Sales and Disposal of Assets

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Scene/Interaction

Narration

Slide 1

This is a scene that introduces the setting for the scenario.

It has a shot of the tax firm and a welcome message. There is a button to start labeled “Begin.”

Slide 2

Scene 1

Inside the accounting firm, in a conference room.

Wade speaking to Carmen

Wade: Hi, Carmen. Good job resolving the issues from last week with Jonathan Dixon. The information concerning delaying paying taxes on the inherited IRA was good advice and should reduce his tax liability a great deal especially since he is too young to retire. Hopefully, when he begins taking distributions from the IRA in the future, he will be in a lower tax bracket.

Carmen: I agree that he should postpone the distribution as well.

Wade: Well then, let’s get started with our work for our final week. Our focus will be on Capital Gains and Losses, Section 1231, and Recapture Provisions.

Carmen: Okay, great!

Slide 3

Scene 2

Wade and Carmen in his office

Wade: Mr. Baxter needs your opinion regarding minimizing his tax liability for property used in his business. He has a couple of issues to discuss with us, so I will make the appointment for this afternoon.

Carmen: This afternoon works for me. Thanks!

Slide 4

Scene 3

Wade, Carmen and Mr. Baxter in the conference room.

Wade: Mr. Baxter, welcome back. Please review your changes with Carmen, and I will take my usual place in the back of the conference room.

Carmen: Hello, Mr. Baxter, what can I do for you?

Mr. Baxter: Thank, you Carmen. Well, first of all, I think that this year's taxes may need to be amended. I sold some copyrighted material and would like to know the tax implications of selling this material, but I cannot remember when and how I acquired it.

From the building that I lease, my tenants canceled their lease, and the lease cancellation fees were not reported on the original tax return.

For next year, I am considering selling the rental properties that I own and possibly several undeveloped lots.

How will these transactions affect Emily and I, since we filed a joint tax return?

Carmen: We can certainly help you make these decisions.

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Interaction

Key Chapter provisions

Title: Property Transactions: Capital Gains and losses, 1231, and Recapture

Introduction: The tax law requires capital gains and losses to be separated from other gains and losses and be matched against one another to distinguish short term gains and losses from long term gains and losses. The tax treatment is generally more favorable for long term gains. Section 1221 provides a list of noncapital assets. Depreciable and real property used in a trade or business is a noncapital asset. However these properties are treated as section 1231 assets if held for more than one year.

Tab 1: A capital asset is property held by a taxpayer whether or not it is used in the course of business that is not inventory, receivables, depreciable property, and certain copyrights. For copyrights, the person whose efforts led to the copyright or creative work has an ordinary asset and any gain would be treated as ordinary gain.

Tab 2: Real property development activities may result in the owner being considered a dealer for tax purposes. Income from the sale of real estate property lots is treated as the sale of inventory if the owner is considered a dealer and profits are recorded as ordinary income. However, taxpayers can engage in limited development activities, which would make the taxpayer eligible for capital gain treatment which is taxed at lower rates.

Tab 3: The tax treatment of payments received for canceling a lease depends on whether the recipient is a lessor or lessee and whether the lease is a capital asset. Payments received by a lessor for a lease cancellation are always ordinary income because they are determined to be in lieu of rental payments.

Tab 4: Depreciable and real property used in a trade or business are not considered capital assets. Recognized gains from the disposition of such property, such as equipment or buildings, are recorded as ordinary income. Due to Section 1231, if the property is held longer than one year, then the gain from the disposition after netting other long term gains and losses is treated as a long term capital gain.

 Tab 5: When Section 1231 property is sold for a gain, it is subject to 1245 recapture, which makes part of the gain ordinary income up to the amount that has been depreciated. The remaining amount would then be classified as capital gain.

Tab 6: Section 1250 property is depreciable real property that is not subject to 1245 recapture. If the depreciable real property has been held for more than a year and is subsequently sold, depreciation recapture applies if the property is sold at a gain. The additional depreciation taken above the straight line amount must be recaptured. Therefore, ordinary income will be recorded for the amount of the excess instead of a capital gain.

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Interaction

From the information provided, what are the tax consequences?

1. The IRS specifically excludes copyrights, literary, musical artistic compositions letters, or memoranda from being classified as capital assets.

2. If a taxpayer is not a corporation or a real estate dealer, the IRS allows real estate investors to record capital gain treatment if they engage in limited development activities. The taxpayer must have held the property for five years. A capital gain can be reported until the sixth lot is sold.

3. Depreciable and real property may be subject to capital gain treatment if the property is sold at a gain but only up to the amount of accumulated depreciation. For buildings that have been depreciated before 1987, the excess of the accelerated depreciation over the straight line amount must be recorded as ordinary income.

Carmen: Since Mr. Baxter received the copyright and he is not sure of its origin, then he has an ordinary asset, and if the copyright is sold, then the income is ordinary.

The income from the canceled lease is considered ordinary income and must be reported on Mr. and Mrs. Baxter's income tax return.

For next year, since we do not know the selling price of the property that you intend to sell, there is a possibility that part of the gain could receive special capital gain treatment and taxed at lower rates. However, we would need to know the anticipated selling price to provide an estimated tax liability.

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Carmen and Wade in Wade's office

Wade: Carmen, I agree with your advice to Mr. Baxter. Let’s review a draft of his amended tax return.

Slide 8

Scene 7

Carmen, Mr. Baxter, and Wade in the conference room

Carmen: Mr. Baxter, we have a draft of your tax return for review, since the income for the lease cancellation fees and the sale of the copyright should be included in income.

For next year, however, when you have an estimate of the selling price for the lots and the building, we can provide you with an estimate of your tax liability. If you sell the property at a loss, the loss will be recorded as an ordinary loss. However, if there is a gain, part of the gain could be recorded as ordinary or long term capital gain. The long term capital gain would be taxed at a reduced tax rate.

Please review the draft of the return and if there are no more revisions, we are ready to file the changes.

Mr. Baxter: Thanks, Carmen! This looks good.

Carmen: You’re most welcome! Let me know if there is anything else you need.

Slide 9

Scene 8

Wade in his office

Wade: Well, it's approaching the end of the day. We have reviewed the complications of Capital Gains and Losses and Recapture Provisions. This is an area where taxpayers must maintain detailed records to substantiate their adjusted basis.

By the way, don’t forget to participate in this week’s discussion questions!

Carmen, this ends the interview process. I just want to commend you on doing such a wonderful job throughout the past ten weeks. I’ll be meeting with Donna shortly to give her my recommendation for the job opening.

Carmen: Thank you, Wade. I’ve really learned a lot by meeting with the clients each week, and I appreciate the opportunity.

Slide 10

Scene 9

Wade and Donna in Wade’s office.

Donna Meyers: Well, Wade, the ten weeks are up. I dropped by to get your final report on Carmen's performance.

Wade: She has been terrific working with our clients and helping them resolve their tax issues.

Her advice to our clients has been thorough and insightful. I can't think of any reason why we should not offer her the position.

Donna Meyers: Well then let's make her the job offer!

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Scene 10

Donna Myers: Carmen, Wade and I have been discussing your job performance over the past ten weeks and we have made a decision to offer you the position of Tax Accountant.

Carmen: Thank you both so much! I would love to continue my work here with Wade.

Wade: Congratulations, Carmen! You will make a great asset to the team.

By the way, don’t forget to participate in this week’s discussion questions.

Bye for now!