chapter 8 p.609 capital gains & losses - houston, … · chapter 8 p.609 capital gains ......

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.


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.


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).


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.


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.


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?


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.


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.


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.


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.


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.


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.


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)?


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.


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.


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?


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.


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.


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).


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.


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?


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.


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.


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chapter 8 p.609 capital gains & losses - houston, … · chapter 8 p.609 capital gains ......

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