FOR LIVE PROGRAM ONLY Fundamentals of Capital Gains: Identifying Section 1231, 1245 and 1250 Gains, 0% Bracket and Form 4797 TUESDAY, JANUARY 21, 2020, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours. To earn credit you must: • Participate in the program on your own computer connection (no sharing) – if you need to register additional people, please call customer service at 1-800-926-7926 ext. 1 (or 404-881-1141 ext. 1). Strafford accepts American Express, Visa, MasterCard, Discover. • Listen on-line via your computer speakers. • Respond to five prompts during the program plus a single verification code. • To earn full credit, you must remain connected for the entire program. 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Fundamentals of Capital Gains: Identifying Section 1231, 1245 and 1250 Gains, 0% Bracket and Form 4797 January 21, 2020 Riley Adams, CPA, Senior Financial Analyst Michael Plaks, Enrolled Agent Google REI Tax Firm [email protected] [email protected] Dawn Polin, CPA, Senior Manager Cherry Bekaert [email protected] Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. Capital Gain Overview Sale of Assets Sale Price – Purchase Price = Loss or Gain Purchase Manufacturing Equipment for $10,000 Use it is the business for 2 years Expense depreciation in the amount of $2,000 Sell in year 3 for $12,000 $12,000 - $8,000 = $4,000 Gain on Sale 6 Considerations for application of tax rates to apply to gain Capital Ordinary Long Term Short Term 7 Current Tax Rates Type Ordinary Capital Individual 37% 20% C Corp 21% 21% 8 Sale of Business Assets Falls into 3 Categories ▪ §1231 Assets - operating assets of the business ▪ Capital Assets (Investments) ▪ Ordinary Income Assets (assets held for resale such as inventory) 9 It ain’t what you know that gets you into trouble. It’s what you know for sure that just ain’t so. - Mark Twain 10 Proprietary + Confidential 0% Capital Gains Tax Rate 11 0% Capital Gains Tax Rate ▪ Long-term capital gains tax rates on taxable income: 2019 Marginal tax rate Single Married, filing Head of Married, filing jointly household separately 0% $0-39,375 $0-78,750 $0-52,750 $0-39,375 15% $39,376-434,550 $78,751-488,850 $52,751-461,700 $39,376-244,425 20% $434,550+ $488,850+ $461,700+ $244,425+ ▪ Modified Adjusted Gross Income (MAGI) above $200,000 (single) and $250,000 (MFJ) is also subject to the 3.8% net investment income tax ▪ With planning, can harvest tax-free gains on invested capital held more than a year or qualified passive income sources 12 How the 0% Rate Works For 2018-2025, 0% tax rate applies to: ▪ Married tax filers with taxable income up to $78,750 ▪ Single filers with taxable income up to $39,375 Most Common Tax Opportunities ▪ Temporarily unemployed/out of labor force ▪ Variable income (e.g., salesperson) ▪ Between ages 55-70 and beginning to transition into retirement / are already retired 13 0% Capital Gains Examples Item Description Filing Status Married Filing Jointly Taxable Income $60,000 (a) Example 1 Capital Loss Carryover? No 15% LTCG Threshold $78,750 (b) Max LTCG with 0% tax $18,750 [(b)-(a)] How to Take Advantage: ▪ If you have unrealized long-term gains in assets (e.g., stocks, mutual funds, etc.) in a taxable account, can sell these investments and recognize $0 in tax liability <$18,750 ▪ Consider exchanging for similar investments to harvest unrealized gain without tax impact 14 0% Capital Gains Examples Item Description Filing Status Married Filing Jointly Taxable Income $80,000 (a) Example 2 Capital Loss Carryover? Yes, $3,000 (b) 15% LTCG Threshold $78,750 (c) Max LTCG with 0% tax $1,750 [(a)-(b)-(c)] How to Take Advantage: ▪ Minimal space, but loss carryover provides room to take <$1,750 in realizable gains with 0% tax impact 15 0% Capital Gains Examples Item Description Filing Status Married Filing Jointly Example 3 Taxable Income $60,000 (a) LT Capital Gains $40,000 (b) 15% LTCG Threshold $78,750 (c) LTCG Tax $3,187.50 [(a)+(b)-(c)]*15% How to Take Advantage: ▪ While taxed, still done so at second tier of long-term capital gains tax rates (15%) 16 What Qualifies for LTCG? ▪ Assets held for longer than 1 year and sold for a gain ▪ Qualified dividends received Generally considered “qualified” if the company pays a dividend on stock investor has held more than 60 days during the 121-day period that began 60 days before the ex-dividend date 17 What is Not Considered Qualified Passive income? ▪ Master limited partnerships (MLPs) - Exists in the form of a publicly traded limited partnership. Combines the tax benefits of a private partnership—profits are taxed only when investors receive distributions—with the liquidity of a publicly-traded company. ▪ Real estate investment trusts (REITs) - Company owning and typically operating real estate which generates income. One benefit of REITs for everyday investors is that they provide the opportunity to own a portion of real estate which generates dividend-based income. Must return a minimum of 90% of its taxable income in the form of shareholder dividends each year. ▪ Dividends paid on employee stock options - Considered nonqualified dividends, taxed at marginal rate. ▪ Dividends paid by tax-exempt companies - Considered nonqualified dividends and pay tax at marginal income tax rate. ▪ Dividends paid on savings or money market accounts - Like any other payment received from an asset. 18 Three asset types and two rate categories? The sale of business assets can result in the application of the capital gain rates or the ordinary income rates depending on the facts and circumstances. Sales of 1231 assets slide between the tax rates 20 Distinguishing and calculating 1231, 1245, and 1250 Gain 21 1231 Assets Defined depreciable property used in the capital assets held for more than one taxpayer’s trade or business and held year in connection with a trade or more than one year, other than (i) business or a transaction entered into property includible in inventory, (ii) for profit, and compulsorily or property held primarily for sale to involuntarily converted; customers, (iii) intangibles an unharvested crop on land used in the real property used in the trade or trade or business and held for more than business and held for more than one one year, if the crop and land are sold, year, other than property that is exchanged, or involuntarily converted at includible in inventory or held primarily the same time to the same person; for sale to customers; certain livestock, but not poultry ( trade or business property held for more ¶1750); and than one year and compulsorily or involuntarily converted (¶1748); timber, domestic iron ore, and coal ( ¶1772) ( Code Sec. 1231(b); Reg. §§1.1231-1 and 1.1231-2). 22 Treatment of 1231 Asset Sales Gains are treated as capital in nature Losses are treated as ordinary in nature 23 1231, 1245, 1250? 1231 Gain Rate 1231 1245 Depreciation Recapture Gain (Ordinary Rate) 1250 Depreciation Recapture (preferential rate) 24 §1250 Real Property Code Sec. 1250 real property, such as a building or a structural component of a building, and most land improvements. Residential rental property that is depreciated over 27.5 years using the straight line method. Nonresidential real property that is depreciated over 39 years using the straight line method. 25 §1245 Personal Property Code Sec. 1245 personal property (Code Sec. 1245(a)(3)(A)), which consists of items such as business machinery and equipment, office furniture and fixtures, and appliances that are furnished to tenants. The principal characteristic of Code Sec. 1245 personal property is that it is readily moveable rather than permanently affixed. Property of Cherry Bekaert LLP 26 1231 Gains in Depth A gain on the sale of the To the extent the asset capital asset can be took prior straight-line subject to the capital gains depreciation expense as a rates, and the 1245 and 1250 asset, 1250 1250 recapture rates. recapture will be To the extent the asset applicable took prior accelerated depreciation expense as a 1245 asset, 1245 recapture will be applicable 27 What about capital losses? Capital Losses are ordinary to the extent of the in nature.