Federal Income Taxation

<p>Each year, an individual&rsquo;s basis is reduced by the amount of the depreciation deduction taken so that his adjusted basis in the property reflects accumulated depreciation deductions. If depreciation is not deducted, his basis must nonetheless be reduced by the amount of depreciation allowable, but the deduction may not be taken in a subsequent year.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <p style="text-align: center"><strong>Recapture</strong></p><p><br /> Upon disposition of property, the seller often realizes more than return of basis after it has been reduced for depreciation. Legislative policy is that on certain dispositions of depreciated property the seller realizes a gain that is, at least in part, attributable to depreciation. To prevent a double benefit, the IRC requires that some of the gain that would otherwise generally be capital gain must be treated as ordinary income. In effect, it requires the seller to &ldquo;recapture&rdquo; some of the ordinary income earlier offset by the depreciation.<a href="#_ftn2" name="_ftnref2">²</a> In addition, if depreciated property ceases to be used predominantly in a trade or business before the end of its recovery period, the owner must recapture in the tax year of cessation any benefit derived from expensing such property.<a href="#_ftn3" name="_ftnref3">³</a> This provision is effective for property placed in service in tax years ending after January 25, 1993.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> </p><hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;IRC &sect; 1016(a)(2).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;IRC &sect;&sect; 1245, 1250.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Treas. Reg. &sect; 1.179-1(e)(1).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Treas. Reg. &sect; 1.179-6.</p></p><br />

<p>For tax purposes, a &ldquo;capital asset&rdquo; is any property that, in the hands of the taxpayer, is not: (1) property (including inventory and stock in trade) held primarily for sale to customers; (2) real or depreciable property used in his trade or business; (3) copyrights and literary, musical, or artistic compositions (or similar properties) created by the taxpayer, or merely owned by him, if his tax basis in the property is determined (other than by reason of IRC Section 1022, which governs the basis determination of inherited property) by reference to the creator&rsquo;s tax basis; (4) letters, memoranda, and similar properties produced by or for the taxpayer, or merely owned by him, if his tax basis is determined by reference to the tax basis of such producer or recipient; (5) accounts or notes receivable acquired in his trade or business for services rendered or sales of property described in (1), above; (6) certain publications of the United States government; (7) any commodities derivative financial instrument held by a commodities derivatives dealer; (8) any hedging instrument that is clearly identified as such by the required time; and (9) supplies of a type regularly used or consumed by the taxpayer in the ordinary course of his trade or business.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> Generally, any property held as an investment is a capital asset, except that rental real estate is generally not a capital asset because it is treated as a trade or business asset (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7791">7791</a>).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>.IRC &sect; 1221; Treas. Reg. &sect; 1.1221-1.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.See IRS Pub. 544.</p></p><br />

<p>As a general rule, the income is taxable to the minor. However, in the case of <em>unearned</em> income (such as trust income) of most children under age nineteen (age 24, if the child is a full-time student), different rules may apply.<br /> <br /> Prior to 2018 and after 2019, the unearned income taxable to the child generally is taxed at the parents&rsquo; marginal rate when it exceeds $2,600 in 2024, up from $2,500 in 2023, $2,300 in 2022, $2,200 in 2015 to 2021, as adjusted for inflation.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> <hr><strong>Planning Point:</strong><p> Taxpayers had the option of applying a different set of rules in 2018 and 2019 under the 2017 tax reform legislation. If the election was made, earned income of minors would be taxed according to the individual income tax rates prescribed for single filers,<a href="#_ftn2" name="_ftnref2">²</a> and <em>unearned</em> income of minors would be taxed according to the applicable tax bracket that would apply if the income was that of a trust or estate (for both income that is subject to ordinary income tax rates and in determining the capital gains rate that will apply if long-term capital gains treatment is appropriate).<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> </p><hr><p><br /> <br /> To the extent that income from the transferred property is used for the minor&rsquo;s support, it may be taxed to the person who is legally obligated to support the minor.<a href="#_ftn4" name="_ftnref4">⁴</a> State laws differ as to a parent&rsquo;s obligation to support. The income will be taxable to the parent only to the extent that it is actually used to discharge or satisfy the parent&rsquo;s obligation under state law.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> The 2017 Tax Act aimed to simplify the treatment of unearned income of minors by applying the tax rates that apply to trusts and estates to this income. The SECURE Act<a href="#_ftn6" name="_ftnref6">⁶</a> repealed this rule for tax years beginning in 2020 and thereafter. For 2018 and 2019, taxpayers had the option of electing which set of rules to apply, and may apply for refunds if appropriate for these tax years.<br /> <br /> </p><hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>.Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.IRC &sect; 1(j)(4)(B).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.IRC &sect; 1(j)(4).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.Rev. Rul. 56-484, 1956 CB 23; Rev. Rul. 59-357, 1959 CB 212.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.IRC &sect; 677(b).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.PL 116-94, 133 Stat. 2534 (120019)</p></p><br />

<p>In order to claim bonus depreciation with respect to used property, the property must not be used by the taxpayer or a predecessor at any time before the taxpayer acquired the property (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>). This requirement raised questions as to whether bonus depreciation could be available with respect to property that the taxpayer previously leased, or in which the taxpayer previously held an interest but did not own entirely. See the heading below for a discussion of the short holding period exception proposed in the 2019 regulations.<br /> <br /> Under the regulations, bonus depreciation may now be available for property that a taxpayer previously leased and later acquired. In some situations, a taxpayer may make improvements to property that is leased and obtained a depreciable interest in the property as a result.&nbsp;If the taxpayer later acquires the property, bonus depreciation is unavailable with respect to the portion of the property in which the taxpayer held a depreciable interest during the lease period.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> Relatedly, if a taxpayer originally held a depreciable interest in property, and later acquires an additional depreciable interest in an additional portion of the same property, the additional depreciable interest is not treated as though it was used by the taxpayer prior to acquisition (i.e., it is eligible for bonus depreciation under the used property rules if all other requirements are satisfied). If the taxpayer previously had a depreciable interest in the subsequently acquired additional portion, bonus depreciation is not available. A different rule applies in situations where a taxpayer sells a partial interest in property and later buys a partial interest in the same property. If a taxpayer holds a depreciable interest in a portion of the property, sells that portion or a part of that portion, and later acquires a depreciable interest in another portion of the same property, the taxpayer is treated as previously having a depreciable interest in the property up to the amount of the portion for which the taxpayer held a depreciable interest in the property before the sale.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Under the 2019 proposed regulations, the mere fact that a business leases property to a disqualified business (i.e., one that does not qualify to use bonus depreciation, such as certain businesses with floor plan financing interest) does not &ldquo;taint&rdquo; the property, meaning that such exclusion from the additional first year depreciation deduction does not apply to lessors of property to a trade or business described in IRC Section 168(k)(9) so long as the lessor is not described the section.<a href="#_ftn3" name="_ftnref3">³</a><br /> <p style="text-align: center"><strong>Short Holding Period Exception</strong></p><p><br /> The 2019 regulations provide an exception to the depreciable interest rule in situations where the taxpayer disposes of the property within a short period of time after placing the property in service. If the following are true:<br /> </p><p style="padding-left: 40px">(a)&nbsp;&nbsp;&nbsp; a taxpayer acquires and places in service property,</p><p style="padding-left: 40px">(b)&nbsp;&nbsp;&nbsp; the taxpayer or a predecessor did not previously have a depreciable interest in the property,</p><p style="padding-left: 40px">(c)&nbsp;&nbsp;&nbsp;&nbsp; the taxpayer disposes of the property to an unrelated party within 90 calendar days after the date the property was originally placed in service by the taxpayer (without taking into account the applicable convention), and</p><p style="padding-left: 40px">(d)&nbsp;&nbsp;&nbsp; the taxpayer reacquires and again places in service the property, then</p><p><br /> the taxpayer&rsquo;s depreciable interest in the property during that 90-day period is not taken into account for determining whether the property was used by the taxpayer or a predecessor at any time prior to its reacquisition by the taxpayer.<a href="#_ftn4" name="_ftnref4">⁴</a> The proposed rule does not apply if the taxpayer reacquires and again places in service the property during the same taxable year the taxpayer disposed of the property.<br /> <br /> </p><hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Treas. Reg. &sect; 1.168(k)-2(b)(3)(iii)(B)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Treas. Reg. &sect; 1.168(k)-2(b)(3)(iii)(B)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Treas. Reg. &sect; 1.168(k)- 2(b)(2)(ii)(F).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Prop. Treas. Reg. &sect; 1.168(k)-2(b)(3)(iii)(B)(4).</p></p><br />

<p>The bonus depreciation rules (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>) may be applied to used property if the property was not used by the taxpayer (or a predecessor) prior to the acquisition. The property is considered to have been used by the taxpayer or a predecessor prior to the acquisition if the taxpayer or predecessor had a depreciable interest in the property at any time prior to the acquisition, regardless of whether depreciation deductions were actually claimed.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> Under the 2019 final regulations, &ldquo;predecessor&rdquo; is defined to include (i) a transferor of an asset to a transferee in a transaction to which IRC Section 381(a) applies, (ii) a transferor of an asset to a transferee in a transaction in which the transferee&rsquo;s basis in the asset is determined, in whole or in part, by reference to the basis of the asset in the hands of the transferor, (iii) a partnership that is considered as continuing under IRC Section 708(b)(2), (iv) the decedent in the case of an asset acquired by an estate, or (v) a transferor of an asset to a trust.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Further, all of the following must be true:<br /> <p style="padding-left: 40px">(1)&nbsp;&nbsp;&nbsp; the property was not acquired from certain related parties, including: (a) the taxpayer&rsquo;s spouse, ancestors and descendants, (b) an individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the individual, (c) a grantor and a fiduciary of any trust, (d) a fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts, (e) a fiduciary and a beneficiary of a trust, (f) a fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts, (g) a fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is a grantor of the trust, (h) a person and an organization to which IRC Section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies and which is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual, (i) a corporation and a partnership if the same person owns more than 50 percent of the outstanding stock in the corporation or capital interest or profits of the partnership, (j) an S corporation and another S corporation if the same person owns more than 50 percent of the outstanding stock of each corporation, (k) an S corporation and a C corporation, if the same persons own more than 50 percent in value of the outstanding stock of each corporation, (l) the executor and beneficiary of an estate, (m) two partnerships in which the same person owns more than 50 percent of the capital interests and profits or (n) a partnership and a person owning more than 50 percent of the capital interests and profits of the partnership.</p><hr><strong><strong>Planning Point:</strong></strong><p> The IRS regulations on the bonus depreciation rules contain a general anti-abuse rule that will apply to determine related party status. The rules provide that in a series of related transactions, the property is treated as though it was transferred directly from its original owner to its ultimate owner. The relationship between the original owner and the ultimate owner is tested immediately after the last transfer in the series of transactions. The 2019 final regulations provide for a five-year &ldquo;lookback&rdquo; period in making the determination as to whether the property was previously used by a prohibited party.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> </p><hr><p style="padding-left: 40px">(2)&nbsp;&nbsp;&nbsp; the property was not acquired by one member of a controlled group from another member of that group,</p><p style="padding-left: 40px">(3)&nbsp;&nbsp;&nbsp; the property was acquired by purchase, within the meaning of IRC Section 179,</p><p style="padding-left: 40px">(4)&nbsp;&nbsp;&nbsp; the basis of the property in the hands of the person acquiring it is not determined in whole or part by reference to the adjusted basis of the property in the hands of the person from whom it was acquired or under IRC Section 1014(a) (basis of property acquired from a decedent),</p><p style="padding-left: 40px">(5)&nbsp;&nbsp;&nbsp; the cost of the property does not include the basis of the property as determined by reference to the basis of other property held by the taxpayer.<a href="#_ftn4" name="_ftnref4">⁴</a></p><hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Prop. Treas. Reg. &sect; 1.168(k)-2(b)(3)(iii)(B)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Treas. Reg. &sect; 1.168(k)-2(a)(2)(iv).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Prop. Treas. Reg. &sect; 1.168(k)-2(b)(3)(iii)(C).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;IRC &sect;&sect; 168(k)(2)(E)(ii), 267(b), 707(b).</p></p><br />

<p>Two spouses may file a joint return. Same-sex couples who are married under state law must now file either jointly or married filing separately for 2013 and beyond because of the Supreme Court&rsquo;s <em>Windsor</em> decision.<a href="#_ftn1" name="_ftnref1">¹</a> Gross income and deductions of both spouses are included; however, a joint return may be filed even though one spouse has no income. A widow or widower <em>who has a dependent child</em> may file as a &ldquo;surviving spouse&rdquo; and calculate tax using joint return tax rates for two years after the taxable year in which the spouse died. However, no personal exemption is allowed for the deceased spouse except in the year of death (note that the personal exemption was suspended from 2018025).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>.<em>Windsor v. U.S</em>. 133 S. Ct. 2675 (2013).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.IRC &sect;&sect; 1(a), 2(a), 6013(a). See IRC &sect; 151(b).</p></p><br />

<p>The personal holding company (PHC) tax is a penalty tax designed to keep shareholders from avoiding personal income taxes on securities and other income-producing property placed in a corporation to avoid higher personal income tax rates. The PHC tax is 20 percent (15 percent for tax years beginning prior to 2013) of the corporation&rsquo;s undistributed PHC income (taxable income adjusted to reflect its net economic income for the year, minus dividends distributed to shareholders), if it meets both the &ldquo;stock ownership&rdquo; and &ldquo;PHC income&rdquo; tests.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> A corporation meets the &ldquo;stock ownership&rdquo; test if more than 50 percent of the value of its stock is owned, directly or indirectly, by or for not more than 5 shareholders.<a href="#_ftn2" name="_ftnref2">²</a> Certain stock owned by families, trusts, estates, partners, partnerships, and corporations may be attributed to individuals for purposes of this rule.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> A corporation meets the &ldquo;PHC income&rdquo; requirement if 60 percent or more of its adjusted ordinary gross income is PHC income, generally defined to include the following: (1) dividends, interest, royalties, and annuities; (2) rents; (3) mineral, oil, and gas royalties; (4) copyright royalties; (5) produced film rents (amounts derived from film properties acquired before substantial completion of the production); (6) compensation from use of corporate property by shareholders; (7) personal service contracts; and (8) income from estates and trusts.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>.IRC &sect;&sect; 541, as amended by ATRA, 542, 545.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.IRC &sect; 542(a)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.IRC &sect; 544.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.IRC &sect;&sect; 542(a)(1), 543(a).</p></p><br />

<p>If an installment sale between related parties is canceled or payment is forgiven, the <em>seller</em> must recognize gain in an amount equal to the difference between the fair market value of the obligation on the date of cancellation (but in no event less than the face amount of the obligation) and the seller&rsquo;s basis in the obligation.<a href="#_ftn1" name="_ftnref1">¹</a> The seller&rsquo;s basis in the obligation is the difference between the face value of the obligation less the amount of income that would be includible in gross income had the obligation been actually satisfied.<a href="#_ftn2" name="_ftnref2">²</a><br /> <p style="padding-left: 40px"><em>Example:</em> Asher sells a tractor to Samuel for $10,000 with an adjusted basis of $2,000. In exchange, Samuel conveys five installment notes ($2,000 each). Asher&rsquo;s gross profit ratio would be 80 percent (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="666">666</a>) meaning that 80 percent of each payment would be included in gross income ($1,600) and 20 percent ($400) would be tax-free return of basis. Therefore, each note would have a basis of $400 ($2,000 face value less $1,600 income). So, if Asher were to forgive a $2,000 installment note, he would recognize a gain of $1,600 (the difference between the face amount of the note and his basis in the note). In other words, a forgiven note is essentially taxed in the same way as it would have been had the seller actually received payment.</p><hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>.IRC &sect; 453B(f).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.IRC &sect; 453B(b).</p></p><br />

<p>Assets that are subject to either the general depreciation system of IRC Section 168(a) or the alternative depreciation system of IRC Section 168(g) may be grouped in one or more general asset accounts. The assets in a particular general asset account are generally depreciable as a single asset. Such an account must include only assets that have the same depreciation method, recovery period, convention, and that are placed in service in the same tax year. An asset may not be included in a general asset account if the asset is used in a personal activity at any time before the end of the tax year in which it was placed in service.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> Upon disposition of an asset from a general asset account, the asset is treated as having an adjusted basis of zero, and the total amount realized on the disposition is generally recognized as ordinary income. However, the ordinary income treatment is limited to the unadjusted basis of the account less amounts previously recognized as ordinary income. The character of the amounts in excess of such ordinary income is determined under other applicable provisions of the IRC (other than IRC Sections 1245 and 1250). Because the basis of the property is considered to be zero, no loss is recognized on such a disposition. Generally, the basis in the account is recoverable only through depreciation, unless the taxpayer disposes of all the assets in the account.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Treas. Reg. &sect; 1.168(i)-1(c), as modified by T.D. 9564.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Treas. Reg. &sect; 1.168(i)-1(e).</p></p><br />

<p>A rollover from one ESA to another ESA is not treated as a distribution (that would be potentially taxable) provided the beneficiaries of both ESAs are the same, or members of the same family. The new beneficiary must be under 30 years old as of the date of such distribution or change, except in the case of a special needs beneficiary.<a href="#_ftn1" name="_ftnref1">¹</a> The rollover contribution must be made no later than 60 days after the date of the distribution from the original ESA. However, no more than one rollover may be made from an ESA during any 12-month period.<a href="#_ftn2" name="_ftnref2">²</a> Similarly, the beneficiary of an ESA may be changed without taxation or penalty if the new beneficiary is a member of the family of the previous ESA beneficiary and has not attained age 30 or is a special needs beneficiary.<a href="#_ftn3" name="_ftnref3">³</a> Transfer of an individual&rsquo;s interest in an ESA can be made from one spouse to another pursuant to a divorce (or upon the death of a spouse) without changing the character of the ESA.<a href="#_ftn4" name="_ftnref4">⁴</a> Likewise, non-spouse survivors who acquire an original beneficiary&rsquo;s interest in an ESA upon the death of the beneficiary will be treated as the original beneficiary of the ESA as long as the new beneficiary is a family member of the original beneficiary.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>.IRC &sect; 530(b)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.IRC &sect; 530(d)(5).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.IRC &sect;&sect; 530(b)(1), 530(d)(6).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.IRC &sect; 530(d)(7).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.IRC &sect; 530(d)(7).</p></p><br />