the gain or loss Longworth will recognize on the sale? ---------------------------------------------------------- -------------- ------------------- ***Description*** ***Amount*** ***Explanation*** *(1) Amount Realized* *(2) Original Basis* *(3) Accumulated Depreciation* *(4) Adjusted Basis* *(5) Gain/(Loss) Recognized* ***(6) Ordinary income (§1245 depreciation recapture)*** ***§1231 gain*** ---------------------------------------------------------- -------------- ------------------- b. What is the amount and character of the gain or loss Longworth will recognize on the sale if the sale proceeds were increased to \$45,000? ---------------------------------------------------------- -------------- ------------------------ ***Description*** ***Amount*** ***Explanation*** *(1) Amount Realized* *Given* *(2) Original Basis* *Given* *(3) Accumulated Depreciation* *Given* *(4) Adjusted Basis* *(2) - (3)* *(5) Gain/(Loss) Recognized* *(1) -- (4)* ***(6) Ordinary income (§1245 depreciation recapture)*** *Lesser of (3) or (5)* ***§1231 gain*** *(5) -- (6)* ---------------------------------------------------------- -------------- ------------------------ c. What is the amount and character of the gain or loss Longworth will recognize on the sale if the sale proceeds were decreased to \$15,000? ---------------------------------------------------------- ------------------------ ------------------- ***Description*** ***Amount*** ***Explanation*** *(1) Amount Realized* *\$15,000* *Given* *(2) Original Basis* *40,000* *Given* *(3) Accumulated Depreciation* *[22,000]* *Given* *(4) Adjusted Basis* *18,000* *(2) - (3)* *(5) Gain/(Loss) Recognized* *(\$3,000)* *(1) -- (4)* ***(6) Ordinary income (§1245 depreciation recapture)*** ***§1231 loss*** ---------------------------------------------------------- ------------------------ ------------------- **P 11-48** (LO 11-2) 48. Lily Tucker (single) owns and operates a bike shop as a sole proprietorship. In the current year, she sells the following long-term assets used in her business: **Asset** **Sales Price** **Cost** **Accumulated Depreciation** ----------- ----------------- ----------- ------------------------------ Building \$ 230,000 \$200,000 \$52,000 Equipment 80,000 148,000 23,000 ***Asset*** ***Sales Price*** ***Adjusted basis*** ***Gain/ (Loss)*** ***Character*** ------------- ------------------- ---------------------- -------------------- ----------------- *Building* *\$ 230,000* *\$148,000* *\$82,000* *Equipment* *80,000* *125,000* *(45,000)*