Tax 2011 Chapter 10

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Chapter 10
Property: Dispositions


Discussion Questions:

1. [LO 1] Compare and contrast different ways in which a taxpayer triggers a realization event by disposing of an asset.

A realization event for tax purposes is created in many ways. Virtually any disposal will result in a sale or other disposition. These include a sale, trade, gift to charity, disposal to the landfill, or destruction in a natural disaster. In a sale or trade (exchange), the taxpayer receives something of value in return for the asset. In contrast, a charitable contribution, disposal, or destruction from a natural disaster generally results in a loss of any remaining basis in the asset without compensation (unless reimbursed by insurance).
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Every sale or disposition results in a realized gain or loss (unless, of course, the amount realized is equal to the adjusted basis). Most realized gains or losses become recognized gains or losses and are included on the taxpayer’s tax return and increases (or decreases in the case of a loss) the taxpayer’s taxable income and subsequent tax. However, there are some realized gains or losses that are excluded from income or deferred to a later time period.

6. [LO 2] What does it mean to characterize a gain or loss? Why is characterizing a gain or loss important?

Once a gain or loss is recognized, a taxpayer must determine how the recognized gain or loss affects the taxpayer’s tax liability. The character depends on a combination of two factors: purpose or use of the asset and holding period. The purpose or use of the asset is important because the law does not treat all assets equally. The general use categories are: (1) trade or business, (2) for the production of income (rental activities), (3) investment, and (4) personal. Based on these criteria, we can categorize an asset into one of three groups: (1) ordinary, (2) capital, or (3) section 1231. Characterizing the gain or loss is important because all gains and losses are not equal. Ordinary gains and losses are taxed at ordinary income rates, regardless of the holding period. Capital gains on assets held for more than a year receive preferential rates while capital gains on assets held for

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