Sale and Repurchase of Capital Assets
Under the Taxpayer Relief Act of 1997, new maximum capital gain rates went into effect January 1, 2001: the 20% capital gain rate was lowered to 18%, provided a property is held for more than five years and the holding period began after 2000. For those in the 15% tax bracket, the 10% capital gain rate was lowered to 8%, provided the property is held for more than five years, regardless of when the holding period began.
This means high-income taxpayers who purchase an asset in 2001 or later automatically will qualify for the 18% rate, as long as the asset purchased is held for more than five years.
In addition, taxpayers who already own assets and plan to hold on to them for at least five years beyond 2001 may elect the reduced capital gain rate by currently paying the tax on any unrealized gain. To qualify, the taxpayer must make a “deemed sale and repurchase election.” This means he or she treats the asset as having been sold and then immediately repurchased for its fair market value on January 1, 2001, or the first business day of 2001, without having to incur the transaction costs of selling and buying back the same asset. An asset qualifies if it was either a “readily tradable stock” as of January 1, 2001, or section 1231 property. A taxpayer recognizes any gain from the election but cannot deduct any losses or add the disallowed losses to his or her basis in the assets. Most taxpayers won’t make this election for assets that would show a loss. However, taxpayers whose assets now would show minimal gain or loss but are expected to have a substantial gain over a holding period of five years or more might benefit from such an election.
In the instructions for Form 4797, Sales of Business Property, the IRS details how and when to make the sale-and-repurchase election. The taxpayer includes the deemed sale on his or her timely filed original or amended tax return (including extensions) in 2001 and attaches a statement that he or she is making the election under section 311 of the Taxpayer Relief Act of 1997. Calendar-year taxpayers have until October 15, 2002, to decide whether to make this election.
Automatic Extensions Soon Available for Estate Returns
An estate tax return is due nine months after a decedent’s death. The current regulations give the IRS the discretion to grant up to a six-month extension to file Form 706, U.S. Estate (and Generation Skipping Transfer) Tax Return, if an executor can show “good and sufficient cause.” In 1998 a substantial number of the more than 110,000 estate tax returns filed were granted the maximum six-month extension. Consequently, the IRS announced, in proposed regulations, that executors automatically will be granted a six-month extension. However, only returns due after the date the regulations become final may take advantage of this (proposed regulations sections 20.6075-1 and 20.6081-1).
Horse Races Aren’t Part of the Entertainment Business
Because Churchill Downs, Inc., is in the business of wagering, it stages horse races. While putting on the Kentucky Derby and the Breeder’s Cup, it sponsored a variety of special events such as the Sport of Kings dinner, brunches, receptions and cocktail and winners’ parties. It invited only select horsemen, employees, members of the press and local dignitaries and paid for all the food, beverages and entertainment.
The company deducted these expenses in full as ordinary and necessary business expenses on its federal income tax return. The IRS asserted they were entertainment expenses and, as such, were governed by IRC section 274(n)(1), which limited the deduction to 50% of the costs.
Churchill Downs contended that taxpayers whose primary product is entertainment are not subject to this limitation. It argued that the purpose of the special events was to add to the “overall glamour and prestige” of the races.
The Tax Court sided with the government and found that, even though Churchill Downs was in the entertainment business, its primary source of revenue was not from special events but from staging horse races. According to the court, since the taxpayer did not provide similar entertainment to the general public, section 274(n) limits the deduction for the costs of the private parties ( Churchill Downs, Inc. v. Commissioner, 115 TC no. 20).
—Michael Lynch, JD, professor of tax accounting at Bryant College, Smithfield, Rhode Island.