Understanding Synthetic Dispositions – Forward Sale, Other Assets

The March 21, 2013 budget closed several loopholes including synthetic dispositions. Knowledge Bureau Report has been examining examples of arrangements that are now closed and their financial outcomes. Last issue we examined the forward sale of securities; in this issue, we provide an example involving the forward sale of other assets.

Example: Synthetic Disposition –
Forward Sale, Other Assets

Issue: James owns an asset which he purchased for $75,000 and which is currently worth $125,000.  In 2013, James enters into an agreement with Melinda to sell it to her in 2015 for $130,000.  How is this transaction taxed?

Answer: If this agreement was entered into before budget day (March 21, 2013), there would be no income tax consequences until 2015 when James would report a capital gain of $130,000 - $75,000 = $55,000. 

If the agreement was entered into after budget day, John is deemed to have disposed of the asset at the time of the agreement for its fair market value ($125,000) and reacquired it for that same price.  The income tax consequences are a capital gain of $125,000 - $75,000 = $50,000 in 2013 and another capital gain of $130,000 - $125,000 = $5,000 in 2015.

Excerpted from EverGreen Explanatory Notes. ©Knowledge Bureau.  All rights reserved.

NEXT TIME: Example: Synthetic Dispositions – Put-Call Collar