Loss realized on sale or exchange of property to a related party is not recognized.

Example:  CDE Company sells machinery to his wife______________company for a loss of $5,000.

Answer:  CDE Company cannot take the loss because CDE and the wife's company are related parties.

Example:  Two years later, the wife's company, DEF, sells the machinery to an unrelated party for a gain

of  $10,000.  The loss not taken by ABC (husband's company) in the prior sale can now offset the gain in 

the current year as follows:

                                                                            $10 ,000 Gain

                                                                              (5,000) prior loss

                                                                               5,000 Gain to DEF

Reason:  Loss is allowed because the machinery was sold to an unrelated party.

Preferential Capital Gain Treatment

There are special rules concerning 1231 assets which differ from 1221 assets.  1221 assets receive

Preferential Tax Treatment and the rate depends on the type of asset and tax bracket.  

                           Year 1  Net loss- $8,000

                           Year 2  Net Gain-$5,250

                           Year 3 Net Gain-$4,600

In this case, the ordinary loss of $8,000 is applied as follows; 

                      Year 2 is the first year that there is gain of $5,250           (5,250)                           5,250 is ordinary Inc.

                     

                      Year 3 Gain 4,600 

                                         (2,750) Remaining loss and is ordinary inc.   (2,750)                          Result 2750 ordinary

                                         1,850 Capital Gain                                                                               1850 cap. gain

Answer:  Year 2  has 5,250 ordinary income.  Year 3 has 2,750 ordinary income and 1850 capital gain and the 8,000 loss is eliminated

Facts:

                                     

                                      Sales price is:                 $1,100                                  

                                     

                                       Basis  11,000                                                     

                                      Dep.  (10,000)

                                       A/B      1,000                (1,000) 

                                                                               100 Gain which is ordinary

Answer:  

Recapture is the lesser of gain  of 100 or depreciation of 10,000.  The lesser is 100 of gain recaptured as ordinary income.             

                   

Second Example of 1245 Recapture   

____________________sells a business car with a cost of $20,000. What is the amount of recapture and capital gain if any?   He used MACRS for the car as follows:

                Depreciation                Basis

Year 1         $1,000                      $20,000

Year 2         $1,000

Year 3         $1,000

                    $3,000                      (3,000)  Depreciation

                                                    $17,000 Adjusted Basis

Computation of Gain:

                      Sales price of Car is:     24,000

                      Adjusted Basis             (17,000)

                                                             7,000 Total Gain

                                                           (3,000) Recapture of Depreciation =Ordinary Income 

                                                            4,000   Capital Gain

Answer:  Of the 7,000 gain, $3,000 is ordinary income and the $4,000 is capital gain.

__________________purchased and placed into service 7 year MACRS machinery costing $100,000 and after 4 years sold the property for $105,0000 after taking $60,000 in MACRS depreciation.  What is the amount of recapture and capital gain if any?

Sales price of Machinery                                                                    $105.000

Basis :                              100,000

Depreciation:                    (60,000) 

 Adjusted Basis:               40,000                                                        (40,000)  

Gain:                                                                                                    65,000

Recapture of  Dep.:                                                                             (60,000) Ordinary Income

Capital Gain:                                                                                          5,000 Capital Gain

Answer:  Of the $65,000 gain, $60,000 is ordinary income and  $5,000 is capital gain.

But what happens when you also have losses and depreciation?

You have to recapture the losses under 1231 and the depreciation.

Remember that 1245 property is first 1231 property which must recapture losses.

_____________________Sells machinery original cost of $40,000, accumulated depreciation taken of

$15,000.  Sale price is $45,000.  There are also 1231 losses of $2,000.  What is the amount of recapture of 1245 Property and 1231 losses?

Sales Price                                                      $45,000

Basis:                      $40,000

Depreciation:         ($15,000)

Adjusted Basis:       $25,000                           (25,000)

Gain:                                                               20,000

Recapture of 1231 losses and 1245 Depreciation

Gain:                                                            $20,000

Depreciation Recapture                               (15,000)  Ordinary Income

1231 Losses                                               (   2,000)  Ordinary Income

                                                                       3,000    Capital Gain

Answer:  Of the $20,000 gain, 17,000 is ordinary income and $3,000 is capital gain.

Remember:  You first apply depreciation and then losses.

1.  All depreciation for purposes of 1245

2.  Amount under 179

3.  General Business Credit

Use form 4797 to figure the ordinary income part of the gain.

1.   Depreciable real property not listed in Section 1245.

     a. acquired prior to 1981 or after 1986

     b.  acquired during 1981 through 1986 and either residential property or property using the straight line method

REMEMBER THAT 1245 PROPERTY IS NONRESIDENTIAL PROPERTY FROM 1981-1986

2.  Land is not 1250 property but leases of land are and improvements on land are 1250 property

Examples of 1250 property include shopping malls, an apartment or office building, low income housing, rental portions of residences and escalators or elevator placed in service after 1986.

The rules for 1250 recapture are different than for 1245 property.

For 1250 property, the excess of accelerated depreciation taken over straight line depreciation is ordinary income.

Other Methods in excess of straight line for 1250 Property are:

1.  ACRS

2.  Declining balance method

3.  Sum of the years digits

4.  Unit of production method

A.  Installment Sales- must be recovered in the year of sale.

B.  Disposition of an asset when it is acquired by gift but not at the time that the gift is given.

C.  Section 351 exchange of stock

D. Section 1245 applies to like-kind exchanges to the amount of recognized gain plus the FMV of non-section 1245 property received

E.  Exception:  Inherited property from decedent does not apply upon acquisition unless there is income in respect of a decedent.

*  Installment is a disposition of property of which the buyer makes at least one payment after the close of the tax year in which the sale occurs.

*  Installment sales do not apply to inventory, personal property sales, revolving credit, dealer dispositions and publicly traded securities.

*  Each payment in an installment sale usually consists of three parts

A.  Interest Income

B.  Return of adjusted basis in the property

C.  Gain on the sale  In each year you receive a payment, one must include the interest portion as ordinary income,  as well as the portion that is gain on the sale.  Return of adjusted basis is not taxable.  The installment computation accounts for the gain and the return of adjusted basis.

1.  Gross profit -selling price minus the basis.  The same as the concept of realized gain.

2.  Contract Price-is the amount that will be collected.  An existing mortgage cannot be collected and reduces the contract price by the amount of the mortgage.

3.  Gross Profit Ratio is:   Gross Profit

                                        Contract Price Gross

4.  Gross profit percentage-is the percentage of income received that is taxable

Facts:

____________ sold his business property for $100,000 with a basis of $50,000.  Interest was paid in the amount of $1,000 the first year and payment of $20,000 per year for a total of 5 years.

*  the interest of $1,000 will be included in income for the first year.

* Next compute the gain by determining the gross profit which is the selling price minus the basis.

      Selling Prince $100,000

       Basis               (50,000)

       Gross profit      50,000

Gross Profit Ratio:    50,000 Gross Profit            =50%

                                 100,000 Contract Price

Gross Profit %                                                     50%

Amount taxable   50% X 20,000 payment      =    $10,000 in the first year

Please note that in our example the contract price and the selling price are the same because there is no liability.

Answer:  Of the payment of $20,000, $10,000 is taxable and $1,000 is included as interest income on the return.

Facts:

_________________sold a vehicle used in his business for $10,000 and his/her basis in the property is $8,000.  he/she will receive payment of $1,250 over 8 years beginning with the year of sale under the installment method.  Depreciation on the property taken was $7,000.  What is the taxable gain and character of the gain?

      Basis                    $8,000

      Depreciation         (7,000)

     Adj. Basis              $1,000

    Selling Price          $10,000

    Adj. Basis                (1,000)

    Gross Profit               9,000

     Gross Profit Ratio:    $9,000 Gross Profit              = 90%

                                      $10,000 Contract Price

     Gross Profit %                                                          90%

     Taxable Amount:  Payment $1,250 X 90% =    $1,125

     

     However, we need to recapture $7,000 as ordinary income in the first year.  Therefore, $7,000 under 1245 is       t    taxable as ordinary income.

When you have a liability the selling price and the contract price are not equal because the contract price represents the amount that will be collected.   A relief of liability cannot be collected.

Facts:

A__________________sold property with an adjusted basis of $35,000 to B________ for $50,000.  B._______

paid cash of $5,000 and assumed an existing mortgage of $20,000.  B. signed an installment note for the $25,000 balance at 8%.  Payments on the note were to be made at the rate of $5,000 a year plus interest beginning 1 year after the date of the contract.  What is the amount of gain that A___________ should include in the first year after the date of contract?

Calculation:

Selling Price                $50,000

Adjusted Basis:           (35,000)

Gross Profit:               $15,000

Contract Price: is the selling price of $50,000 minus the mortgage assumed by the buyer__________B. of $20,000

($50,000-$20,000)= $30,000

Gross Profit Ratio:  $15,000 Gross Profit         = 50%

                               $30,000 Contract Price

Gross Profit %:                                                   50%

Taxable Amount:    $5,000 X 50% = $2,500 includible in income.  The other $2,500 is return of basis and not taxable

  1.  One of the outcomes occurs when the buyer stops paying the installments and the seller is forced to take repossession of the property.

  2.  Another outcome is when the seller may need additional cash and sells the installment contract to someone else usually at a discount.

OR

                 B.  Gross profit in remaining installments less repossession costs

  Facts:

________________ sold a residential lot 3 years ago and reported $50,000 capital gain on the installment method.  In the third year of payments, the buyer defaulted and ___________had to repossess the lot.   In the first year

___________reported $10,000 ($20,000 X 50%).  The second year ______ reported $5,000 (10,000 X 50%) In the third year no payments were received.  _________ spent $5,000 in legal fees to repossess the property.  What is the taxable gain on the repossession?

Calculation:

FIRST:  compute gain on repossession

Payments received before repossession                  $30,000

Minus gain reported                                                  (15,000)

 Gain on repossession                                               15,000

SECOND:                                                                        

Gross profit on remaining installments                                                                   $50,000

: as stated in the facts:

Gain reported                                                          $15,000

Plus repo. costs                                                         +5,000

                                                                                $ 20,000                              ($20,000)

                                                                                                                             $30,000

Taxable Gain is the lesser of:

                                

                                             A.    gain on repossession                           $15,000

                                                                       OR

                                            B.  repossession costs and gain l                  

                                                  reported minus profit on sale                 $30,000

The lesser of the two is $15,000.  Therefore taxable gain is $15,000

Sale/Disposition of Installment​ Obligation

Upon sale of an installment there are tax consequences to the owner  who disposes of  the installment obligation 

as follows:

Income is recognized if there is an excess of fair market value (FMV).  Excess of FMV is amount realized over adjusted basis of an installment obligation.

Facts:

_____________ unimproved land basis of $100,000 sold property for $400,000.  the seller accepted a note for the entire $300,000.  Buyer owed $40,000 when the note was sold for $28,000 cash.  what gain if any should be shown on the seller's return.

Calculation:

FIRST compute the gross profit percentage at time of sale:  

           Sales Price                                                                               $400,000

           Minus adjusted basis:                                                              (100,000)          

            Gross Profit:                                                                             300,000

           Gross Profit Ratio:     $300,000 Gross Profit        =  75%

                                             $400,000 Contract Price     

           Gross Profit %                                                          75%

SECOND Determine the excess of FMV.

The face amount (the amount owed by the buyer is reduced by the gross profit % determined in step 1 

 to determine basis as follows:

 40,000 face amount -30,000(75% of 40,000) = 10,000 Basis

Excess of basis minus amount realized:

   $28,000 amount realized -$10,000 Basis = $18,000 taxable income

Answer:  The disposition of the installment obligation results in $18,000 taxable income.