2. Ordinary or
Capital Gain or Loss
You must classify your gains and losses as either
ordinary or capital (and your capital gains or losses as
either short-term or long-term). You must do this to
figure your net capital gain or loss.
For individuals, a net capital gain may be taxed at a
lower tax rate than ordinary income. See Capital Gains Tax Rates
in chapter 4. Your deduction for a net
capital loss may be limited. See Treatment of Capital Losses
in chapter 4.
Capital gain or loss.
Generally, you will have a capital gain or
loss if you sell or exchange a capital asset. You also
may have a capital gain if your section 1231
transactions result in a net gain.
Section 1231 transactions.
Section 1231 transactions are sales and
exchanges of property held longer than 1 year and either
used in a trade or business or held for the production
of rents or royalties. They also include certain
involuntary conversions of business or investment
property, including capital assets. See Section 1231 Gains and Losses
in chapter 3 for more information.
Topics - This
chapter discusses:
Useful Items - You
may want to see:
Form (and Instructions)
-
Schedule D (Form
1040)
Capital Gains
and Losses
-
4797
Sales of Business
Property
-
8594
Asset Acquisition Statement Under
Section 1060
See chapter 5 for information about getting
publications and forms.
Almost everything you own and use for personal
purposes or investment is a capital asset. For
exceptions, see Noncapital
Assets, later.
The following items are examples of capital assets.
-
Stocks and bonds.
-
A home owned and occupied by you and your
family.
-
Timber grown on your home property or investment
property, even if you make casual sales of the
timber.
-
Household furnishings.
-
A car used for pleasure or commuting.
-
Coin or stamp collections.
-
Gems and jewelry.
-
Gold, silver, and other metals.
Personal-use property. Property
held for personal use is a capital asset. Gain from a
sale or exchange of that property is a capital gain.
Loss from the sale or exchange of that property is not
deductible. You can deduct a loss relating to
personal-use property only if it results from a casualty
or theft.
Investment property.
Investment property (such as stocks and
bonds) is a capital asset, and a gain or loss from its
sale or exchange is a capital gain or loss. This
treatment does not apply to property used to produce
rental income. See Business
assets, later, under Noncapital Assets.
Release of restriction on land. Amounts
you receive for the release of a restrictive covenant in
a deed to land are treated as proceeds from the sale of
a capital asset.
A noncapital asset is property that is not a capital
asset. The following kinds of property are not capital
assets.
-
Property held mainly for sale to customers or
property that will physically become part of
merchandise for sale to customers. This includes stock
in trade, inventory, and other property you hold
mainly for sale to customers in your trade or
business. Inventories are discussed in Publication
538, Accounting Periods and Methods.
-
Accounts or notes receivable acquired in the
ordinary course of a trade or business for services
rendered or from the sale of any properties described
in (1).
-
Depreciable property used in your trade or business
or as rental property (including section 197
intangibles defined later ), even if the property is
fully depreciated (or amortized). Sales of this type
of property are discussed in chapter 3.
-
Real property used in your trade or business or as
rental property, even if the property is fully
depreciated.
-
A copyright; a literary, musical, or artistic
composition; a letter; a memorandum; or similar
property (such as drafts of speeches, recordings,
transcripts, manuscripts, drawings, or photographs)
-
Created by your personal efforts,
-
Prepared or produced for you (in the case of a
letter, memorandum, or similar property), or
-
Acquired from a person who created the property
or for whom the property was prepared under
circumstances (for example, by gift) entitling you
to the basis of the person who created the property,
or for whom it was prepared or produced.
-
U.S. Government publications you got from the
government for free or for less than the normal sales
price or that you acquired under circumstances
entitling you to the basis of someone who got the
publications for free or for less than the normal
sales price.
-
Any commodities derivative financial instrument
(discussed later) held by a commodities derivatives
dealer unless it meets both the following
requirements.
-
It is established to the satisfaction of the IRS
that the instrument has no connection to the
activities of the dealer as a dealer.
-
The instrument is clearly identified in the
dealer's records as meeting (a) by the end of the
day on which it was acquired, originated, or entered
into.
-
Any hedging transaction (defined later) that is
clearly identified as a hedging transaction by the end
of the day on which it was acquired, originated, or
entered into.
-
Supplies of a type you regularly use or consume in
the ordinary course of your trade or
business.
Property held mainly for sale to
customers. Stock in trade, inventory,
and other property you hold mainly for sale to customers
in your trade or business are not capital assets.
Inventories are discussed in Publication 538.
Business assets. Real
property and depreciable property used in your trade or
business or as rental property (including section 197
intangibles defined later under Dispositions of Intangible Property)
are not capital assets. The sale or
disposition of business property is discussed in chapter
3.
Letters and memorandums.
Letters, memorandums, and similar property
(such as drafts of speeches, recordings, transcripts,
manuscripts, drawings, or photographs) are not treated
as capital assets (as discussed earlier) if your
personal efforts created them or if they were prepared
or produced for you. Nor is this property a capital
asset if your basis in it is determined by reference to
the person who created it or the person for whom it was
prepared. For this purpose, letters and memorandums
addressed to you are considered prepared for you. If
letters or memorandums are prepared by persons under
your administrative control, they are considered
prepared for you whether or not you review them.
Commodities derivative financial
instrument.
A commodities derivative financial
instrument is a commodities contract or other financial
instrument for commodities (other than a share of
corporate stock, a beneficial interest in a partnership
or trust, a note, bond, debenture, or other evidence of
indebtedness, or a section 1256 contract) the value or
settlement price of which is calculated or determined by
reference to a specified index (as defined in section
1221(b) of the Internal Revenue Code).
Commodities derivative dealer.
A commodities derivative dealer is a person
who regularly offers to enter into, assume, offset,
assign, or terminate positions in commodities derivative
financial instruments with customers in the ordinary
course of a trade or business.
Hedging transaction. A hedging
transaction is any transaction you enter into in the
normal course of your trade or business primarily to
manage any of the following.
-
Risk of price changes or currency fluctuations
involving ordinary property you hold or will hold.
-
Risk of interest rate or price changes or currency
fluctuations for borrowings you make or will make, or
ordinary obligations you incur or will incur.
Sales and Exchanges
Between Related Persons
This section discusses the rules that may apply to
the sale or exchange of property between related
persons. If these rules apply, gains may be treated as
ordinary income and losses may not be deductible. See
Transfers to Spouse
in chapter 1 for rules that apply to
spouses.
If a gain is recognized on the sale or exchange of
property to a related person, the gain may be ordinary
income even if the property is a capital asset. It is
ordinary income if the sale or exchange is a depreciable
property transaction or a controlled partnership
transaction.
Depreciable property transaction.
Gain on the sale or exchange of property,
including a leasehold or a patent application, that is
depreciable property in the hands of the person who
receives it is ordinary income if the transaction is
either directly or indirectly between any of the
following pairs of entities.
-
A person and the person's controlled entity or
entities.
-
A taxpayer and any trust in which the taxpayer (or
his or her spouse) is a beneficiary unless the
beneficiary's interest in the trust is a remote
contingent interest; that is, the value of the
interest computed actuarially is 5% or less of the
value of the trust property.
-
An executor and a beneficiary of an estate unless
the sale or exchange is in satisfaction of a pecuniary
bequest.
-
An employer (or any person related to the employer
under rules (1), (2), or (3)) and a welfare benefit
fund (within the meaning of section 419(e) of the
Internal Revenue Code) that is controlled directly or
indirectly by the employer (or any person related to
the employer).
A person's controlled entity is
either of the following.
-
A corporation in which more than 50% of the value
of all outstanding stock, or a partnership in which
more than 50% of the capital interest or profits
interest, is directly or indirectly owned by or for
that person.
-
An entity whose relationship with that person is
one of the following.
-
A corporation and a partnership if the same
persons own more than 50% in value of the
outstanding stock of the corporation and more than
50% of the capital interest or profits interest in
the partnership.
-
Two corporations that are members of the same
controlled group as defined in section 1563(a) of
the Internal Revenue Code, except that �more than 50%� is substituted for
�at least 80%� in that
definition.
-
Two S corporations, if the same persons own more
than 50% in value of the outstanding stock of each
corporation.
-
Two corporations, one of which is an S
corporation, if the same persons own more than 50%
in value of the outstanding stock of each
corporation.
Controlled partnership
transaction.
A gain recognized in a controlled
partnership transaction may be ordinary income. The gain
is ordinary income if it results from the sale or
exchange of property that, in the hands of the party who
receives it, is a noncapital asset such as trade
accounts receivable, inventory, stock in trade, or
depreciable or real property used in a trade or
business.
A controlled partnership transaction
is a transaction directly or indirectly between either
of the following pairs of entities.
-
A partnership and a partner who directly or
indirectly owns more than 50% of the capital interest
or profits interest in the partnership.
-
Two partnerships, if the same persons directly or
indirectly own more than 50% of the capital interests
or profits interests in both partnerships.
Determining ownership.
In the transactions under Depreciable property transaction
and Controlled
partnership transaction, earlier, use the
following rules to determine the ownership of stock or a
partnership interest.
-
Stock or a partnership interest directly or
indirectly owned by or for a corporation, partnership,
estate, or trust is considered owned proportionately
by or for its shareholders, partners, or
beneficiaries. (However, for a partnership interest
owned by or for a C corporation, this applies only to
shareholders who directly or indirectly own 5% or more
in value of the stock of the corporation.)
-
An individual is considered as owning the stock or
partnership interest directly or indirectly owned by
or for his or her family. Family includes only
brothers, sisters, half-brothers, half-sisters,
spouse, ancestors, and lineal descendants.
-
For purposes of applying (1) or (2), stock or a
partnership interest constructively owned by a person
under (1) is treated as actually owned by that person.
But stock or a partnership interest constructively
owned by an individual under (2) is not treated as
owned by the individual for reapplying (2) to make
another person the constructive owner of that stock or
partnership interest.
A loss on the sale or exchange of property between
related persons is not deductible. This applies to both
direct and indirect transactions, but not to
distributions of property from a corporation in a
complete liquidation. The following are related persons.
-
Members of a family, including only brothers,
sisters, half-brothers, half-sisters, spouse,
ancestors (parents, grandparents, etc.), and lineal
descendants (children, grandchildren, etc.).
-
An individual and a corporation if the individual
directly or indirectly owns more than 50% in value of
the outstanding stock of the corporation.
-
Two corporations that are members of the same
controlled group as defined in section 267(f) of the
Internal Revenue Code.
-
A trust fiduciary and a corporation if the trust or
the grantor of the trust directly or indirectly owns
more than 50% in value of the outstanding stock of the
corporation.
-
A grantor and fiduciary, and the fiduciary and
beneficiary, of any trust.
-
Fiduciaries of two different trusts, and the
fiduciary and beneficiary of two different trusts, if
the same person is the grantor of both trusts.
-
A tax-exempt educational or charitable organization
and a person who directly or indirectly controls the
organization, or a member of that person's family.
-
A corporation and a partnership if the same persons
own more than 50% in value of the outstanding stock of
the corporation and more than 50% of the capital
interest or profits interest in the partnership.
-
Two S corporations if the same persons own more
than 50% in value of the outstanding stock of each
corporation.
-
Two corporations, one of which is an S corporation,
if the same persons own more than 50% in value of the
outstanding stock of each corporation.
-
An executor and a beneficiary of an estate unless
the sale or exchange is in satisfaction of a pecuniary
bequest.
-
Two partnerships if the same persons directly or
indirectly own more than 50% of the capital interests
or profits interests in both partnerships.
-
A person and a partnership if the person directly
or indirectly owns more than 50% of the capital
interest or profits interest in the partnership.
If a sale or exchange is between any of these related
persons and involves the lump-sum sale of a number of
blocks of stock or pieces of property, the gain or loss
must be figured separately for each block of stock or
piece of property. The gain on each item is taxable. The
loss on any item is nondeductible. Gains from the sales
of any of these items may not be offset by losses on the
sales of any of the other items.
Partnership interests. The
nondeductible loss rule does not apply to a sale or
exchange of an interest in the partnership between the
related persons described in (12) or (13) above.
Controlled groups.
Losses on transactions between members of
the same controlled group described in (3) earlier are
deferred rather than denied.
For more information, see section
267(f) of the Internal Revenue Code.
Ownership of stock or partnership
interests. In
determining whether an individual directly or indirectly
owns any of the outstanding stock of a corporation or an
interest in a partnership for a loss on a sale or
exchange, the following rules apply.
-
Stock or a partnership interest directly or
indirectly owned by or for a corporation, partnership,
estate, or trust is considered owned proportionately
by or for its shareholders, partners, or
beneficiaries. (However, for a partnership interest
owned by or for a C corporation, this applies only to
shareholders who directly or indirectly own 5% or more
in value of the stock of the corporation.)
-
An individual is considered as owning the stock or
partnership interest directly or indirectly owned by
or for his or her family. Family includes only
brothers, sisters, half-brothers, half-sisters,
spouse, ancestors, and lineal descendants.
-
An individual owning (other than by applying (2))
any stock in a corporation is considered to own the
stock directly or indirectly owned by or for his or
her partner.
-
For purposes of applying (1), (2), or (3), stock or
a partnership interest constructively owned by a
person under (1) is treated as actually owned by that
person. But stock or a partnership interest
constructively owned by an individual under (2) or (3)
is not treated as owned by the individual for
reapplying either (2) or (3) to make another person
the constructive owner of that stock or partnership
interest.
Indirect transactions.
You cannot deduct your loss on the sale of
stock through your broker if under a prearranged plan a
related person or entity buys the same stock you had
owned. This does not apply to a cross-trade between
related parties through an exchange that is purely
coincidental and is not prearranged.
Property received from a related
person. If, in a purchase or exchange,
you received property from a related person who had a
loss that was not allowable and you later sell or
exchange the property at a gain, you recognize the gain
only to the extent it is more than the loss previously
disallowed to the related person. This rule applies only
to the original transferee.
Example 1.
Your brother sold stock to you for $7,600. His cost
basis was $10,000. His loss of $2,400 was not
deductible. You later sell the same stock to an
unrelated party for $10,500, realizing a gain of $2,900
($10,500 - $7,600). Your recognized gain is only $500,
the gain that is more than the $2,400 loss not allowed
to your brother.
Example 2.
Assume the same facts as in Example 1, except that
you sell the stock for $6,900 instead of $10,500. Your
recognized loss is only $700 ($7,600 - $6,900). You
cannot deduct the loss not allowed to your brother.
This section discusses rules for determining the
treatment of gain or loss from various dispositions of
property.
The sale of a business usually is not a sale of one
asset. Instead, all the assets of the business are sold.
Generally, when this occurs, each asset is treated as
being sold separately for determining the treatment of
gain or loss.
A business usually has many assets. When sold, these
assets must be classified as capital assets, depreciable
property used in the business, real property used in the
business, or property held for sale to customers, such
as inventory or stock in trade. The gain or loss on each
asset is figured separately. The sale of capital assets
results in capital gain or loss. The sale of real
property or depreciable property used in the business
and held longer than 1 year results in gain or loss from
a section 1231 transaction (discussed in chapter 3). The
sale of inventory results in ordinary income or loss.
Partnership interests. An
interest in a partnership or joint venture is treated as
a capital asset when sold. The part of any gain or loss
from unrealized receivables or inventory items will be
treated as ordinary gain or loss. For more information,
see Disposition of Partner's
Interest in Publication 541.
Corporation interests.
Your interest in a corporation is
represented by stock certificates. When you sell these
certificates, you usually realize capital gain or loss.
For information on the sale of stock, see chapter 4 in
Publication 550.
Corporate liquidations.
Corporate liquidations of property generally
are treated as a sale or exchange. Gain or loss
generally is recognized by the corporation on a
liquidating sale of its assets. Gain or loss generally
is recognized also on a liquidating distribution of
assets as if the corporation sold the assets to the
distributee at fair market value.
In certain cases in which the
distributee is a corporation in control of the
distributing corporation, the distribution may not be
taxable. For more information, see Internal Revenue Code
section 332 and its regulations.
Allocation of consideration paid for a
business. The sale of a trade or
business for a lump sum is considered a sale of each
individual asset rather than of a single asset. Except
for assets exchanged under any nontaxable exchange
rules, both the buyer and seller of a business must use
the residual method (explained later) to allocate the
consideration to each business asset transferred. This
method determines gain or loss from the transfer of each
asset and how much of the consideration is for goodwill
and certain other intangible property. It also
determines the buyer's basis in the business assets.
Consideration. The
buyer's consideration is the cost of the assets
acquired. The seller's consideration is the amount
realized (money plus the fair market value of property
received) from the sale of assets.
Residual method. The
residual method must be used for any transfer of a group
of assets that constitutes a trade or business and for
which the buyer's basis is determined only by the amount
paid for the assets. This applies to both direct and
indirect transfers, such as the sale of a business or
the sale of a partnership interest in which the basis of
the buyer's share of the partnership assets is adjusted
for the amount paid under section 743(b) of the Internal
Revenue Code. Section 743(b) applies if a partnership
has an election in effect under section 754 of the
Internal Revenue Code.
A group of assets constitutes a trade
or business if either of the following applies.
-
Goodwill or going concern value could, under any
circumstances, attach to them.
-
The use of the assets would constitute an active
trade or business under section 355 of the Internal
Revenue Code. The residual method
provides for the consideration to be reduced first by
the cash and general deposit accounts (including
checking and savings accounts but excluding certificates
of deposit). The consideration remaining after this
reduction must be allocated among the various business
assets in a certain order.
For asset acquisitions occurring
after March 15, 2001, make the allocation among the
following assets in proportion to (but not more than)
their fair market value on the purchase date in the
following order.
-
Certificates of deposit, U.S. Government
securities, foreign currency, and actively traded
personal property, including stock and securities.
-
Accounts receivable, other debt instruments, and
assets that you mark to market at least annually for
federal income tax purposes. However, see section
1.338-6(b)(2)(iii) of the regulations for exceptions
that apply to debt instruments issued by persons
related to a target corporation, contingent debt
instruments, and debt instruments convertible into
stock or other property.
-
Property of a kind that would properly be included
in inventory if on hand at the end of the tax year or
property held by the taxpayer primarily for sale to
customers in the ordinary course of business.
-
All other assets except section 197
intangibles.
-
Section 197 intangibles (other than goodwill and
going concern value).
-
Goodwill and going concern value (whether the
goodwill or going concern value qualifies as a section
197 intangible). If an asset
described in (1) through (6) is includible in more than
one category, include it in the lower number category.
For example, if an asset is described in both (4) and
(6), include it in (4).
Example.
The total paid in the January 10, 2004, sale of the
assets of Company SKB is $21,000. No cash or deposit
accounts or similar accounts were sold. The company's
U.S. Government securities sold had a fair market value
of $3,200. The only other asset transferred (other than
goodwill and going concern value) was inventory with a
fair market value of $15,000. Of the $21,000 paid for
the assets of Company SKB, $3,200 is allocated to U.S.
Government securities, $15,000 to inventory assets, and
the remaining $2,800 to goodwill and going concern
value.
Agreement. The
buyer and seller may enter into a written agreement as
to the allocation of any consideration or the fair
market value of any of the assets. This agreement is
binding on both parties unless the IRS determines the
amounts are not appropriate.
Reporting requirement.
Both the buyer and seller involved in the
sale of business assets must report to the IRS the
allocation of the sales price among section 197
intangibles and the other business assets. Use Form 8594
to provide this
information. The buyer and seller should each attach
Form 8594 to their federal income tax return for the
year in which the sale occurred.
Dispositions of
Intangible Property
Intangible property is any personal property that has
value but cannot be seen or touched. It includes such
items as patents, copyrights, and the goodwill value of
a business.
Gain or loss on the sale or exchange of amortizable
or depreciable intangible property held longer than 1
year (other than an amount recaptured as ordinary
income) is a section 1231 gain or loss. The treatment of
section 1231 gain or loss and the recapture of
amortization and depreciation as ordinary income are
explained in chapter 3. See chapter 9 of Publication
535, Business Expenses, for information on amortizable
intangible property and chapter 1 of Publication 946,
How To Depreciate Property, for information on
intangible property that can and cannot be depreciated.
Gain or loss on dispositions of other intangible
property is ordinary or capital depending on whether the
property is a capital asset or a noncapital asset.
The following discussions explain special rules that
apply to certain dispositions of intangible property.
Section 197 intangibles are certain intangible assets
acquired after August 10, 1993 (after July 25, 1991, if
chosen), and held in connection with the conduct of a
trade or business or an activity entered into for profit
whose costs are amortized over 15 years. They include
the following assets.
-
Goodwill.
-
Going concern value.
-
Workforce in place.
-
Business books and records, operating systems, and
other information bases.
-
Patents, copyrights, formulas, processes, designs,
patterns, know how, formats, and similar items.
-
Customer-based intangibles.
-
Supplier-based intangibles.
-
Licenses, permits, and other rights granted by a
governmental unit.
-
Covenants not to compete entered into in connection
with the acquisition of a business.
-
Franchises, trademarks, and trade
names.
For more information, see chapter 9 of Publication
535.
Dispositions. The
following rules apply to dispositions of section 197
intangibles.
Covenant not to compete. A covenant
not to compete (or similar arrangement) that is a
section 197 intangible cannot be treated as disposed of
or worthless before you have disposed of your entire
interest in the trade or business for which the covenant
was entered into. Members of the same controlled group
of corporations and commonly controlled businesses are
treated as a single entity in determining whether a
member has disposed of its entire interest in a trade or
business.
Nondeductible loss.
You cannot deduct a loss from the
disposition or worthlessness of a section 197 intangible
you acquired in the same transaction (or series of
related transactions) as another section 197 intangible
you still hold. Instead, you must increase the adjusted
basis of your retained section 197 intangible by the
nondeductible loss. If you retain more than one section
197 intangible, increase each intangible's adjusted
basis. Figure the increase by multiplying the
nondeductible loss by a fraction, the numerator (top
number) of which is the retained intangible's adjusted
basis on the date of the loss and the denominator
(bottom number) of which is the total adjusted basis of
all retained intangibles on the date of the loss.
In applying this rule, members of the
same controlled group of corporations and commonly
controlled businesses are treated as a single entity.
For example, a corporation cannot deduct a loss on the
sale of a section 197 intangible if, after the sale, a
member of the same controlled group retains other
section 197 intangibles acquired in the same transaction
as the intangible sold.
Anti-churning rules.
Anti-churning rules prevent a taxpayer from
converting section 197 intangibles that do not qualify
for amortization into property that would qualify for
amortization. However, these rules do not apply to part
of the basis of property acquired by certain related
persons if the transferor chooses to do both the
following.
If the transferor is a partnership or
S corporation, the partnership or S corporation (not the
partners or shareholders) can make the choice. But each
partner or shareholder must pay the tax on his or her
share of gain.
To make the choice, you, as the
transferor, must attach a statement containing certain
information to your income tax return for the year of
the transfer. You must file the tax return by the due
date (including extensions). You must also notify the
transferee of the choice in writing by the due date of
the return.
If you timely filed your return
without making the choice, you can make the choice by
filing an amended return within 6 months after the due
date of the return (excluding extensions). Attach the
statement to the amended return and write � Filed under section 301.9100-2� at
the top of the statement. File the amended return at the
same address the original return was filed.
For more information about making the choice, see
section 1.197-2(h)(9) of the regulations. For
information about reporting the tax on your income tax
return, see the instructions for Form 4797.
The transfer of a patent by an individual is treated
as a sale or exchange of a capital asset held longer
than 1 year. This applies even if the payments for the
patent are made periodically during the transferee's use
or are contingent on the productivity, use, or
disposition of the patent. For information on the
treatment of gain or loss on the transfer of capital
assets, see chapter 4.
This treatment applies to your transfer of a patent
if you meet all the following conditions.
-
You are the holder of the patent.
-
You transfer the patent other than by gift,
inheritance, or devise.
-
You transfer all substantial rights to the patent
or an undivided interest in all such rights.
-
You do not transfer the patent to a related
person.
Holder. You are the
holder of a patent if you are either of the following.
-
The individual whose effort created the patent
property and who qualifies as the original and first
inventor.
-
The individual who bought an interest in the patent
from the inventor before the invention was tested and
operated successfully under operating conditions and
who is neither related to, nor the employer of, the
inventor.
All substantial rights.
All substantial rights to patent property
are all rights that have value when they are
transferred. A security interest (such as a lien), or a
reservation calling for forfeiture for nonperformance,
is not treated as a substantial right for these rules
and may be kept by you as the holder of the patent.
All substantial rights to a patent
are not transferred if any of the following apply to the
transfer.
-
The rights are limited geographically within a
country.
-
The rights are limited to a period less than the
remaining life of the patent.
-
The rights are limited to fields of use within
trades or industries and are less than all the rights
that exist and have value at the time of the transfer.
-
The rights are less than all the claims or
inventions covered by the patent that exist and have
value at the time of the transfer.
Related persons. This tax
treatment does not apply if the transfer is directly or
indirectly between you and a related person as defined
earlier under Nondeductible
Loss, with the following changes.
-
Members of your family include your spouse,
ancestors, and lineal descendants, but not your
brothers, sisters, half-brothers, or half-sisters.
-
Substitute �25% or more�
ownership for �more than 50%�
in that listing.
If you fit within the definition of a
related person independent of family status, the
brother-sister exception in (1), earlier, does not
apply. For example, a transfer between a brother and a
sister as beneficiary and fiduciary of the same trust is
a transfer between related persons. The brother-sister
exception does not apply because the trust relationship
is independent of family status.
Franchise,
Trademark, or Trade Name
If you transfer or renew a franchise, trademark, or
trade name for a price contingent on its productivity,
use, or disposition, the amount you receive generally is
treated as an amount realized from the sale of a
noncapital asset. A franchise includes an agreement that
gives one of the parties the right to distribute, sell,
or provide goods, services, or facilities within a
specified area.
Significant power, right, or continuing
interest. If you keep any significant
power, right, or continuing interest in the subject
matter of a franchise, trademark, or trade name that you
transfer or renew, the amount you receive is ordinary
royalty income rather than an amount realized from a
sale or exchange.
A significant power, right, or
continuing interest in a franchise, trademark, or trade
name includes, but is not limited to, the following
rights in the transferred interest.
-
A right to disapprove any assignment of the
interest, or any part of it.
-
A right to end the agreement at will.
-
A right to set standards of quality for products
used or sold, or for services provided, and for the
equipment and facilities used to promote such products
or services.
-
A right to make the recipient sell or advertise
only your products or services.
-
A right to make the recipient buy most supplies and
equipment from you.
-
A right to receive payments based on the
productivity, use, or disposition of the transferred
item of interest if those payments are a substantial
part of the transfer agreement.
If you own a tract of land and, to sell or exchange
it, you subdivide it into individual lots or parcels,
the gain normally is ordinary income. However, you may
receive capital gain treatment on at least part of the
proceeds provided you meet certain requirements. See
section 1237 of the Internal Revenue Code.
Standing timber held as investment property is a
capital asset. Gain or loss from its sale is reported as
a capital gain or loss on Schedule D (Form 1040). If you
held the timber primarily for sale to customers, it is
not a capital asset. Gain or loss on its sale is
ordinary business income or loss. It is reported in the
gross receipts or sales and cost of goods sold items of
your return.
Farmers who cut timber on their land and sell it as
logs, firewood, or pulpwood usually have no cost or
other basis for that timber. These sales constitute a
very minor part of their farm businesses. In these
cases, amounts realized from such sales, and the
expenses of cutting, hauling, etc., are ordinary farm
income and expenses reported on Schedule F (Form 1040),
Profit or Loss From Farming.
Different rules apply if you owned the timber longer
than 1 year and choose to either:
Under the rules discussed below, disposition of the
timber is treated as a section 1231 transaction. See
chapter 3. Gain or loss is reported on Form 4797.
Christmas trees.
Evergreen trees, such as Christmas trees,
that are more than 6 years old when severed from their
roots and sold for ornamental purposes are included in
the term timber. They qualify for both rules discussed
below.
Choice to treat cutting as a sale or
exchange. Under the general rule, the
cutting of timber results in no gain or loss. It is not
until a sale or exchange occurs that gain or loss is
realized. But if you owned or had a contractual right to
cut timber, you can choose to treat the cutting of
timber as a section 1231 transaction in the year the
timber is cut. Even though the cut timber is not
actually sold or exchanged, you report your gain or loss
on the cutting for the year the timber is cut. Any later
sale results in ordinary business income or loss. See
Example, later.
To choose this treatment, you must:
-
Own, or hold a contractual right to cut, the timber
for a period of more than 1 year before it is cut,
and
-
Cut the timber for sale or for use in your trade or
business.
Making the choice.
You make the choice on your return for the
year the cutting takes place by including in income the
gain or loss on the cutting and including a computation
of the gain or loss. You do not have to make the choice
in the first year you cut timber. You can make it in any
year to which the choice would apply. If the timber is
partnership property, the choice is made on the
partnership return. This choice cannot be made on an
amended return.
Once you have made the choice, it
remains in effect for all later years unless you cancel
it.
An
election to treat the cutting of timber as a sale or
exchange may be revoked without IRS approval if the
election was made before October 23, 2004, for a tax
year ending after October 22, 2004. Currently, IRS
approval is required only if an election is made for a
tax year ending before October 23, 2004.
Gain or loss. Your
gain or loss on the cutting of standing timber is the
difference between its adjusted basis for depletion and
its fair market value on the first day of your tax year
in which it is cut.
Your adjusted basis for depletion of
cut timber is based on the number of units (feet board
measure, log scale, or other units) of timber cut during
the tax year and considered to be sold or exchanged.
Your adjusted basis for depletion is also based on the
depletion unit of timber in the account used for the cut
timber, and should be figured in the same manner as
shown in section 611 of the Internal Revenue Code and
regulation section 1.611-3.
Timber depletion is discussed in
chapter 10 in Publication 535.
Example.
In April 2004, you had owned 4,000 MBF (1,000 board
feet) of standing timber longer than 1 year. It had an
adjusted basis for depletion of $40 per MBF. You are a
calendar year taxpayer. On January 1, 2004, the timber
had a fair market value (FMV) of $350 per MBF. It was
cut in April for sale. On your 2004 tax return, you
choose to treat the cutting of the timber as a sale or
exchange. You report the difference between the fair
market value and your adjusted basis for depletion as a
gain. This amount is reported on Form 4797 along with
your other section 1231 gains and losses to figure
whether it is treated as capital gain or as ordinary
gain. You figure your gain as follows.
The fair market value becomes your basis in the cut
timber and a later sale of the cut timber including any
by-product or tree tops will result in ordinary business
income or loss.
Cutting contract. You
must treat the disposal of standing timber under a
cutting contract as a section 1231 transaction if all
the following apply to you.
-
You are the owner of the timber.
-
You held the timber longer than 1 year before its
disposal.
-
You kept an economic interest in the
timber.
The difference between the amount
realized from the disposal of the timber and its
adjusted basis for depletion is treated as gain or loss
on its sale. Include this amount on Form 4797 along with
your other section 1231 gains or losses to figure
whether it is treated as capital or ordinary gain or
loss.
Date of disposal.
The date of disposal is the date the timber
is cut. However, if you receive payment under the
contract before the timber is cut, you can choose to
treat the date of payment as the date of disposal.
This choice applies only to figure
the holding period of the timber. It has no effect on
the time for reporting gain or loss (generally when the
timber is sold or exchanged).
To make this choice, attach a
statement to the tax return filed by the due date
(including extensions) for the year payment is received.
The statement must identify the advance payments subject
to the choice and the contract under which they were
made.
If you timely filed your return for
the year you received payment without making the choice,
you still can make the choice by filing an amended
return within 6 months after the due date for that
year's return (excluding extensions). Attach the
statement to the amended return and write � Filed under section 301.9100-2� at
the top of the statement. File the amended return at the
same address the original return was filed.
Owner. The owner
of timber is any person who owns an interest in it,
including a sublessor and the holder of a contract to
cut the timber. You own an interest in timber if you
have the right to cut it for sale on your own account or
for use in your business.
Economic interest.
You have kept an economic interest in
standing timber if, under the cutting contract, the
expected return on your investment is conditioned on the
cutting of the timber.
Tree stumps. Tree
stumps are a capital asset if they are on land held by
an investor who is not in the timber or stump business
as a buyer, seller, or processor. Gain from the sale of
stumps sold in one lot by such a holder is taxed as a
capital gain. However, tree stumps held by timber
operators after the saleable standing timber was cut and
removed from the land are considered by-products. Gain
from the sale of stumps in lots or tonnage by such
operators is taxed as ordinary income.
Precious Metals
and Stones, Stamps, and Coins
Gold, silver, gems, stamps, coins, etc., are capital
assets except when they are held for sale by a dealer.
Any gain or loss from their sale or exchange generally
is a capital gain or loss. If you are a dealer, the
amount received from the sale is ordinary business
income.
You must treat the disposal of coal (including
lignite) or iron ore mined in the United States as a
section 1231 transaction if both the following apply to
you.
For this rule, the date the coal or iron ore is mined
is considered the date of its disposal.
Your gain or loss is the difference between the
amount realized from disposal of the coal or iron ore
and the adjusted basis you use to figure cost depletion
(increased by certain expenses not allowed as deductions
for the tax year). This amount is included on Form 4797
along with your other section 1231 gains and losses.
You are considered an owner if you own or sublet an
economic interest in the coal or iron ore in place. If
you own only an option to buy the coal in place, you do
not qualify as an owner. In addition, this gain or loss
treatment does not apply to income realized by an owner
who is a co-adventurer, partner, or principal in the
mining of coal or iron ore.
The expenses of making and administering the contract
under which the coal or iron ore was disposed of and the
expenses of preserving the economic interest kept under
the contract are not allowed as deductions in figuring
taxable income. Rather, their total, along with the
adjusted depletion basis, is deducted from the amount
received to determine gain. If the total of these
expenses plus the adjusted depletion basis is more than
the amount received, the result is a loss.
Special rule. The above
treatment does not apply if you directly or indirectly
dispose of the iron ore or coal to any of the following
persons.
-
A related person whose relationship to you would
result in the disallowance of a loss (see Nondeductible Loss
under Sales and
Exchanges Between Related Persons,
earlier).
-
An individual, trust, estate, partnership,
association, company, or corporation owned or
controlled directly or indirectly by the same
interests that own or control your business.
Recognized gain on the disposition or termination of
any position held as part of certain conversion
transactions is treated as ordinary income. This applies
if substantially all your expected return is
attributable to the time value of your net investment
(like interest on a loan) and the transaction is any of
the following.
-
An applicable straddle (generally, any set of
offsetting positions with respect to personal
property, including stock).
-
A transaction in which you acquire property and, at
or about the same time, you contract to sell the same
or substantially identical property at a specified
price.
-
Any other transaction that is marketed and sold as
producing capital gain from a transaction in which
substantially all of your expected return is due to
the time value of your net investment.
For more information, see chapter 4 of Publication
550.
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