Chapter 14 Sale of property
Anytime you sell or exchange a piece of property at a gain—whether it be your house, a stock you own, or something you use in your trade or business—you usually have to pay taxes on the transaction. That, of course, doesn’t mean that sales and exchanges should be avoided, but the manner in which you choose to dispose of an asset may determine how much you will have to pay in taxes. This chapter describes the various options available to you and the tax consequences of each.
Because the amounts involved in sales and exchanges of property are often quite large relative to other items that make up your income, this chapter merits careful attention. It not only spells out how you determine the way in which various transactions are taxed but also offers suggestions about how to minimize or defer the tax burdens that you may incur.
In addition, this chapter discusses bad debts. When a borrower cannot repay a loan, it is known as a bad debt. Some loans are made in connection with a trade or a business, some are made for purely personal reasons, and still others are made to make a profit. All sorts of rules have to be followed, and not every bad debt qualifies for a deduction. This chapter spells out what kind of documentation you need to prove that the money you lost was a bona fide debt and that there is no chance of repayment—the two conditions that must be met for you to take a deduction.
50% Exclusion of Qualified Small Business Stock Capital Gains. 50% (60% for certain empowerment zone businesses) of the gain from the sale of certain qualified small business stock acquired at original issue after December 31, 2013 or before February 18, 2009, and held for more than five years is excluded from income.
S Corporation Built-In Gains Tax. For tax years beginning in 2014, no tax is imposed on the net recognized built-in gain of an S corporation after the 10th year in the recognition period.
Foreign income. If you are a U.S. citizen who sells property located outside the United States, you must report all gains and losses from the sale of that property on your tax return unless it is exempt by U.S. law. This is true whether you reside inside or outside the United States and whether or not you receive a Form 1099 from the payer.
This chapter discusses the tax consequences of selling or trading investment property. It explains the following.
What a sale or trade is.
Figuring gain or loss.
Related party transactions.
Capital gains or losses.
Capital assets and noncapital assets.
Rollover of gain from publicly traded securities.
Other property transactions. Certain transfers of property are not discussed here. They are discussed in other IRS publications. These include the following.
Sales of a main home, covered in . chapter 15
Installment sales, covered in Publication 537, Installment Sales.
Transactions involving business property, covered in Publication 544, Sales and Other Dispositions of Assets.
Dispositions of an interest in a passive activity, covered in Publication 925, Passive Activity and At-Risk Rules.
Publication 550, Investment Income and Expenses (Including Capital Gains and Losses), provides a more detailed discussion about sales and trades of investment property. Publication 550 includes information about the rules covering nonbusiness bad debts, straddles, Section 1256 contracts, puts and calls, commodity futures, short sales, and wash sales. It also discusses investment-related expenses.
You may want to see:
550 Investment Income and Expenses
Schedule D (Form 1040) Capital Gains and Losses
4797 Sales of Business Property
8949 Sales and Other Dispositions of Capital Assets
8824 Like-Kind Exchanges
If you sold property such as stocks, bonds, or certain commodities through a broker during the year, you should receive, for each sale, a Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, or substitute statement, from the broker. Generally, you should receive the statement by February 15 of the next year. It will show the gross proceeds from the sale. If you sold a covered security in 2014, your 1099-B (or substitute statement) will show your basis. Generally, a covered security is a security you acquired after 2010, with certain exceptions. See the Instructions for Form 8949. The IRS will also get a copy of Form 1099-B from the broker.
Use Form 1099-B (or substitute statement received from your broker) to complete Form 8949.
This section explains what is a sale or trade. It also explains certain transactions and events that are treated as sales or trades.
A sale is generally a transfer of property for money or a mortgage, note, or other promise to pay money.
A trade is a transfer of property for other property or services and may be taxed in the same way as a sale.
Sale and purchase. Ordinarily, a transaction is not a trade when you voluntarily sell property for cash and immediately buy similar property to replace it. The sale and purchase are two separate transactions. But see under Like-kind exchanges Nontaxable Trades, later.
Redemption of stock. A redemption of stock is treated as a sale or trade and is subject to the capital gain or loss provisions unless the redemption is a dividend or other distribution on stock.
Dividend versus sale or trade. Whether a redemption is treated as a sale, trade, dividend, or other distribution depends on the circumstances in each case. Both direct and indirect ownership of stock will be considered. The redemption is treated as a sale or trade of stock if:
The redemption is not essentially equivalent to a dividend (see ), chapter 8
There is a substantially disproportionate redemption of stock,
There is a complete redemption of all the stock of the corporation owned by the shareholder, or
The redemption is a distribution in partial liquidation of a corporation.
Redemption or retirement of bonds. A redemption or retirement of bonds or notes at their maturity is generally treated as a sale or trade.
In addition, a significant modification of a bond is treated as a trade of the original bond for a new bond. For details, see Regulations section 1.1001-3.
Surrender of stock. A surrender of stock by a dominant shareholder who retains ownership of more than half of the corporation’s voting shares is treated as a contribution to capital rather than as an immediate loss deductible from taxable income. The surrendering shareholder must reallocate his or her basis in the surrendered shares to the shares he or she retains.
Worthless securities. Stocks, stock rights, and bonds (other than those held for sale by a securities dealer) that became completely worthless during the tax year are treated as though they were sold on the last day of the tax year. This affects whether your capital loss is long term or short term. See , later. Holding Period
Worthless securities. You can claim a capital loss on a security, such as stocks, stock rights, and bonds that become worthless during the year. The security is treated as if it had been sold on the last day of the year for purposes of determining whether your loss is short-term or long-term. You are permitted to claim the loss only in the year the security actually becomes worthless. That can be tricky to determine. As an alternative, if you hold securities that are on the verge of becoming worthless, consider selling them now and take your capital loss in the year you sell, rather than having to discover proof that the securities have, in fact, become worthless. Make sure you sell the securities to an unrelated buyer—otherwise your loss may be disallowed. Tax regulations adopted in 2008 allow you to treat securities abandoned after March 12, 2008, as worthless securities. For more information, see , in Worthless securities What Is a Sale or Trade, later.
Like-Kind Exchanges. In general, any gain realized from selling your property must be included in your taxable income. However, if you trade or exchange business or investment property for “like-kind” property—that is, property of a similar nature or character—the gain on the property you traded is deferred until you ultimately sell the new property received in the trade. Your newly acquired property is considered to be a continuation of the investment in the original property. Therefore, your basis in the new property is generally the same as it was in the property you traded. For more information, see in Nontaxable Exchanges and Like-Kind Exchanges chapter 13, Basis of property.
Installment Sales. Selling property through an installment sale can enable you to spread out the recognition of the tax gain on the sale over a period of years. This may result in a lower overall tax on your realized gain. With an installment sale, you receive part or all of the sales proceeds in one or more years after the year in which you sold the property. You report your gain only as you actually receive the payment, and are taxed only on the portion of each payment that represents your profit from the sale. For more information, see , later. Installment sales
Nontaxable Trades: You usually have to pay tax on any gains you realize when you sell or exchange a piece of property. However, the tax law provides a number of specific exceptions to this general rule. Following is a list of exchanges or trades that do not result in a taxable gain (nor trigger a deductible loss):
Like-kind exchanges: an exchange of business or investment property for other business or investment property of a similar nature;
Corporate reorganizations: an exchange of common stock for preferred stock or vice versa, or stock in one corporation for stock in another company as a result of a reorganization of a corporation, such as through a merger, recapitalization, or corporate division or acquisition;
Stock for stock of the same corporation: an exchange of common stock for other common stock or preferred stock for other preferred stock in the same corporation;
Convertible stocks and bonds: a conversion of bonds into stock or preferred stock into common stock of the same corporation in accordance with a conversion privilege that was included in the terms of the bond or the preferred stock certificate; and
Property for stock of a controlled corporation: an exchange of property with a corporation in return for stock in the company, and you control the corporation immediately after the trade.
For more information, see , later. Nontaxable Trades
Nontaxable exchanges of insurance policies and annuities. You will not have to recognize a gain or loss on the exchange of a life insurance contract for another life insurance contract, endowment, or annuity contract, or an annuity contract for another annuity contract, if the insured or annuitant are the same under both contracts. However, starting in 2011, restrictions have changed for certain annuity contract exchanges. For more information, see , later. Nontaxable Trades: Insurance policies and annuities
Nonbusiness bad debts. If you are owed money, and you can no longer collect on that debt, you may be able to deduct the amount still owed to you as a bad debt. If the debt came about from operating your trade or business, the bad debt deduction is an ordinary loss. A non-business bad debt, on the other hand, can only be deducted as a short-term capital loss. You are entitled to claim a bad debt deduction only in the year the debt becomes totally worthless. That can be tricky to determine. As a result, you should claim the bad debt deduction at the earliest time you believe the debt to be worthless. For more information, see , later. Nonbusiness Bad Debts
Worthless securities also include securities that you abandon after March 12, 2008. To abandon a security, you must permanently surrender and relinquish all rights in the security and receive no consideration in exchange for it. All the facts and circumstances determine whether the transaction is properly characterized as an abandonment or other type of transaction, such as an actual sale or exchange, contribution to capital, dividend, or gift.
If you are a cash basis taxpayer and make payments on a negotiable promissory note that you issued for stock that became worthless, you can deduct these payments as losses in the years you actually make the payments. Do not deduct them in the year the stock became worthless.
The deduction for a worthless security must be taken in the year the security becomes worthless, even if it is sold for a nominal sum in the following year. If you do not learn that a security has become worthless until a later year, you should file an amended return for the year in which it became worthless. Because it may be difficult to determine exactly when a stock becomes worthless, the capital loss deduction should be claimed in the earliest year a claim may be reasonably made.
If you hold securities that seem to be on the verge of worthlessness, it may be easier to sell them now and take your capital loss without waiting for proof of worthlessness. Make sure you sell the securities to an unrelated buyer—otherwise your loss may be disallowed. If you hold shares that are delisted—stock that is removed from a national exchange such as the New York Stock Exchange or NASDAQ (this sometimes happens because the share trading price drops below the minimum price required to continue trading)—you may want to consider abandoning your ownership of the shares, as they may be very difficult to sell. To abandon shares, you must give up your legal right to the shares and receive no remuneration in exchange for giving up that right. You should retain documentation of the shares being removed from your account, as the transaction generates no proceeds and therefore may not be reported on your year-end statements.
When securities are bought on credit, the timing of the deduction for worthlessness depends on the type of debt you have incurred. If the stock is purchased by giving the seller a note and the stock becomes worthless before the note is paid off, you may deduct the loss only as you make the payments on the note. However, if you borrow the funds from a third party, you may deduct the loss in the year in which the stock becomes worthless. In either case, an accrual basis taxpayer takes the deduction in the year the security becomes worthless.
Report worthless securities in Part I or Part II, whichever applies, of Form 8949. In column (a), enter “Worthless.” How to report loss.
If you do not claim a loss for a worthless security on your original return for the year it becomes worthless, you can file a claim for a credit or refund due to the loss. You must use Form 1040X, Amended U.S. Individual Income Tax Return, to amend your return for the year the security became worthless. You must file it within 7 years from the date your original return for that year had to be filed, or 2 years from the date you paid the tax, whichever is later. For more information about filing a claim, see Filing a claim for refund. in Amended Returns and Claims for Refund chapter 1.
You may save taxes by carefully planning major sales and exchanges. It may be better to wait until after the end of the year before finalizing a sale so that a gain may be deferred until the next year. Alternatively, you may want to finalize the sale before the end of the year to take advantage of any losses in the current year. Professional advice should be obtained before a major transaction, not after.
Estates. The transfer of property of a decedent to the executor or administrator of the estate, or to the heirs or beneficiaries, generally is not a sale or exchange. No taxable gain or deductible loss results from the transfer.
Easements. Granting or selling an easement may not be a taxable sale of property. Instead, the amount received for the easement is subtracted from the basis of the property. If only a part of an entire tract of property is permanently affected by the easement, only the basis of that part is reduced by the amount received. Any amount received that is more than the basis of the property to be reduced is a taxable gain. The transaction is reported as if it were a sale of the property.
If you transfer a perpetual easement for consideration, the transaction will be treated as a sale of property.
Life estate, etc. The entire amount you realize from disposing of a life interest in property, an interest in property for a set number of years, or an income interest in a trust is a taxable gain if you first got the interest as a gift, inheritance, or transfer in trust. Your basis in the property is considered to be zero. This rule does not apply if all interests in the property are disposed of at the same time.
Your father dies, leaving his farm to you for life, with a remainder interest to your younger brother. You decide to sell your life interest in the farm. The entire amount you receive is a taxable gain, and your basis in the farm is disregarded.
The facts are the same as in Example 1, except that your younger brother joins you in selling the farm. Because the entire interest in the property is conveyed, your taxable gain is the amount by which your share of the proceeds exceeds your adjusted basis in the farm.
Note: In Example 2, each brother’s gain is computed by allocating the tax basis between them. The basis for the entire property—the fair market value at the date of the decedent’s death—is adjusted for depreciation and improvements. Then, using actuarial tables, you compute the value of the life interest and of the remainder interest at the date of sale.
The younger brother could sell his remainder interest in the property independently of his brother, using his separate basis in computing his gain or loss on the sale. However, the older brother may not get the benefit of his basis in the property if he sells his life interest separately. The moral of the story is: Sometimes you save on taxes if you get along with your brother.
Sale versus lease. Just because a document says that it is a lease does not necessarily make it a lease for tax purposes. The rules are very complicated and not completely clear. Professional help is advisable. See Publication 544, Sales and Other Dispositions of Assets.
Installment sales. Some sales are made under a plan that provides for part or the entire sales price to be paid in a later year. These are called installment sales. If you finance the buyer’s purchase of your property instead of the buyer getting a loan or mortgage from a bank, you probably have an installment sale.
You report your gain on an installment sale only as you actually receive payment. You are taxed only on the part of each payment that represents your profit on the sale. In this way, the installment method of reporting income relieves you of paying tax on income that you have not yet collected.
The first step in using the installment method is to find what portion of each installment payment represents a gain. This is determined by calculating the gross profit percentage, which is your gross profit divided by the contract price. Apply this percentage to all payments you receive in a year.
Gross profit is the selling price less the adjusted basis of the property sold. The selling price includes any cash you receive, the fair market value of any property received from the buyer, plus the amount of any existing mortgage on the property that the buyer became subject to or assumed.
Contract price is the selling price less any mortgage encumbrance on the property. However, if the amount of the mortgage is more than the adjusted basis of the property, then the selling price is reduced only by the adjusted basis, so the gross profit percentage is 100%.
In 1994, Martha bought commercial real estate for $100,000. She put $20,000 down and took out a mortgage for $80,000. By 2014, Martha had reduced the mortgage to $40,000 and had an adjusted basis in the real estate of $85,000 (original cost, less depreciation, plus improvements). Martha sold the real estate to Benjamin for $190,000. To pay Martha, Benjamin assumed the rest of the mortgage and made three installment payments of $50,000 each.
Martha figures her gross profit as follows:
Selling price Less: Adjusted tax basis
Martha figures her contract price as follows: Selling price Less: Mortgage assumed
Martha’s gross profit percentage is 70% (gross profit divided by contract price). Martha must report 70% of all contract-price collections as a taxable gain in the year they are received.
Installment sale treatment is not obligatory. You may elect not to follow the installment sale rules, in which case your total gain is recognized in the year of the sale.
While it is generally advantageous to defer recognition of a gain or part of a gain by using the installment sale method, under certain circumstances, accelerating recognition may result in overall tax savings. For example, if you expect your income in future years to be much higher than it is now or if you currently have a capital loss that may be offset by a gain, you may want to recognize your gain immediately.
The law limits the ability to defer tax by restricting use of the installment sale method to certain kinds of property. For example, the installment sale method may not be used for sales of publicly traded stocks or securities. However, you may sell other types of property, such as real property used in your business or for rental, under an installment sale and still defer the tax on the gain.
If you decide not to use the installment sale reporting method, indicate this decision by reporting the full transaction sales price on either Form 8949 and Schedule D (Form 1040) or Form 4797 by the date your tax return for the year of the sale is due. (Form 8949 and Schedule D are used to report sales of capital assets. Form 4797 is used to report sales of trade or business property and other noncapital assets.) Once you decide not to use the installment sale method, you may change your decision only with the consent of the IRS.
Sales at a loss do not qualify for installment sale reporting. Also, sales by dealers or by persons who regularly sell personal property on the installment basis no longer qualify for the installment method.
The gain you have from an installment sale will be treated as capital gain if the property you sold was a capital asset (discussed later). However, if you took depreciation deductions on the assets, including the Section 179 deduction, part of your gain may be treated as ordinary income.
On January 31, 2014, Susan sells property for $4,000 on which she has a $1,000 gain. Half of the gain is taxable at ordinary rates.
If Susan receives the initial $2,000 payment in 2014, she is receiving one-half the proceeds and must report one-half of the gain, or $500. Because the ordinary income portion must be reported first, the entire $500 is treated as an ordinary gain. When Susan receives the second $2,000 payment, she reports the second half of the gain, $500, as a capital gain.
Any depreciation claimed on personal property must be recaptured as ordinary income in the year of sale, even if there are no payments received in the year of sale. The depreciation recapture for real property is generally limited to the amount by which the depreciation claimed exceeds the amount available under the straight-line method of depreciation. The adjusted basis of the property being sold is increased by the amount of recaptured income that you include in your gross income in the year of sale so that the gain recognized in future years is decreased.
Sam sells tangible personal property to Betty in 2014 for $100,000 to be paid in installments over 5 years, beginning in 2014. Interest is payable at market rates. The property was originally purchased for $30,000. Because of depreciation, it has an adjusted basis of $20,000. There is a gain of $80,000 ($100,000 − $20,000), of which $10,000 is recaptured income to be reported on Sam’s 2014 return.
The $10,000 that is included in Sam’s income in the year of sale is added to the $20,000 adjusted basis to figure how much income Sam must report using the installment method. Therefore, Sam’s gross profit is $70,000 ($100,000 − $30,000). Sam’s gross profit percentage is 70%.
On each of the $20,000 payments that Sam receives from 2014 through 2018, $14,000 would be included in his income ($20,000 × 70%).
The installment sale rules contain a number of very important limitations.
Sales to a spouse or an 80% controlled entity. If you sell depreciable property to your spouse or to a partnership or corporation of which you own 80% or more, you must report all of the gain in the year of the sale, despite any installment payment schedules set up under the sale agreement. The same rule may also apply to the sale of property to a trust of which you (or your spouse) are a beneficiary.
Sales to other relatives. If you sell property, other than marketable securities, to a related person on an installment basis and that person resells (or makes a gift of) the property within 2 years, you have to recognize any additional gain in the year of the resale.
A related person includes your spouse, children, grandchildren, brothers and sisters, and parents. A related person is also any partnership in which you are a partner, any estates and trusts of which you are a beneficiary, any grantor trusts of which you are treated as an owner, and any corporation in which you own at least half of the total value of the stock.
The normal 3-year statute of limitations for tax assessments by the IRS is extended for resales of installment property by a related person. In these cases, the statute of limitations will not expire until 2 years after you report to the IRS that a resale took place.
Nontaxable trades. Special rules apply to the exchange of like-kind property, which is tax-free. However, property that is not like-kind included in the exchange is taxable. The installment method may be used for the property that is not like-kind.
Like-kind exchanges. For like-kind exchanges involving related parties, both parties must hold the property for more than 2 years for the original exchange to qualify as tax-free. This rule is applicable to both parties to the transaction, even though only one party avails himself or herself of like-kind treatment. Also, real property located in the United States and real property located outside the United States does not qualify as property of a like kind.
Disposing of installment obligations. If you sell property on an installment basis and then later dispose of the installment note, you may have to report a gain or a loss. Generally, the amount of your gain or loss is equal to the difference between your basis in the installment note and the amount you receive when you dispose of the note.
Toni sells real estate on an installment basis for a $200,000 note receivable and has a $120,000 gross profit from the sale. After she collects $100,000 (and reports a profit of $60,000, half her gross profit), she sells the remaining $100,000 note receivable to a bank for $95,000. Toni reports a $55,000 profit in the year of the sale of the note (the remaining $60,000 of gross profit less the $5,000 loss on the sale of the note).
A disposition for this purpose is not limited to a sale of the installment note. For example, if you make a sale of property after December 31, 1988, for more than $150,000, and you assign the installment obligation as collateral security for a loan, the IRS will treat this as a disposition. This is because you would have deferred the gain on the sale while obtaining the use of the money through a loan.
Publicly traded property. The installment method cannot be used for sales of publicly traded property, including stock or securities that are traded on an established securities market.
Repossessing property sold under the installment method. If you sell property on an installment plan, you may have to repossess it if, for example, the buyer defaults on his or her obligation. When repossession takes place, you may have to report a gain or a loss. You follow different rules for determining your gain or loss, depending on whether the property being repossessed is personal property or real property.
If you repossess personal property sold under an installment plan, you must compare the fair market value of the property recovered with your basis in the installment notes plus any expenses you had in connection with repossession. Under the installment method, your basis is the face value of the note still outstanding less the amount of unreported profit on the original sale. (If you did not use the installment reporting method, your basis is the value of the property at the time of the original sale less payments of principal received to date.) Personal property.
Your gain or loss is of the same character (short term or long term) as the gain or loss realized on the original sale if you used the installment method. If you did not, any gain resulting from repossession is treated as ordinary income. Any loss is an ordinary loss if the property is business property. If it is nonbusiness property, any loss resulting from repossession is treated as a short-term capital loss.
Real property. If you have to repossess your former residence because the buyer defaults and you excluded the gain (see chapter 15, Selling your home, for details), no gain or loss is recognized if you resell the house within 1 year of repossession. If the property is not resold within 1 year, you may have to recognize the gain. The amount of tax you may have to pay on the gain will depend on whether the house you repossessed was originally sold before, on, or after May 6, 1997. For houses sold before May 7, 1997, $125,000 of the gain could have been excluded or the gain could have been deferred by acquiring a replacement home. For houses sold after May 6, 1997, up to $250,000 or $500,000 of the gain may be excluded (see , chapter 15 Selling your home, for more information). You may never deduct a loss on repossession because you may not deduct losses on property used primarily for personal purposes.
Computing your gain or loss on repossessed real property. Generally, your gain or loss on property that you have repossessed equals (1) the total amount of payments you have received under the installment sale minus (2) the amount of taxable gain you have already reported on the installment sale.
The gain you report on the repossessed property is limited, however, to the gross profit you expected on the installment sale less repossession costs and the amount of taxable gain you have already reported on the installment sale. Your basis in the repossessed property is your adjusted basis at the time of the original sale less deferred gain on repossession.
Linda Smith sold a building that was not her personal residence to Ann Carter in 2009 for $100,000, payable in 10 annual installments. Linda’s basis in the building was $70,000, and no mortgage was outstanding. The expected gross profit in the sale was $30,000, and the gross profit percentage was 30%.
In 2014, Ann failed to pay the sixth installment. By then, Linda had recognized $15,000 of gain from the $50,000 in payments received. She repossessed the building, incurring legal fees of $1,000 in the process. Linda’s gain is computed as follows:
Payments received Less: Taxable gain already reported on sale
Gain subject to limitation
Limitation on gain
Gross profit expected on installment sale Less: Repossession costs Less: Taxable gain already reported on sale
$30,000 (1,000) (15,000)
Linda must report a $14,000 gain on repossession. Her basis in the reacquired building is $49,000, figured by taking $70,000 (her original adjusted basis) and subtracting $21,000 ($35,000 − $14,000), the amount of gain on repossession unrecognized because of the limitation on gain.
Computing interest on installment sales. Special rules may apply regarding the amount of interest to be recognized on installment sales of more than $3,000.
If the amount of interest is not specifically stated in the sales agreement or if the stated interest is at an unrealistically low rate, you must calculate unstated or imputed interest. In general, you have unstated interest if (1) the sum of all payments due more than 6 months after the date of sale exceeds (2) the present value of such payments and the present value of any interest payment provided for in the contract. Present value is determined by using a so-called testing rate compounded semiannually. If there is unstated interest, you are required to impute interest using the testing rate.
The testing rate is calculated by using the applicable federal rate (AFR). The AFR is based on average market yields of U.S. obligations. The AFR may be the short-, medium-, or long-term rate that U.S. obligations are yielding, depending on the length of the contract. If unstated interest results using the testing rate, then interest must be computed using the testing rate, compounded semiannually.
On June 1, 2014, Nicholas and Alexandra sell their limousine for $45,000, to be paid in three annual installments of $15,000 each on June 1, 2014, June 1, 2015, and June 1, 2016. No interest is stated in the sales contract. Their basis in the car is $35,000.
The imputed interest over the 2 years is $108 (0.18% compounded semiannually). This amount must be subtracted from the selling price when the gain on the sale is computed:
Stated selling price
Less: Unstated interest
Adjusted selling price
Gain on sale
Gross profit percentage: ($9,892 ÷ $44,892)
Imputed interest is important to consider for two reasons: (1) It alters the amount of gain on a sale, and (2) it is deductible as an interest expense by the buyer, subject to limitations (see chapter 24, Interest expense), and must be reported as interest income by the seller.
Note: If all of the installment payments are due within 1 year after the date of sale, it is not necessary to figure your imputed interest. Additionally, payments received within the first 6 months of a sale have no imputed interest. The AFR will be determined by the IRS every month.
You figure gain or loss on a sale or trade of property by comparing the amount you realize with the adjusted basis of the property.
Gain. If the amount you realize from a sale or trade is more than the adjusted basis of the property you transfer, the difference is a gain.
Loss. If the adjusted basis of the property you transfer is more than the amount you realize, the difference is a loss.
Adjusted basis. The adjusted basis of property is your original cost or other original basis properly adjusted (increased or decreased) for certain items. See chapter 13 for more information about determining the adjusted basis of property.
For tax years beginning in 2011, if the stock you sold during the year was acquired after 2010, your broker will be required to report on Form 1099-B your basis in the shares sold and whether any capital gain or loss was short-term or long-term. (For stock purchased and sold during 2014, any gain or loss will be classified as short-term since the securities have been held for less than a year.) The requirements to report basis and holding period (i.e., short- or long-term) was expanded in 2012 to cover mutual fund shares and stocks in a dividend reinvestment plan and beginning in 2013 has been expanded further to include bonds, commodity contracts, and options on securities. On the other hand, brokers are not required to report basis or holding period for any securities acquired before 2011. Regulations providing the requirements for broker reporting of the basis of debt instruments and options have phased-in effective dates. The IRS provided a January 1, 2014, start date for less complex debt instruments, options, and securities futures contracts. Basis reporting on other complex instruments is not required until January 1, 2016. See chapter 13, Basis of property, for more information.
Amount realized. The amount you realize from a sale or trade of property is everything you receive for the property minus your expenses of sale (such as redemption fees, sales commissions, sales charges, or exit fees). Amount realized includes the money you receive plus the fair market value of any property or services you receive. If you received a note or other debt instrument for the property, see How To Figure Gain or Loss in chapter 4 of Publication 550 to figure the amount realized.
If you finance the buyer’s purchase of your property and the debt instrument does not provide for adequate stated interest, the unstated interest that you must report as ordinary income will reduce the amount realized from the sale. For more information, see Publication 537.
Fair market value. Fair market value is the price at which the property would change hands between a buyer and a seller, neither being forced to buy or sell and both having reasonable knowledge of all the relevant facts.
Example. You trade A Company stock with an adjusted basis of $7,000 for B Company stock with a fair market value of $10,000, which is your amount realized. Your gain is $3,000 ($10,000 – $7,000).
Debt paid off. A debt against the property, or against you, that is paid off as a part of the transaction, or that is assumed by the buyer, must be included in the amount realized. This is true even if neither you nor the buyer is personally liable for the debt. For example, if you sell or trade property that is subject to a nonrecourse loan, the amount you realize generally includes the full amount of the note assumed by the buyer even if the amount of the note is more than the fair market value of the property.
Example. You sell stock that you had pledged as security for a bank loan of $8,000. Your basis in the stock is $6,000. The buyer pays off your bank loan and pays you $20,000 in cash. The amount realized is $28,000 ($20,000 + $8,000). Your gain is $22,000 ($28,000 – $6,000).
Payment of cash. If you trade property and cash for other property, the amount you realize is the fair market value of the property you receive. Determine your gain or loss by subtracting the cash you pay plus the adjusted basis of the property you trade in from the amount you realize. If the result is a positive number, it is a gain. If the result is a negative number, it is a loss.
If you receive a mortgage or a trust note, payments include some interest income in addition to principal.
Assume that a $10,000 installment note with a discounted value of $8,000 is given by an individual to a cash basis taxpayer in payment for a capital asset with a basis of $7,000. The taxpayer recognizes $1,000 ($8,000 − $7,000) as a capital gain. As each installment is paid, eight-tenths ($8,000 ÷ $10,000) of the payment is a return of principal and two-tenths is interest income.
If you are an accrual basis taxpayer—and most people are not—use the full face value of the note in computing your gain or loss on the sale. Consequently, payments on the note are returns of principal.
If you are a cash basis taxpayer, and if the installment note is given by a corporation and the discounted value of the note is used to compute your gain on the sale of a capital asset, the income to be recognized is a capital gain. If the note is given by an individual, the income is taxable as ordinary income.
A cash basis taxpayer sells a capital asset to a corporation in exchange for a $10,000 note with an interest rate of 5%. Because current interest rates are more than 5% or because of the corporation’s low credit status, the note has a discounted value of $8,000, 80% of its face value. The taxpayer uses the $8,000 value to compute gain or loss on the sale. When the corporation later pays the note, the $2,000 difference, which must be reported as income, is treated as a capital gain. If an individual had issued the note, the $2,000 gain to the taxpayer realized on payment of the note would be taxed as ordinary income.
Property used partly for business. If you sell or exchange property that you used for both business and personal purposes, the gain or loss on the sale or exchange must be figured as though you had sold two separate pieces of property. You must divide the selling price, selling expenses, and the basis between the business and personal parts. Depreciation is deducted from the basis of the business part. Gain or loss realized on the business part of the property may be treated as capital gain or loss, or as ordinary gain or loss (see Publication 544, Sales and Other Dispositions of Assets). Any gain realized on the personal part of the property is a capital gain. A loss on the personal part is not deductible.
No gain or loss. You may have to use a basis for figuring gain that is different from the basis used for figuring loss. In this case, you may have neither a gain nor a loss. See in Basis Other Than Cost chapter 13.
This section discusses trades that generally do not result in a taxable gain or deductible loss. For more information on nontaxable trades, see chapter 1 of Publication 544.
Like-kind exchanges. If you trade business or investment property for other business or investment property of a like kind, you do not pay tax on any gain or deduct any loss until you sell or dispose of the property you receive. To be nontaxable, a trade must meet all six of the following conditions.
The property must be business or investment property. You must hold both the property you trade and the property you receive for productive use in your trade or business or for investment. Neither property may be property used for personal purposes, such as your home or family car.
The property must not be held primarily for sale. The property you trade and the property you receive must not be property you sell to customers, such as merchandise.
The property must not be stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest, including partnership interests. However, see Special rules for mutual ditch, reservoir, or irrigation company stock, in chapter 4 of Publication 550 for an exception. Also, you can have a nontaxable trade of corporate stocks under a different rule, as discussed later.
There must be a trade of like property. The trade of real estate for real estate, or personal property for similar personal property, is a trade of like property. The trade of an apartment house for a store building, or a panel truck for a pickup truck, is a trade of like property. The trade of a piece of machinery for a store building is not a trade of like property. Real property located in the United States and real property located outside the United States are not like property. Also, personal property used predominantly within the United States and personal property used predominantly outside the United States are not like property.
The property to be received must be identified in writing within 45 days after the date you transfer the property given up in the trade.
The property to be received must be received by the earlier of:
The 180th day after the date on which you transfer the property given up in the trade, or
The due date, including extensions, for your tax return for the year in which the transfer of the property given up occurs.
Only gold members can continue reading. Log In or