Tl& neatrtABhrc Book of O&l,i,f

orkia

REx B. GooDcDLL
Aolbctor Interrntr Retehne
Sotl h.trr Cdlilornia Di stri.l
Los ,hltcles
 The Re( tg BLueBook of Calilorniar 183

Income Tax as Relatedto Real Estate

Bv REX B. CooDcELL

Sale ol "Capital A$ets"-S,tLbdbisions-1itq)ro1)enLelLts

Erected blJ Leases-Propertlt Acqaired, Prior to March 1,
1913-S&le of Pl operta A.quie(L ba Gilt E$changes.

HERE seemsto be a misunderstaDding or the part of many tax-

paye$ relative to the provisionsof the Internal Rev€nuelaws
'with respectto IncomeTax in conDectionwith the saleof pro!-
erty, and, due to this erroneous irterpretation, many sales of property
in which large amounts are involved are not consllmmated becauseof
the fact that taxpaye$ believe the goverDment 1\'ill requirc them to
pay the major po*ion of the amount leceived as Income Tax-
Prior to the enaction of the 1921 Income Tax Law. the surtax rates
did apply upon ir(ome receivpdfrom thesesour..es,ire same as upon
allolhar income: however.h uas app|eciaLedby thc $vernment rhrt
it was not entirely equitable to tax, in the year of sale, the profits
realized from such sale, when the increase in value was probably dis-
tributed over a number of years. In older to correct this iniustice.
Section206a of lhe JlevpnueAcl ol l92l was enacled.whiah Dro-
vidpstha( anJ taxpayer may clecl to be raxad sr 'he fale oI 12,2_per
cent upon the proft realized from the sale of capital assets,in lieu of
the regular lates provided by Sections 210 and 211. The tenn
"capital assets," as used in the above section, means property ac-
quired and h€ld by the taxpayer for profit or investment for more
than two yeaN, but does not include property held for' personal use or
consumptioDo{ the taxpayer.
It will be seen from the above that the govemment does not tale
as Internal Revenue taxes the major portion of the profits; and if
this new provision of the Income Tax larv is tholoughly explained to
your cli€nts, it is believed the larger sales involving large amounts
of profit will be more easily closed. (See Art. 1651-Regulations 62).
It has alsobepnbroughl lo my arlertion upon numarouso..asions,
by auditom in my office, that there seemedto be a qeneral misunder-
standingof Ihc appli.ation o[ (he lnternal Rc\erutLaws felarinE ro
profirslealized lrom the sale of property. Pfior to lhe decisiondlen-
dercd by the Supreme Coult, holding that profits from such sales did
rcpresent taxable income, many persons were under the efrcneous
imprcssionthat no income was realized from the sale of caDital assets.
The profil fro'n rhe salp ol rhe propert) constirutesonp;f {he .hiel
sourcesof income to our taxpayers, especialty in Southern California.
and every deal"r.jn rpal esral" sl-ould info|rn himself ur rhe mair
pmvisiorN of the Internal Revenue laws in this reEar.al.
Every sale or transfpr o[ reel esiate made by a raxpayer should
be itemized upon his income tax return for the year in which the
saleor transfer was consummated. Any profit realized fi.om such sale
 184 Tke Eea,ltaBl,ueBoolr of Cal,iforrui)0,

is subjectto incometax; and in the caseof propedy acquirealsubse.

quent to March l. 1913,rhe taxabteincomeis tie ain"""nce telw"en
**" price leceivpd,iess any cxpensesin connection
Hih"",",l""l$lJ-n"
There is also to be taken into consideration depreciation sus_
{,ainedon_the improvementssold in connection*llt tt" ri"r"ii".
ueprecratlonrs allowedas a deductibleexpense,by the Inteinai Re;_
enue Bureau, upon all propefty used in ionneclion rnitt . irra"
ouslness,and wherein implovementssuch as olfice buildinqs. aDalt_ ""
ment houseaor improvemcnlsupon rental propedy are usedin con_
]rFcuonwlth ltre taxpayer'strade or businessa depreciationallowance
ls aUowedas pelmissibjedeductionin computingthe taxDaveds
net income for each year. The rate of aepreiiation is l'aseU
u.pon the physical life ot the improvements upon the proDertv.
upon rhp saleoI tnls property, this deprecialioDis to be restorehand
raKenrnto conslcterationjn computinglhe profit or lossfrom the sale.
anq I ends1or€ciucethe.ost of the property. This depreciationis sus_
[arneqregarcuessoI whetheror not the taxpayerdeductsihis amount
rn nrs lncometax retuTnsfor prioT yearc.
Many q-uFstions are also aakeda; to whefheror not the taxDaver
can add to his cost taxes and inrerest ct""ge" f* prio"-v"u'rii-dui
many persons,in computingl,heir pro6uor loss,endeivor ti add such
amounls lo the cost of the propeny, This is also an er.roneous Dro_
cedure..Inasmuchas laxes and inlerest are an allowable dealuciion
upon the.taxpayer'sreturn [orrhe ycar in which paid or accrueal.
rnqurnes In targe numbershave alsobeenreceivedbv the DeDart_
men!, rn connectionwith property sold upon the installinent nlan or
wrrn res-pecl(o saleslnvolving deferredpalanents, When proiertv is
sord,and only a relativetysmall inilial paymentis rnade.gener; y jess
than one-fourth of thc saleprice, and the balanceof the paymentsare
orslrrbuteo over a number of years, then the laxpayer mav elect lo
pay.rncometax upon the propodionaleparl of the DrofiLre;resenle.l
ln ute amount receLvedea(h year. ll the initial pal,,rnent -is
g€neraflymore than one-folrrthof the sale price, and the bala[ce;flarce.
rne paymentsaTemacleovet a short peliod of Lime,and securedbv a
mongage or olhcr secunly, the taxcs are due upon ihe total Dr;fit
reanzedlrom Urat satein the year in whi.h it is made.
ne i;wo metnodsoI reportjng transacrionsof this naj ure are verv
" .r covpledIn ArrrclFs44. 45 and 46 of Regulajions
rully 62.
SUB-DIVISIONS
. .Any personcontemplating sub-dividinga tract of lanaland sell_
mg l]le.satne in lots shouldfamiliarize himielf wir,l Ure fncomei-ax
r€gutarlons,panrcutarty Arl icle 43 of Reg'Lllal ion 62, \MhichDrovides
rnar cosr.anclolher expenscsin connection\Mithsub_division, shall
allocat€dto pachindividuat touand the profil reportpd;D;; th;;"i;be
or. eacn tor. treat rlg such as a separatetransa(tion. It is not per_
mrssrofll: repo'"ttl1egain or toss realizedfrom the sale of the tract

IMPROWMENTS MECT}TD BY LESSEE

Wlen buildingsare erectedor improvementsmadl!by a lesseein
pursuanceot an agreementFil,h the lessor,and suchbuildinqs
or im_
provementa are not subject to removal by th" t"sse", tt l"s"o?Injv'ri
"
 r
I
TheReal,tABLueBoohof Calilonrirr :

his option report the incomethelefrom upon eithel of the following

Dases:
(a) "The lessormay report as incomeat the time when
such buildings or improvements ale completed the fair
market value of such buildings or improvementssubject to
the lease. This amount would ordina ly be the difference
betweenthe value of the land free from the lease without
such improvementsaDd the value of the land subject to the
lpasewilh suchimplovemenls.
(b) "The lessormay spreadover the life ol the leasethe
estimateddepreciatedvalue of such buildings or. improve-
meDtsat the temination of the leaseand repor.tas income
for eachyear of the leasean aliquot paft thereof."
For a full explanationof imDr'ovementsbv lessee.seeArticle 48
of R€gulations62.
PROPER,TY
ACQUIREDPRIORTO MAR,CII 1, 1913
In computinggain and derluctibleloss upon the sale or exchange
of propertyacquiredprjor lo March 1, 1913,bolh the originalcoir
and Lhefair markeLvalueas oI Marcht, 1913.are tnkpninio consid-
eration. The examplesir the following tabie vrill give a bdef sum-
mary of the amount to be repolted or of the amountthat mav be d+.
ductedas a loss. (FoI full explanctionseeAl1icle1561- RegLrlalions
62.) To avoid complexity no adjustment has been made in these
examplesfor depreciationor depletion.
:'F"'.M.*"1

Cost lvalue March Sale Price

| 1,1913
10t000 F1 5 . 0 , 0 0 $2 0 , { r 0 0 $5,0'00 Tarabre Cain.
Excess or amount realized oyer
fair barket valDe as of March 1,
1913. Gain attributable to tie
Deriod prior to March 1, 1913,
10,000 5 , 0 00 !2,000 Deduclible l-oss.
E\cess of fair market value oyer
aDroDtrtrealizeil Loss attrtbutablo
to the perioil ldor to Narcl 1,
1913, lot deduclible.
10,000 30,r'00 2 0too0 No taxaDle sain or denucttble loss.
] Re*o!: A gain on vhole lrans-
action, which gain is attrlbrlable
lo peliod trior io trIarch 1, 1913.
10,000 5,000 No tdxable sair or deductible

ReasoD: ,{ loss otr whole traDs

a.tion whi.h loss is atirlbutabre
to leriod prior to March 1, 1913.
10,000 2 0 . 00 0 $10,000 Ta\able Gain.
Reason: Gain on whole t.arsac-
tton, all ot rich ls attrllutable
to L'eriod subsequent to March 1,
1913,
10,000 I5,000 $5,00o-Deductible LoBs.
Reaon: l-o$ oD whole traDsac-
tion, all of vhich is attribubbr€
to leriorl strbsequelt to March 1,
1913. Only acturl loss sustained
186 The Ree,l,taBLueBook ol Cal,ifomin

SAI,E OF PROPTRTYYACQUIR,EDBY GII-]

This ofice alsoreceivedmany inquiriesas to the amountof proit
to be repolteal upon propedy acquired by gift. The 1921 law also
made changes reletive to computing gain or loss from property so
acquired, the change being that upon propelty acquired by gift after
December31, 1920,the gain or lossis to be the differencebetweenthe
cost (or March 1, 1913,value) to the alonor,or the last preceding
own€r by whom it was not acquirealby gift, anal the a.rnountreceived
therefor. Inasmuch as this is a change from t}Ie provisions made by
the 1918 RevenueLaw, all dealersshould acquaint themselveswith
Article 1562 of Regulations62, for information relative to taxable
gain upon property acquired by gift.
EXCHANCEOF PROPERTYWHICH RESULTSIN NO CAIN OR LOSS
Where property held for investment is exchangedfor other prop-
erty of a like lind, or where property held for prodluctiv€usein trade
or businessis exchangedfor other property of a like use,no gain or
loss is recognized. Under these provisions, no gain or loss is recog-
nized by one other than the dealer from the exchanqeof reel estaie
for real estatenor for lhe exchangeof evidencesof indebtedness,
such as bonds or notes, for evidencesof inalebtedness. Any lroductive
real estate held by one other than the dealer for future use or future
realizationof the incrementin value, is held for investmentand not
primarily for sale, under the Intemal Revenueresulations. For full
explanation of tha rpgrlationson exchanges of property,seeArlicle
1566,Regulations62.
Where prope.ty such as that above described is exchansed for
other proparly, and no gain or loss is recogrized.the prcp;rty re-
ceivedshall, for the purposeof determining gain or loss foi its sub-
sequentsale,be treated as taking the placeof the property exchanged
therefor. (SeeArhcle1567of Regulations62).
Particular attention is invited to the provisions relating to the
exchangeof propp y s',ilhoutgain or lossbeing reporled,viz. that the
exchangemusi be a {rade of propefly Jor other property; wherein
property is exchangedfor propeny, together wilh money,othpr pro-
visions of the Iniemal RevcnlreLaw $rill apply.
In cases\ 'here moneyor other securitiesare receivedin exchanse
wilh olher real properry, ir is suggestedl.Iat the taxpayer obtainl
ruling upon the individual transaction.or that he familisrize himself
with A*icle 1568 of the Resulations.
The Internal Revenueoffiieis openfrom 8:30 A. M. to 4:BOp. M.,
and it is our desireto assistthe taxpayingpublicof SouthpmCal-
jfomia to jhe fullestexlenl. You are cordiallyinvircdjo call at the
office in the Federal Building and submit your problemsin person,
or to addressyour quFsl,ionsby ielicr, and every endpavor will bp
madeto explainfully the provisiohsof the Intemal RevenueLaw
and Regulalions.
Copiesof Regllations62 may be obiaineduponrequestby calliDg
at Room.300 Federal Building. tos Angelei. during the houri
menltonedabove_