SolutionspManual—TaxationpofpIndividualspandpBusinesspEntities,pbypSpilkerpetpal.
Chapter 11 p
Property: Dispositions
p
SOLUTIONS MANUAL p
Discussion Questions p
1. [LOp1]pComparepandpcontrastpdifferentpwayspinpwhichpaptaxpayerptriggerspaprealizationpe
ventpbypdisposingpofpanpasset.p
Aprealizationpeventpforptaxppurposespispcreatedpinpmanypways.pVirtuallypanypdispos
alpwillpresultpinpapsaleporpotherpdisposition.pThesepincludepapsale,ptrade,pgiftptopcha
rity,pdisposalptoptheplandfill,porpdestructionpinpapnaturalpdisaster.pInpapsaleporptrade
p(exchange),ptheptaxpayerpreceivespsomethingpofpvaluepinpreturnpforpthepasset.pInpc
ontrast,papcharitablepcontribution,pdisposal,porpdestructionpfrompapnaturalpdisaste
rpgenerallypresultspinpaplosspofpanypremainingpbasispinpthepassetpwithoutpcompensat
ionp(unlesspreimbursedpbypinsurance).
2. [LOp1]pPotomacpCorporationpwantsptopsellpapwarehousepthatpitphaspusedpinpitspbusinesspf
orp10pyears.pPotomacpispaskingp$450,000pforpthepproperty.pThepwarehousepispsubjectptopa
pmortgagepofp$125,000.pIfpPotomacpacceptspWydenpInc.’spofferptopgivepPotomacp$325,0
00pinpcashpandpassumespfullpresponsibilitypforpthepmortgageponpthepproperty,pwhatpamou
ntpdoespPotomacprealizeponpthepsale?p
Whenptheppropertypdisposedpofpispsubjectptopapliabilitypandpthepbuyerpassumespthepl
iability,pthepreliefpofpdebtpincreasespthepamountprealized.pThus,pPotomac’spamount
prealizedpconsistspofp$450,000,pwhichpispcashpofp$325,000pplusp$125,000preliefpofp
debt.pThispresultpassumespthatpthepbuyerphypotheticallyptransferspcashptopthepseller
pinporderptoppaypoffpthepmortgage.
3. [LOp1]pMontanapMaxpsellspap2,500-
acrepranchpforp$1,000,000pinpcash,papnotepreceivablepofp$1,000,000,pandpdebtpreliefpofp$2
,400,000.pHepalsoppayspsellingpcommissionspofp$60,000.pInpaddition,pMaxpagreesptopbuil
dpapnewpbarnponptheppropertyp(costp$250,000)pandpspendp$100,000pupgradingpthepfencep
onptheppropertypbeforepthepsale.pWhatpispMax’spamountprealizedponpthepsale?
$4,340,000.pAnythingpreceivedpbypthepsellerpduringpapsaleporpexchangepispincluded
pinpthepamountprealized.pMostpdispositionspresultpinpcashptopthepseller.pHowever,pa
mountprealizedpincludes,pbutpispnotplimitedpto,pcash,pthepfairpmarketpvaluepofpanypot
herppropertypreceivedp(e.g.pmarketablepsecuritiesporpapsimilarpasset),porpreliefpofpd
ebt.pInpaddition,psellingpexpensespreducepthepamountprealized.pTherefore,pMax’spa
mountprealizedpincludespthep$1,000,000pofpcash,p$1,000,000pnotepreceivable,prelie
fpofpdebtpofp$2,400,000,pandpispreducedpbypsellingpcommissionspofp$60,000p(selling
©pMcGrawpHillpLLC.pAllprightspreserved.pNopreproductionporpdistributionpwithoutptheppriorpwrittenpconsentpofpMcGrawpHillpLLC.
1
, SolutionspManual—TaxationpofpIndividualspandpBusinesspEntities,pbypSpilkerpetpal.
pexpensespreducepthepamountprealized,pS.C.pChapin,pCA-8,p50-
1pUSTCp¶9171).pAnythingpthepsellerpgivespuppinptheptransactionpispaddedptopthepba
sispofptheppropertypgivenpuppandpispnotpconsideredppartpofpthepamountprealized.pTh
erefore,pthepbarnpandpfencepimprovementsparepnotpconsideredppartpofpMax’spamou
ntprealized.pNote,phowever,pthatpmakingpthesepimprovementspdecreasesphisprealize
dpgainpbypincreasingpMontanapMax’spadjustedpbasispinptheppropertypdueptopthepim
provements.
4. [LOp1]pHawkeyepsoldpfarmingpequipmentpforp$55,000.pItpboughtpthepequipmentpfourpye
arspagopforp$75,000,pandpitphaspsincepclaimedpaptotalpofp$42,000pinpdepreciationpdeductio
nspagainstpthepasset.pExplainphowptopcalculatepHawkeye’spadjustedpbasispinpthepfarmingp
equipment.p
Hawkeyepwillpcalculatepitspadjustedpbasispinpthepfarmingpequipmentpbypreducingpt
hephistoricalpcostpbypanypcostprecoverypdeductionsptaken—
namely,pdepreciation.pTherefore,pHawkeye’spadjustedpbasispisp$33,000p($75,000pl
essp$42,000).pTheptaxpadjustedpbasispispusuallypdifferentpthanpthepbookpadjustedpba
sis.pThispispbecausepmostpassetspusepapdifferentprecoverypperiod,pcostprecoverypmet
hodp(e.g.,pdoublepdecliningpbalance),pandpconventionp(e.g.,phalf-
year)pforptaxpthanpforpbookppurposes.pSeepthepPropertypAcquisitionpandpCostpReco
verypchapterpforphowpthesepdifferencesparise.pDueptopthepdifferencepinpcostprecover
ypdeductions,pthepadjustedpbasispisplikelypdifferentpunlesspthepassetpispfullypdepreci
atedpforpbothpbookpandptaxppurposes.p
5. [LOp1]pWhenpaptaxpayerpsellspanpasset,pwhatpispthepdifferencepbetweenprealizedpandpreco
gnizedpgainporplossponpthepsale?
Theprealizedpgainporplosspispsimplypthepamountprealizedplesspthepadjustedpbasispofpt
hepassetpsold.pEverypsaleporpdispositionpresultspinpaprealizedpgainporplossp(unless,po
fpcourse,pthepamountprealizedpispequalptopthepadjustedpbasis).pMostprealizedpgainsp
orplossespbecomeprecognizedpgainsporplossespandparepincludedponptheptaxpayer’spt
axpreturnpandpincreasesp(orpdecreasespinpthepcasepofpaploss)ptheptaxpayer’sptaxable
pincomepandpsubsequentptax.pHowever,pthereparepsomeprealizedpgainsporplossespth
atparepexcludedpfrompincomeporpdeferredptopaplaterptimepperiod.
6. [LOp2]pWhatpdoespitpmeanptopcharacterizepapgainporploss?ppWhypispcharacterizingpapgainp
orplosspimportant?p
Oncepapgainporplosspisprecognized,paptaxpayerpmustpdeterminephowptheprecognizedp
gainporplosspaffectsptheptaxpayer’sptaxpliability.pThepcharacterpdependsponpapcombi
nationpofptwopfactors:ppurposeporpusepofpthepassetpandpholdingpperiod.pTheppurpos
eporpusepofpthepassetpispimportantpbecauseptheplawpdoespnotptreatpallpassetspequally.
pThepgeneralpusepcategoriespare:p(1)ptradeporpbusiness,p(2)pforpthepproductionpofpin
comep(rentalpactivities),p(3)pinvestment,pandp(4)ppersonal.pBasedponpthesepcriteria,
©pMcGrawpHillpLLC.pAllprightspreserved.pNopreproductionporpdistributionpwithoutptheppriorpwrittenpconsentpofpMcGrawpHillpLLC.
2
, SolutionspManual—TaxationpofpIndividualspandpBusinesspEntities,pbypSpilkerpetpal.
pwepcanpcategorizepanpassetpintoponepofpthreepgroups:p(1)pordinary,p(2)pcapital,porp
(3)p§1231.pCharacterizingpthepgainporplosspispimportantpbecauseptheptaxptreatmentp
forpgainspandplossespvarypdependingponpthepcharacter.pOrdinarypgainspandplossesp
areptaxedpatpordinarypincomeprates,pregardlesspofpthepholdingpperiod.pCapitalpgai
nsponpassetspheldpforpmorepthanpapyearphaveppreferentialptaxpratespforpnon-
corporateptaxpayerspwhilepcapitalpgainsponpassetspheldpforponepyearporplesspdopnot
.p§1231pgainspandplossespreceivepthepbestpofpbothpworlds—thepgainspbecomeplong-
termpcapitalpgainspandptheplossespbecomepordinary.pHowever,ptopqualifypaspap§123
1passet,pthepassetpmustpbepusedpinpaptradeporpbusinesspforpmorepthanpapyear.
7. [LOp2]pExplainpthepdifferencepbetweenpordinary,pcapital,pandp§1231passets.p
Anpordinarypassetpispanpassetpthatpispheldpforpsalepinpthepordinarypcoursepofpaptaxpa
yer’spbusinessp(e.g.,pinventory)porparisespfrompsalespinpthepordinarypcoursepofpbusi
nessp(e.g.,paccountspreceivable).pCapitalpassetsparepheldpforpinvestmentp(expecting
pappreciation)porpareppersonal-
usepassetsp(e.g.,paptaxpayer’sppersonalpbelongings).p§1231passetsparepusedpinpaptra
deporpbusinessporpforpthepproductionpofpincomepandparepheldpforpmorepthanponepye
ar.pAnpassetpthatpispusedpinpaptradeporpbusinessporpforpthepproductionpofpincomepan
dpispheldpforponepyearporplesspispanpordinarypasset.pGainsponppersonal-
useppropertyparepcapitalpgainspwhileplossesparepnon-deductible.
8. [LOp2]pDiscusspthepreasonspwhypindividualspgenerallyppreferpcapitalpgainspoverpordinar
ypgains.pExplainpwhypcorporateptaxpayerspmightppreferpcapitalpgainspoverpordinarypgain
s.
Individualptaxpayersppreferpcapitalpgainspbecauseptheypmaypbeptaxedpatppreferenti
alprates.pNetplong-
termpcapitalpgainspareptaxedpatppreferentialpratesp(0,p15,porp20ppercent).pShort-
termpcapitalpgainsparepsimplyptaxedpatpordinaryprates.pCapitalpgainspcanpoffsetpca
pitalplosses,pwhilepordinarypgainspcannot.pAdditionally,pindividualptaxpayerspcanp
offsetp$3,000pofpnetpcapitalplossespagainstpordinarypincomepandpcarrypthepremaini
ngpcapitalplosspforwardpindefinitely.p
Evenpthoughpcorporateptaxpayerspareptaxedpatpthepsameprateponpordinarypincomep
andpcapitalpgains,ptheyppreferpcapitalpgainspbecausepcapitalpgainspcanpoffsetpcapit
alplosses.pCapitalplossespcannotpbepusedptopoffsetpordinarypincome;ptherefore,pcapi
talpgainspallowpcorporateptaxpayersptopbenefitpfromptheirpcapitalplosses.pCorporat
eptaxpayerspcanpcarrypcapitalplossespbackpthreepyearspandpforwardpfivepyears.pHo
wever,pafterpthepcarrypbackpandpcarrypforwardpperiodspexpire,pcapitalplossespexpir
epandparepworthless.
9. [LOp2]pDakotapConradpownspapparcelpofplandphepwouldplikeptopsell.pDescribepthepcircum
stancespinpwhichpthepsalepofptheplandpwouldpgeneratep§1231pgainporploss,pordinarypgainpo
©pMcGrawpHillpLLC.pAllprightspreserved.pNopreproductionporpdistributionpwithoutptheppriorpwrittenpconsentpofpMcGrawpHillpLLC.
3
, SolutionspManual—TaxationpofpIndividualspandpBusinesspEntities,pbypSpilkerpetpal.
rploss,porpcapitalpgainporploss.pAlso,pdescribepthepcircumstancespunderpwhichpDakotapwo
uldpnotpbepallowedptopdeductpaplossponpthepsale.p
ThepparcelpofplandpcouldpqualifypaspapcapitalpassetpifpitpispheldpbypDakotapaspanpinv
estmentp(e.g.,ptheppurposepforpholdingptheplandpispforpexpectedpappreciationpinpval
ue).pTheplandpcouldpqualifypaspap§1231passetpifpDakotapusespitpinpaptradeporpbusine
sspsuchpaspapsole-
proprietorshipporpforpthepproductionpofpincomep(aprentalpproperty)pandptheypusepitp
forptheseppurposespforpmorepthanponepyear.pTheplandpcouldpbepordinarypincomeppr
opertyptopDakotapifpitpispheldpinpaptradeporpbusinessporpforpthepproductionpofpincom
epforponepyearporplessporpifpitpispconsideredptopbepinventoryp(e.g.,papreal-
estatepdealer).pTheplosspwouldpbepnon-
deductibleptopDakotapifptheypheldptheplandpforppersonal-useppurposes.
10. [LOp2]pLincolnpBrownphaspusedpappiecepofplandpinptheirpbusinesspforptheppastpfivepyears.p
Theplandpqualifiespasp§1231pproperty.pItpispunclearpwhetherpLincolnpwillphaveptoprecogni
zepapgainporplosspwhenptheypeventuallypsellpthepasset.pLincolnpasksptheirpaccountantphowp
thepgainporplosspwouldpbepcharacterizedpifptheypdecideptopsell.pThepaccountantpsayspthatps
ellingp§1231passetspgivespsellersp“thepbestpofpbothpworlds.”pExplainpwhatpthepaccountant
pmeanspbypthispstatement.p
Anpassetpqualifiespaspap§1231passetpifpusedpinpaptradeporpbusinessporpheldpforptheppr
oductionpofpincomepforpmorepthanponepyear.pTheptaxptreatmentpispsometimespdescri
bedpaspreceivingp“thepbestpofpbothpworlds”pbecausepnetpgainspreceivepcapitalpgain
ptreatmentpandpnetplossespreceivepordinaryplossptreatment.pCapitalpgainsparepprefe
rablepbecauseptheypareptaxedpatpappreferentialpratep(forpnon-
corporateptaxpayers)pandpcanpoffsetpcapitalplosses,pwhichpcannotpalwayspbepoffsetp
againstpordinarypincome.pOrdinaryplossespareppreferredptopcapitalplossespbecause
ptheypoffsetpordinarypincomepinpthepcurrentpyearpratherpthanpbeingpaccumulatedptop
offsetpfuturepcapitalpgains.
p
11. [LOp3]pExplainpCongress’sprationalepforpdepreciationprecapture.
Theppurposepofpdepreciationprecapturepisptoptreatpthepgainponpthepsalepofpdeprecia
blepassetspaspordinarypincomeptopthepextentpthepgainpispattributableptopdepreciation
p(orpotherpcostprecoverypdeductions).pThepMACRSpsystempallowspacceleratedpded
uctionspthatpoftenpreducepthepbasispofpanpassetpfasterpthanptheprealpeconomicpdecli
nepinpvalue.pThus,pdepreciationpdeductionspgeneratepanpartificialpgainponpthepdisp
ositionpofpdepreciablepassets.pTheprecaptureprulespensurepthatpsomeporpallpofpthepa
rtificialpgainpispcharacterizedpaspordinarypsimilarptopthepdepreciationpdeductionspt
hatpcreatedpthepartificialpgain.pItpispimportantptopnotepthatpdepreciationprecapturep
doespnotpaffectpthepamountpofpthepgain;pratherpitpaffectsponlypthepcharacterpofpthepg
ain.pAdditionally,pdepreciationprecaptureponlypappliesptopsalesporpdispositionspres
ultingpinpgainsp(e.g.,pitpdoespnotpapplyptoplosses).p
©pMcGrawpHillpLLC.pAllprightspreserved.pNopreproductionporpdistributionpwithoutptheppriorpwrittenpconsentpofpMcGrawpHillpLLC.
4
Chapter 11 p
Property: Dispositions
p
SOLUTIONS MANUAL p
Discussion Questions p
1. [LOp1]pComparepandpcontrastpdifferentpwayspinpwhichpaptaxpayerptriggerspaprealizationpe
ventpbypdisposingpofpanpasset.p
Aprealizationpeventpforptaxppurposespispcreatedpinpmanypways.pVirtuallypanypdispos
alpwillpresultpinpapsaleporpotherpdisposition.pThesepincludepapsale,ptrade,pgiftptopcha
rity,pdisposalptoptheplandfill,porpdestructionpinpapnaturalpdisaster.pInpapsaleporptrade
p(exchange),ptheptaxpayerpreceivespsomethingpofpvaluepinpreturnpforpthepasset.pInpc
ontrast,papcharitablepcontribution,pdisposal,porpdestructionpfrompapnaturalpdisaste
rpgenerallypresultspinpaplosspofpanypremainingpbasispinpthepassetpwithoutpcompensat
ionp(unlesspreimbursedpbypinsurance).
2. [LOp1]pPotomacpCorporationpwantsptopsellpapwarehousepthatpitphaspusedpinpitspbusinesspf
orp10pyears.pPotomacpispaskingp$450,000pforpthepproperty.pThepwarehousepispsubjectptopa
pmortgagepofp$125,000.pIfpPotomacpacceptspWydenpInc.’spofferptopgivepPotomacp$325,0
00pinpcashpandpassumespfullpresponsibilitypforpthepmortgageponpthepproperty,pwhatpamou
ntpdoespPotomacprealizeponpthepsale?p
Whenptheppropertypdisposedpofpispsubjectptopapliabilitypandpthepbuyerpassumespthepl
iability,pthepreliefpofpdebtpincreasespthepamountprealized.pThus,pPotomac’spamount
prealizedpconsistspofp$450,000,pwhichpispcashpofp$325,000pplusp$125,000preliefpofp
debt.pThispresultpassumespthatpthepbuyerphypotheticallyptransferspcashptopthepseller
pinporderptoppaypoffpthepmortgage.
3. [LOp1]pMontanapMaxpsellspap2,500-
acrepranchpforp$1,000,000pinpcash,papnotepreceivablepofp$1,000,000,pandpdebtpreliefpofp$2
,400,000.pHepalsoppayspsellingpcommissionspofp$60,000.pInpaddition,pMaxpagreesptopbuil
dpapnewpbarnponptheppropertyp(costp$250,000)pandpspendp$100,000pupgradingpthepfencep
onptheppropertypbeforepthepsale.pWhatpispMax’spamountprealizedponpthepsale?
$4,340,000.pAnythingpreceivedpbypthepsellerpduringpapsaleporpexchangepispincluded
pinpthepamountprealized.pMostpdispositionspresultpinpcashptopthepseller.pHowever,pa
mountprealizedpincludes,pbutpispnotplimitedpto,pcash,pthepfairpmarketpvaluepofpanypot
herppropertypreceivedp(e.g.pmarketablepsecuritiesporpapsimilarpasset),porpreliefpofpd
ebt.pInpaddition,psellingpexpensespreducepthepamountprealized.pTherefore,pMax’spa
mountprealizedpincludespthep$1,000,000pofpcash,p$1,000,000pnotepreceivable,prelie
fpofpdebtpofp$2,400,000,pandpispreducedpbypsellingpcommissionspofp$60,000p(selling
©pMcGrawpHillpLLC.pAllprightspreserved.pNopreproductionporpdistributionpwithoutptheppriorpwrittenpconsentpofpMcGrawpHillpLLC.
1
, SolutionspManual—TaxationpofpIndividualspandpBusinesspEntities,pbypSpilkerpetpal.
pexpensespreducepthepamountprealized,pS.C.pChapin,pCA-8,p50-
1pUSTCp¶9171).pAnythingpthepsellerpgivespuppinptheptransactionpispaddedptopthepba
sispofptheppropertypgivenpuppandpispnotpconsideredppartpofpthepamountprealized.pTh
erefore,pthepbarnpandpfencepimprovementsparepnotpconsideredppartpofpMax’spamou
ntprealized.pNote,phowever,pthatpmakingpthesepimprovementspdecreasesphisprealize
dpgainpbypincreasingpMontanapMax’spadjustedpbasispinptheppropertypdueptopthepim
provements.
4. [LOp1]pHawkeyepsoldpfarmingpequipmentpforp$55,000.pItpboughtpthepequipmentpfourpye
arspagopforp$75,000,pandpitphaspsincepclaimedpaptotalpofp$42,000pinpdepreciationpdeductio
nspagainstpthepasset.pExplainphowptopcalculatepHawkeye’spadjustedpbasispinpthepfarmingp
equipment.p
Hawkeyepwillpcalculatepitspadjustedpbasispinpthepfarmingpequipmentpbypreducingpt
hephistoricalpcostpbypanypcostprecoverypdeductionsptaken—
namely,pdepreciation.pTherefore,pHawkeye’spadjustedpbasispisp$33,000p($75,000pl
essp$42,000).pTheptaxpadjustedpbasispispusuallypdifferentpthanpthepbookpadjustedpba
sis.pThispispbecausepmostpassetspusepapdifferentprecoverypperiod,pcostprecoverypmet
hodp(e.g.,pdoublepdecliningpbalance),pandpconventionp(e.g.,phalf-
year)pforptaxpthanpforpbookppurposes.pSeepthepPropertypAcquisitionpandpCostpReco
verypchapterpforphowpthesepdifferencesparise.pDueptopthepdifferencepinpcostprecover
ypdeductions,pthepadjustedpbasispisplikelypdifferentpunlesspthepassetpispfullypdepreci
atedpforpbothpbookpandptaxppurposes.p
5. [LOp1]pWhenpaptaxpayerpsellspanpasset,pwhatpispthepdifferencepbetweenprealizedpandpreco
gnizedpgainporplossponpthepsale?
Theprealizedpgainporplosspispsimplypthepamountprealizedplesspthepadjustedpbasispofpt
hepassetpsold.pEverypsaleporpdispositionpresultspinpaprealizedpgainporplossp(unless,po
fpcourse,pthepamountprealizedpispequalptopthepadjustedpbasis).pMostprealizedpgainsp
orplossespbecomeprecognizedpgainsporplossespandparepincludedponptheptaxpayer’spt
axpreturnpandpincreasesp(orpdecreasespinpthepcasepofpaploss)ptheptaxpayer’sptaxable
pincomepandpsubsequentptax.pHowever,pthereparepsomeprealizedpgainsporplossespth
atparepexcludedpfrompincomeporpdeferredptopaplaterptimepperiod.
6. [LOp2]pWhatpdoespitpmeanptopcharacterizepapgainporploss?ppWhypispcharacterizingpapgainp
orplosspimportant?p
Oncepapgainporplosspisprecognized,paptaxpayerpmustpdeterminephowptheprecognizedp
gainporplosspaffectsptheptaxpayer’sptaxpliability.pThepcharacterpdependsponpapcombi
nationpofptwopfactors:ppurposeporpusepofpthepassetpandpholdingpperiod.pTheppurpos
eporpusepofpthepassetpispimportantpbecauseptheplawpdoespnotptreatpallpassetspequally.
pThepgeneralpusepcategoriespare:p(1)ptradeporpbusiness,p(2)pforpthepproductionpofpin
comep(rentalpactivities),p(3)pinvestment,pandp(4)ppersonal.pBasedponpthesepcriteria,
©pMcGrawpHillpLLC.pAllprightspreserved.pNopreproductionporpdistributionpwithoutptheppriorpwrittenpconsentpofpMcGrawpHillpLLC.
2
, SolutionspManual—TaxationpofpIndividualspandpBusinesspEntities,pbypSpilkerpetpal.
pwepcanpcategorizepanpassetpintoponepofpthreepgroups:p(1)pordinary,p(2)pcapital,porp
(3)p§1231.pCharacterizingpthepgainporplosspispimportantpbecauseptheptaxptreatmentp
forpgainspandplossespvarypdependingponpthepcharacter.pOrdinarypgainspandplossesp
areptaxedpatpordinarypincomeprates,pregardlesspofpthepholdingpperiod.pCapitalpgai
nsponpassetspheldpforpmorepthanpapyearphaveppreferentialptaxpratespforpnon-
corporateptaxpayerspwhilepcapitalpgainsponpassetspheldpforponepyearporplesspdopnot
.p§1231pgainspandplossespreceivepthepbestpofpbothpworlds—thepgainspbecomeplong-
termpcapitalpgainspandptheplossespbecomepordinary.pHowever,ptopqualifypaspap§123
1passet,pthepassetpmustpbepusedpinpaptradeporpbusinesspforpmorepthanpapyear.
7. [LOp2]pExplainpthepdifferencepbetweenpordinary,pcapital,pandp§1231passets.p
Anpordinarypassetpispanpassetpthatpispheldpforpsalepinpthepordinarypcoursepofpaptaxpa
yer’spbusinessp(e.g.,pinventory)porparisespfrompsalespinpthepordinarypcoursepofpbusi
nessp(e.g.,paccountspreceivable).pCapitalpassetsparepheldpforpinvestmentp(expecting
pappreciation)porpareppersonal-
usepassetsp(e.g.,paptaxpayer’sppersonalpbelongings).p§1231passetsparepusedpinpaptra
deporpbusinessporpforpthepproductionpofpincomepandparepheldpforpmorepthanponepye
ar.pAnpassetpthatpispusedpinpaptradeporpbusinessporpforpthepproductionpofpincomepan
dpispheldpforponepyearporplesspispanpordinarypasset.pGainsponppersonal-
useppropertyparepcapitalpgainspwhileplossesparepnon-deductible.
8. [LOp2]pDiscusspthepreasonspwhypindividualspgenerallyppreferpcapitalpgainspoverpordinar
ypgains.pExplainpwhypcorporateptaxpayerspmightppreferpcapitalpgainspoverpordinarypgain
s.
Individualptaxpayersppreferpcapitalpgainspbecauseptheypmaypbeptaxedpatppreferenti
alprates.pNetplong-
termpcapitalpgainspareptaxedpatppreferentialpratesp(0,p15,porp20ppercent).pShort-
termpcapitalpgainsparepsimplyptaxedpatpordinaryprates.pCapitalpgainspcanpoffsetpca
pitalplosses,pwhilepordinarypgainspcannot.pAdditionally,pindividualptaxpayerspcanp
offsetp$3,000pofpnetpcapitalplossespagainstpordinarypincomepandpcarrypthepremaini
ngpcapitalplosspforwardpindefinitely.p
Evenpthoughpcorporateptaxpayerspareptaxedpatpthepsameprateponpordinarypincomep
andpcapitalpgains,ptheyppreferpcapitalpgainspbecausepcapitalpgainspcanpoffsetpcapit
alplosses.pCapitalplossespcannotpbepusedptopoffsetpordinarypincome;ptherefore,pcapi
talpgainspallowpcorporateptaxpayersptopbenefitpfromptheirpcapitalplosses.pCorporat
eptaxpayerspcanpcarrypcapitalplossespbackpthreepyearspandpforwardpfivepyears.pHo
wever,pafterpthepcarrypbackpandpcarrypforwardpperiodspexpire,pcapitalplossespexpir
epandparepworthless.
9. [LOp2]pDakotapConradpownspapparcelpofplandphepwouldplikeptopsell.pDescribepthepcircum
stancespinpwhichpthepsalepofptheplandpwouldpgeneratep§1231pgainporploss,pordinarypgainpo
©pMcGrawpHillpLLC.pAllprightspreserved.pNopreproductionporpdistributionpwithoutptheppriorpwrittenpconsentpofpMcGrawpHillpLLC.
3
, SolutionspManual—TaxationpofpIndividualspandpBusinesspEntities,pbypSpilkerpetpal.
rploss,porpcapitalpgainporploss.pAlso,pdescribepthepcircumstancespunderpwhichpDakotapwo
uldpnotpbepallowedptopdeductpaplossponpthepsale.p
ThepparcelpofplandpcouldpqualifypaspapcapitalpassetpifpitpispheldpbypDakotapaspanpinv
estmentp(e.g.,ptheppurposepforpholdingptheplandpispforpexpectedpappreciationpinpval
ue).pTheplandpcouldpqualifypaspap§1231passetpifpDakotapusespitpinpaptradeporpbusine
sspsuchpaspapsole-
proprietorshipporpforpthepproductionpofpincomep(aprentalpproperty)pandptheypusepitp
forptheseppurposespforpmorepthanponepyear.pTheplandpcouldpbepordinarypincomeppr
opertyptopDakotapifpitpispheldpinpaptradeporpbusinessporpforpthepproductionpofpincom
epforponepyearporplessporpifpitpispconsideredptopbepinventoryp(e.g.,papreal-
estatepdealer).pTheplosspwouldpbepnon-
deductibleptopDakotapifptheypheldptheplandpforppersonal-useppurposes.
10. [LOp2]pLincolnpBrownphaspusedpappiecepofplandpinptheirpbusinesspforptheppastpfivepyears.p
Theplandpqualifiespasp§1231pproperty.pItpispunclearpwhetherpLincolnpwillphaveptoprecogni
zepapgainporplosspwhenptheypeventuallypsellpthepasset.pLincolnpasksptheirpaccountantphowp
thepgainporplosspwouldpbepcharacterizedpifptheypdecideptopsell.pThepaccountantpsayspthatps
ellingp§1231passetspgivespsellersp“thepbestpofpbothpworlds.”pExplainpwhatpthepaccountant
pmeanspbypthispstatement.p
Anpassetpqualifiespaspap§1231passetpifpusedpinpaptradeporpbusinessporpheldpforptheppr
oductionpofpincomepforpmorepthanponepyear.pTheptaxptreatmentpispsometimespdescri
bedpaspreceivingp“thepbestpofpbothpworlds”pbecausepnetpgainspreceivepcapitalpgain
ptreatmentpandpnetplossespreceivepordinaryplossptreatment.pCapitalpgainsparepprefe
rablepbecauseptheypareptaxedpatpappreferentialpratep(forpnon-
corporateptaxpayers)pandpcanpoffsetpcapitalplosses,pwhichpcannotpalwayspbepoffsetp
againstpordinarypincome.pOrdinaryplossespareppreferredptopcapitalplossespbecause
ptheypoffsetpordinarypincomepinpthepcurrentpyearpratherpthanpbeingpaccumulatedptop
offsetpfuturepcapitalpgains.
p
11. [LOp3]pExplainpCongress’sprationalepforpdepreciationprecapture.
Theppurposepofpdepreciationprecapturepisptoptreatpthepgainponpthepsalepofpdeprecia
blepassetspaspordinarypincomeptopthepextentpthepgainpispattributableptopdepreciation
p(orpotherpcostprecoverypdeductions).pThepMACRSpsystempallowspacceleratedpded
uctionspthatpoftenpreducepthepbasispofpanpassetpfasterpthanptheprealpeconomicpdecli
nepinpvalue.pThus,pdepreciationpdeductionspgeneratepanpartificialpgainponpthepdisp
ositionpofpdepreciablepassets.pTheprecaptureprulespensurepthatpsomeporpallpofpthepa
rtificialpgainpispcharacterizedpaspordinarypsimilarptopthepdepreciationpdeductionspt
hatpcreatedpthepartificialpgain.pItpispimportantptopnotepthatpdepreciationprecapturep
doespnotpaffectpthepamountpofpthepgain;pratherpitpaffectsponlypthepcharacterpofpthepg
ain.pAdditionally,pdepreciationprecaptureponlypappliesptopsalesporpdispositionspres
ultingpinpgainsp(e.g.,pitpdoespnotpapplyptoplosses).p
©pMcGrawpHillpLLC.pAllprightspreserved.pNopreproductionporpdistributionpwithoutptheppriorpwrittenpconsentpofpMcGrawpHillpLLC.
4
