Enrolled Agent > EA - Part 2: Businesses > Unit 9: Disposition of Business Assets > Flashcards

Unit 9: Disposition of Business Assets Flashcards

Calculate gain/loss on asset sales and apply Section 1231/1245/1250 rules. (58 cards)

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1
Q

What are the methods a business can use to dispose of an asset?

A
  • Selling
  • Trading
  • Exchanging
  • Abandoning
  • Gifting
  • Destroying
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2
Q

What must a business determine to properly report the disposition of an asset?

A

Whether it is a capital asset, a noncapital asset, or a Section 1231 asset.

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3
Q

True or False:

C corporations receive preferential tax treatment for long-term capital gains.

A

False

C corporations do not get preferential tax treatment for long-term capital gains; they are added to the corporation’s ordinary income and taxed at the regular rate.

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4
Q

What form is generally used to report gains and losses on dispositions of business assets?

A

Form 4797, Sales of Business Property

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5
Q

In related party dispositions, what is generally not allowed?

A

No deduction is allowed for losses resulting from a sale or exchange of property between related parties.

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6
Q

What are considered capital assets?

A
  • Personal-use assets (e.g., primary residences, personal vehicles)
  • Investment property (e.g., stocks, bonds)
  • Collectibles or raw land held for investment
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7
Q

What is a noncapital asset?

A

Any property that is not a capital asset.

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8
Q

What types of property are considered noncapital assets?

A
  • Inventory held for sale
  • Depreciable property used in a business
  • Real property used in a trade or business
  • Self-created copyrights, manuscripts, photographs
  • Accounts or notes receivable acquired by a business
  • Stocks and bonds held by professional dealers
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9
Q

How is Section 1231 property classified for tax purposes?

A

Real or personal property held for more than one year, used in a trade or business or in the production of income.

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10
Q

What favorable tax treatment is given to transactions involving Section 1231 assets?

A

Section 1231 gains are taxed at lower capital gains rates, and net losses are treated as ordinary losses.

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11
Q

For livestock to qualify as a Section 1231 asset, what conditions must be met?

A
  • Held for draft, breeding, dairy, or sporting purposes
  • Cattle and horses held for 24 months or longer
  • Other livestock held for 12 months or longer
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12
Q

How is depreciation recapture treated in the sale of Section 1231 assets?

A

The depreciation recapture portion is treated as ordinary income.

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13
Q

What is the tax treatment for gains exceeding depreciation recapture on Section 1231 assets?

A

Treated as a long-term capital gain.

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14
Q

What is a Section 1231 asset?

A

Assets held for more than one year that are used in a trade or business and subject to depreciation, like livestock, machinery, and buildings.

Section 1231 assets do not include inventory, self-created copyrighted works, accounts receivable, or U.S. government publications.

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15
Q

Describe the five-year ‘look-back’ rule for Section 1231 gains.

A
  • Net 1231 gains are treated as long-term capital gains unless there are net 1231 losses in the prior five years.
  • Prior losses change the character of current 1231 gains to ordinary income.
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16
Q

What is Section 1245 property?

A

Depreciable personal property used in business, such as machinery and equipment, excluding buildings and structural components.

Gain on Section 1245 property is taxed as ordinary income to the extent of any unrecaptured depreciation or amortization.

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17
Q

What does Section 1250 property include?

A

Real property that can be depreciated.

Examples: Buildings and their structural components and residential rental properties.

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18
Q

What is unrecaptured Section 1250 gain?

A

The portion of a capital gain related to previously taken straight-line depreciation, taxed at a maximum rate of 25%.

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19
Q

What is depreciation recapture?

A

When a business sells previously depreciated property at a gain, the gain is taxed as ordinary income to the extent of the depreciation taken.

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20
Q

What is an installment sale?

A

A disposition of property where the seller receives at least one payment after the year of sale, typically reported using the installment method.

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21
Q

What must be calculated for an installment sale?

A

Gross profit percentage, representing the ratio of the gain on the sale to total proceeds minus interest income.

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22
Q

What is the installment method in tax reporting?

A

A method that allows a taxpayer to report a portion of the gain from the sale of property on their tax return each year as they receive payments.

The installment method is reported using Form 6252, and any applicable depreciation recapture under section 1245 or 1250 is taxable in the year of sale.

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23
Q

Which transactions do not qualify for installment sale treatment?

A
  • The sale of inventory
  • A sale that results in a loss
  • The sale of stock or securities traded on an established market

Installment sales to related persons are allowed, but there are specific rules if the related person sells the property within two years.

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24
Q

What is a Section 1031 like-kind exchange?

Study These Flashcards
A

An exchange where a business or individual exchanges business or investment property for similar property, deferring tax on a resulting gain.

The Tax Cuts and Jobs Act limits Section 1031 exchanges to real property only.

25
What conditions must be met for nonrecognition treatment in a **Section 1031 exchange**?
* The property exchanged must be real property * Both properties must be held for investment or business use * There must be an actual exchange of properties, not a sale * A qualified intermediary is generally required for deferred exchanges * Strict deadlines must be met for deferred exchanges
26
What are the **deadlines** for identifying and receiving replacement property in a deferred Section 1031 exchange?
* The property must be identified within 45 days after the transfer of the relinquished property * The replacement property must be received by the earlier of the 180th day after the transfer or the due date of the tax return for the year of the transfer
27
What happens if a related party disposes of property within two years of a **Section 1031 exchange**?
The exchange is usually disqualified from nonrecognition treatment and any deferred gain or loss must be recognized in the year of disposition. ## Footnote Exceptions include death of a party, involuntary conversions, or if the IRS is satisfied that the exchange was not for tax avoidance.
28
What **types of property** exchanges are disqualified from Section 1031 treatment?
* Personal-use realty * Foreign realty * Inventory ## Footnote An exchange of domestic real estate is generally eligible unless it involves personal-use property or foreign property.
29
What is '**boot**' in a Section 1031 exchange?
Cash or other non-like-kind property included to compensate for a difference in property values. ## Footnote Receiving boot may require recognition of gain up to the value of the boot, but it doesn't invalidate the exchange.
30
How is the basis of property received in a **1031 exchange** generally determined?
The adjusted basis of the property transferred is the adjusted basis of the like-kind property given up + amount of gain recognized + basis of any boot given - fair market value of any boot received - any loss recognized
31
What is an **involuntary conversion** under Section 1033?
When a taxpayer's property is lost, damaged, or destroyed, and the taxpayer receives payment or reimbursement from insurance or another source. ## Footnote Examples include theft, fire, flood, condemnation, or other disasters.
32
What are the **replacement periods** for involuntary conversions?
* General property: 2 years (after the close of the first tax year in which gain is realized) * Real property held for business or investment: 3 years * Property in federally declared disaster areas: 4 years
33
What happens if a taxpayer **does no**t replace involuntarily converted property within the allowed time period?
They must file an amended tax return for the year the involuntary conversion occurred, reporting a taxable transaction. ## Footnote This applies if the replacement property is not purchased before the end of the tax year in which the replacement deadline applies.
34
How is the basis of replacement property calculated in an **involuntary conversion**?
The basis of the converted property, decreased by any recognized loss or unspent money, and increased by recognized gain or additional costs.
35
What is a **condemnation** in the context of involuntary conversions?
A legal process by which private property is taken from its owner for public use, often referred to as '**eminent domain**.' ## Footnote The owner typically receives compensation based on the property's fair market value.
36
What is the **time period** for replacing condemned property under Section 1033 exchanges?
**Two years** after the end of the first tax year in which any part of the gain on the condemnation is realized. ## Footnote For real property held for business use or investment, the replacement period is three years instead of two.
37
What is a **capital asset**?
**Assets** such as primary residences, personal vehicles, vacation homes, and investment property like stocks and bonds.
38
What does **Section 1245** cover?
Depreciable **business personal property**, such as machinery, vehicles and equipment.
39
What does **Section 1250** cover?
Depreciable **real property**, like buildings and residential rentals property, used in a business or held for investment.
40
Are gains and losses on **related party sales** deductible?
**Gains** are taxable, but **losses** are not deductible or offsetable against any other gains.
41
How is gain on the sale of **Section 1250 property** taxed?
**Unrecaptured gain** is taxed at a maximum rate of 25%, while excess gain is treated as long-term capital gain. ## Footnote Unrecaptured Section 1250 gain relates to the amount of straight-line depreciation taken.
42
True or False: **Section 1245 and Section 1250 properties** are separate classes from Section 1231 property.
False ## Footnote Section 1245 and Section 1250 properties are types of Section 1231 property, subject to specific recapture rules.
43
What components can each payment received on an **installment sale** transaction include?
* Return of the seller’s adjusted basis in the property * Gain on the sale * Interest income
44
Which form is used to report gain from an **installment sale**?
Form 6252 | (Installment Sale Income)
45
What types of property qualify for a **Section 1031 Exchange**?
* Land and improvements to land. * Unsevered natural products of land. * Water and air space superjacent to land. * Certain intangible interests in real property. * Property that is real property under state or local law.
46
What is a **qualified intermediary** in a section 1031 exchange?
A **qualified intermediary** is an independent party who facilitates section 1031 exchanges by holding the sales proceeds and acquiring the replacement property.
47
# True or False: A **section 1031 exchange** is disqualified if the property is disposed of within two years after the exchange.
True ## Footnote Unless exceptions apply such as death, involuntary conversion, or non-tax avoidance purpose.
48
What types of exchanges qualify as **non-taxable** under section 1031?
Exchanges of **real estate** held for investment or business use, such as a factory building for farmland or a parking lot for an apartment complex.
49
How is gain recognized in a **partially taxable 1031 exchange**?
The lesser of: * The realized gain on the exchange * The value of the non-like-kind property ('boot') received ## Footnote Gain recognition occurs when boot is received in addition to like-kind property.
50
# True or False: Receiving **boot** in a 1031 exchange can result in a recognized loss.
False ## Footnote While gain may be recognized, a loss is not recognized if boot is received in a 1031 exchange.
51
What is **eminent domain**?
The government's power to take **private property** in exchange for compensation based on the property's fair market value.
52
What typically happens before the government pursues legal action in **eminent domain** cases?
Property owners generally have the opportunity to **negotiate a voluntary sale**.
53
Name three examples of projects that might use **eminent domain**.
* Urban Renewal Projects * Highway Expansion * Public Utilities
54
What is a **condemnation award**?
Compensation given to a property owner when their property is taken under **eminent domain**.
55
# True or False: A property owner can challenge the **fair market value** offered in a condemnation award.
True
56
What is a **Section 1033 exchange**?
A tax provision allowing taxpayers to **defer recognizing gain** from condemned property if replacement property is purchased within a specified period.
57
In a condemnation scenario, what is considered the **seller**?
The property owner
58
# Fill in the blank: Amounts taken out of a condemnation award to pay debts on the property are considered paid to the _\_\_\_\_.
taxpayer
EA - Part 2: Businesses
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