Chapter 8

CHAPTER
8
Property Transactions:
Capital Gains and Losses, 1231,
and Recapture Provisions
Essentials of Taxation
2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Big Picture (slide 1 of 4)
Alice owns land that she received from her
father 10 years ago as a gift
The land was purchased by her father in 1993 for
$2,000 and was worth $10,000 at the time of the gift
The property is currently worth about $50,000
If Alice sells the land, you previously determined
that she would have a taxable gain of $48,000
2
Alice also owns 500 shares of AppleCo stock
300 shares were inherited when Alices grandfather died
Alices grandfather paid $12,000 for the AppleCo shares, and
they were worth $30,000 at the time of his death
If Alice sells those shares for $120 each, you previously
determined that she would have a $6,000 taxable gain
The other 200 shares were purchased by Alice two
months ago for $28,000
If Alice sells those shares for $120 each, you determined that
she would have a recognized loss of $4,000
Nine months ago, Alice purchased 100 shares of Eagle
Company stock for $5,000
3
Nine months ago Alice invested $50,000 in a 50 percent
interest in a patent that Kathy, an unemployed inventor,
had obtained for a special battery she had developed to
power green cars
To date, Kathy has been unable to market the battery to an auto
manufacturer or supplier
Alice also purchased a franchise from Orange, Inc., for
$100,000 which she subsequently sells to Maurve, Inc.,
for $101,000 nine months later
Alice owns a house that she inherited from her
grandmother two years ago
The fair market value of the house at the date of her
grandmothers death was $475,000
Alice will recognize a $125,000 gain on the sale of the property
4
Finally Alices new husband sold depreciable
equipment used in his sole proprietorship
The business purchased a $50,000 equipment and
deducted $35,000 of depreciation before selling it for
$60,000
Now Alice would like to know more about the
gains and losses and the tax liability that she
and her husband can expect from these
transactions
Read the chapter and formulate your response
5
Taxation of Capital Gains and
Losses
Capital gains and losses must be separated
from other types of gains and losses for two
reasons:
Long-term capital gains may be taxed at a lower rate
than ordinary gains
A net capital loss is only deductible up to $3,000 per
year
6
Proper Classification of
Gains and Losses
Depends on three characteristics:
The tax status of the property
Capital asset, 1231 asset, or ordinary asset
The manner of the propertys disposition
By sale, exchange, casualty, theft, or condemnation
The holding period of the property
Short-term and long-term
7
Capital Assets
(slide 1 of 5)
1221 defines capital assets as everything

except:
Inventory (stock in trade)
Notes and accounts receivables acquired from the
sale of inventory or performance of services
Realty and depreciable property used in a trade or
business (1231 assets)
8
Capital Assets
(slide 2 of 5)
1221 defines capital assets as everything

except (contd):
Certain copyrights; literary, musical, or artistic
compositions; or letters, memoranda, or similar
property
Taxpayers may elect to treat a sale or exchange of certain
musical compositions or copyrights in musical works as the
disposition of a capital asset
Certain publications of U.S. government
Supplies of a type regularly used or consumed in the
ordinary course of a business
9
Capital Assets
(slide 3 of 5)
Thus, capital assets usually include:

Assets held for investment (e.g., stocks, bonds, land)
Personal-use assets (e.g., residence, car)
Miscellaneous assets selected by Congress
10
Capital Assets
(slide 4 of 5)
Dealers in securities
In general, securities are the inventory of securities
dealers, thus ordinary assets
However, a dealer can identify securities as an
investment and receive capital gain treatment
Clear identification must be made on the day of acquisition
11
Capital Assets
(slide 5 of 5)
Real property subdivided for sale

Taxpayer may receive capital gain treatment on the
subdivision of real estate if the following requirements
are met:
Taxpayer is not a corporation
Taxpayer is not a real estate dealer
No substantial improvements made to the lots
Taxpayer held the lots for at least 5 years
Capital gain treatment occurs until the year in which the 6th
lot is sold
Then up to 5% of the revenue from lot sales is potential
ordinary income
That potential ordinary income is offset by any selling expenses
from the lot sales
12
Sale or Exchange
Recognition of capital gains and losses
generally requires a sale or exchange of assets
Sale or exchange is not defined in the Code
There are some exceptions to the sale or
exchange requirement
13
Sale or ExchangeWorthless
Securities and 1244 Stock (slide 1 of 2)
A security that becomes worthless creates a
deductible capital loss without being sold or
exchanged
The Code sets an artificial sale date for the securities
on the last day of the year in which worthlessness
occurs
Section 1244 allows an ordinary deduction on
disposition of stock at a loss
The stock must be that of a small business company
The ordinary deduction is limited to $50,000
($100,000 for married individuals filing jointly) per
year 14
Sale or ExchangeWorthless
Securities (slide 2 of 2)
Worthless securities example:
Calendar year taxpayer purchased stock on
December 5, 2015
The stock becomes worthless on April 5, 2016
The loss is deemed to have occurred on December
31, 2016
The result is a long-term capital loss
15
Sale or Exchange
Retirement of Corporate Obligations
Collection of the redemption value of corporate
obligations (e.g., bonds payable) is treated as a
sale or exchange and may result in a capital
gain or loss
OID amortization increases basis and reduces gain
on disposition or retirement
16
Sale or ExchangeOptions
(slide 1 of 2)
For the grantee of the option, if the property

subject to the option is (or would be) a capital
asset in the hands of the grantee
Sale of an option results in capital gain or loss
Lapse of an option is considered a sale or exchange
resulting in a capital loss
For the grantor of an option, the lapse creates
Short-term capital gain, if the option was on stocks,
securities, commodities or commodity futures
Otherwise, gain is ordinary income
17
Sale or ExchangeOptions
(slide 2 of 2)
Exercise of an option by a grantee

Increases the gain (or reduces the loss) to the grantor
from the sale of the property
Gain is ordinary or capital depending on the tax status
of the property
Grantee adds the cost of the option to the basis
of the property acquired
18
The Big Picture - Example 10
Options (slide 1 of 4)
Return to the facts of The Big Picture on p. 8-1
On February 1, 2016, Alice purchases 100
shares of Eagle Company stock for $5,000
On April 1, 2016, she writes a call option on the stock,
giving the grantee the right to buy the stock for $6,000
during the following six-month period
Alice (the grantor) receives a call premium of $500 for
writing the call
19
If the call is exercised by the grantee on August
1, 2016, Alice has $1,500 of short-term capital
gain from the sale of the stock
$6,000 + $500 $5,000 = $1,500
The grantee has a $6,500 basis for the stock
$500 option premium + $6,000 purchase price
20
Assume that Alice decides to sell her stock prior to
exercise for $6,000 and enters into a closing transaction
by purchasing a call on 100 shares of Eagle Company
stock for $5,000
Because the Eagle stock is selling for $6,000, Alice must pay a
call premium of $1,000
She recognizes a $500 short-term capital loss on the
closing transaction
$1,000 (call premium paid) $500 (call premium received)
On the actual sale of the Eagle stock, Alice has a short-
term capital gain of $1,000
$6,000 (selling price) $5,000 (cost)
21
Assume that the original option expired
unexercised
Alice has a $500 short-term capital gain equal to the
call premium received for writing the option
This gain is not recognized until the option expires
The grantee has a loss from expiration of the option
The nature of the loss will depend upon whether the option
was a capital asset or an ordinary asset
22
Sale or ExchangePatents
When all substantial rights to a patent are
transferred by a holder to another, the transfer
produces long-term capital gain or loss
The holder of a patent must be an individual, usually
the creator, or an individual who purchases the patent
from the creator before the patented invention is
reduced to practice
23
Patents (slide 1 of 2)
Return to the facts of The Big Picture on p. 8-1.
Kathy transfers her 50% share of the rights in
the battery patent to the Green Battery Co.
In exchange, she receives $1 million plus $.50 for
each battery sold.
24
Patents (slide 2 of 2)
Assuming Kathy has transferred all substantial
rights, Kathy automatically has a long-term
capital gain
Both her share of the lump-sum payment and the
$.50 per battery royalty qualify (less her basis in the
patent)
Kathy also had an automatic long-term capital gain
when she sold 50% of her rights in the patent to Alice
Whether Alice gets long-term capital gain
treatment on the transfer to Green Battery will
depend on whether she is a holder (see the
discussion in Example 12)
25
Holder of a Patent (slide 1 of 2)
Return to the facts of The Big Picture on p. 8-1 and
continuing with the facts of Example 11
Kathy is clearly a holder of the patent
She is the inventor and was not an employee when
she invented the battery
26
Holder of a Patent (slide 2 of 2)
When Alice purchased a 50% interest in the patent, she
became a holder if the patent had not yet been reduced
to practice
Since batteries were not being manufactured at the time of the
purchase, the patent had not been reduced to practice
Consequently, Alice is also a holder
She has an automatic long-term capital gain or loss when the
patent is transferred to Green Battery Company
Alices basis for her share of the patent is $50,000, and
her share of the proceeds is $1 million plus $.50 for each
battery sold
Thus, Alice has a long-term capital gain even though she
has not held her interest in the patent for more than one
year
27
Sale or ExchangeFranchises,
Trademarks, and Trade Names (slide 1 of 3)
The licensing of franchises, trade names,
trademarks, and other intangibles is generally
not considered a sale or exchange of a capital
asset
Therefore, ordinary income results to transferor
Exception: Capital gain (loss) may result if the transferor
does not retain any significant power, right, or continuing
interest
28
Significant powers, rights, or continuing interests
include:
Control over assignment, quality of products and
services
Sale or advertising of other products or services
The right to require that substantially all supplies and
equipment be purchased from the transferor
The right to terminate the franchise at will, and
The right to substantial contingent payments
29
Noncontingent payments are ordinary income to
the transferor
The franchisee capitalizes the payments and
amortizes them over 15 years
Contingent payments are ordinary income for
the franchisor and an ordinary deduction for the
franchisee
30
Sale of Franchise
Alice sells for $101,000 to Mauve, Inc., the
franchise purchased from Orange, Inc., nine
months ago
The $101,000 received by Alice is not contingent, and
all significant powers, rights, and continuing interests
are transferred
The $1,000 gain ($101,000 proceeds $100,000
adjusted basis) is a short-term capital gain because
Alice has held the franchise for only nine months
31
Sale or Exchange
Lease Cancellation Payments
Lessee treatment
Treated as received in exchange for underlying
leased property
Capital gain results if asset leased was a capital asset (e.g.,
personal use )
Ordinary income results if asset leased was an ordinary
asset (e.g., used in lessees business and lease has existed
for one year or less when canceled)
Lease could be a 1231 asset if the property is used in
lessees trade or business and the lease has existed for > a
year when it is canceled
Lessor treatment
Payments received are ordinary income (rents)
32
Holding Period
(slide 1 of 3)
Short-term
Asset held for 1 year or less
Long-term
Asset held for more than 1 year
Holding period starts on the day after the
property is acquired and includes the day of
disposition
33
Holding Period
Assume that Alice purchased the AppleCo stock
on January 15, 2015
If she sells it on January 16, 2016, Alices holding
period is more than one year
If instead Alice sells the stock on January 15, 2016,
the holding period is exactly one year, and the gain or
loss is short term
34
Holding Period
(slide 2 of 3)
Nontaxable Exchanges
Holding period of property received includes holding
period of former asset if a capital or 1231 asset
Transactions involving a carryover basis
Former owners holding period tacks on to present
owners holding period if a nontaxable transaction and
basis carries over
Inherited property is always treated as long term
no matter how long it is held by the heir
35
Holding Period
(slide 3 of 3)
Short sales
Taxpayer sells borrowed securities and then repays
the lender with substantially identical securities
Gain or loss is not recognized until the short sale is
closed
Generally, the holding period for a short sale is
determined by how long the property used for
repayment is held
If substantially identical property (e.g., other shares of the
same stock) is held by the taxpayer, the short-term or long-
term character of the short sale gain or loss may be affected
36
Tax Treatment of Capital
Gains and Losses (slide 1 of 6)
Noncorporate taxpayers
Capital gains and losses must be netted by holding
period
Short-term capital gains and losses are netted
Long-term capital gains and losses are netted
If possible, long-term gains or losses are then netted with
short-term gains or losses
If the result is a loss:
The capital loss deduction is limited to a maximum
deduction of $3,000
Unused amounts retain their character and carryforward
indefinitely
37
Noncorporate taxpayers (contd)
If net from capital transactions is a gain, tax treatment
depends on holding period
Short-term (assets held 12 months or less)
Taxed at ordinary income tax rates
Long-term (assets held more than 12 months)
An alternative tax calculation is available using
preferential tax rates
38
Noncorporate taxpayers (contd)
Net long-term capital gain is eligible for one or more
of five alternative tax rates: 0%, 15%, 20%, 25%, and
28%
The 25% rate applies to unrecaptured 1250 gain and is
related to gain from disposition of 1231 assets
The 28% rate applies to collectibles
The 0%/15%/20% rates apply to any remaining net long-term
capital gain
39
Income Layers for Alternative Tax on Capital Gain Computation
40
Collectibles, even though they are held long
term, are subject to a 28% alternative tax rate
Collectibles include any:
Work of art
Rug or antique
Metal or gem
Stamp
Alcoholic beverage
Historical objects (documents, clothes, etc.)
Most coins
41
The alternative tax on net capital gain applies
only if taxable income includes some net long-
term capital gain
Net capital gain may be made up of various rate
layers
For each layer, compare the regular tax rate with the
alternative tax rate on that portion of the net capital gain
The layers are taxed in the following order:
25% gain, 28% gain, the 0% portion of the 0%/15%/20%
gain, the 15% portion of the 0%/15%/20% gain, and then the
20% portion of the 0%/15%/20% gain.
This allows the taxpayer to receive the lower of the regular
tax or the alternative tax on each layer of net capital gain
42
Gains and LossesCorporate Taxpayers
Differences in corporate capital treatment
There is a NCG alternative tax rate of 35%
Since the max corporate tax rate is 35%, the alternative tax is
not beneficial
Net capital losses can only offset capital gains (i.e.,
no $3,000 deduction in excess of capital gains)
Net capital losses are carried back 3 years and
carried forward 5 years as short-term losses
43
1231 Assets
(slide 1 of 4)
1231 assets defined

Depreciable and real property used in a business or
for production of income and held >1 year
Includes timber, coal, iron, livestock, unharvested
crops
Certain purchased intangibles
44
1231 Assets
(slide 2 of 4)
1231 property does not include the following:

Property not held for the long-term holding period
Nonpersonal use property where casualty losses
exceed casualty gains for the taxable year
Inventory and property held primarily for sale to
customers
Copyrights, literary, musical, or artistic compositions
and certain U.S. government publications
Accounts receivable and notes receivable arising in
the ordinary course of a trade or business
45
1231 Assets
(slide 3 of 4)
If transactions involving 1231 assets result in:

Net 1231 loss = ordinary loss
Net 1231 gain = long-term capital gain
46
1231 Assets
(slide 4 of 4)
Provides the best of potential results for the

taxpayer
Ordinary loss that is fully deductible for AGI
Gains subject to the lower capital gains tax rates
47
Special Rules For
Certain 1231 Assets (slide 1 of 2)
Casualty gains and losses from 1231 assets
and from long-term nonpersonal use capital
assets are determined and netted together
If a net loss, items are treated separately
1231 casualty gains and nonpersonal use capital asset
casualty gains are treated as ordinary gains
1231 casualty losses are deductible for AGI
Nonpersonal use capital asset casualty losses are
deductible from AGI subject to the 2% of AGI limitation
If a net gain, treat as 1231 gain
48
Special Rules For
Certain 1231 Assets (slide 2 of 2)
The special netting process for casualties &
thefts does not include condemnation gains and
losses
A 1231 asset disposed of by condemnation
receives 1231 treatment
Personal-use property condemnation gains and
losses are not subject to the 1231 rules
Gains are capital gains
Personal-use property is a capital asset
Losses are nondeductible
They arise from the disposition of personal-use property
49
General Procedure for
1231 Computation (slide 1 of 3)
Step 1: Casualty Netting
Net all recognized long-term gains & losses from
casualties of 1231 assets and nonpersonal-use
capital assets
If casualty gains exceed casualty losses, add the net gain to
the other 1231 gains for the taxable year
If casualty losses exceed casualty gains, exclude all casualty
losses and gains from further 1231 computation
All casualty gains are ordinary income
Section 1231 asset casualty losses are deductible for AGI
Other casualty losses are deductible from AGI
50
Step 2: 1231 Netting
After adding any net casualty gain from previous step
to the other 1231 gains and losses, net all 1231
gains and losses
If gains exceed the losses, net gain is offset by the
lookback nonrecaptured 1231 losses from the 5 prior tax
years
To the extent of this offset, the net 1231 gain is classified as
ordinary gain
Any remaining gain is long-term capital gain
If the losses exceed the gains, all gains are ordinary income
Section 1231 asset losses are deductible for AGI
Other casualty losses are deductible from AGI
51
Step 3: 1231 Lookback Provision
The net 1231 gain from the previous step is offset
by the nonrecaptured net 1231 losses for the five
preceding taxable years
To the extent of the nonrecaptured net 1231 loss, the
current-year net 1231 gain is ordinary income
The nonrecaptured net 1231 losses are those that have
not already been used to offset net 1231 gains
Only the net 1231 gain exceeding this net 1231 loss
carryforward is given long-term capital gain treatment
52
Lookback Provision Example
Taxpayer had the following net 1231 gains

and losses:
2014 $ 4,000 loss
2015 $10,000 loss
2016 $16,000 gain
In 2016, taxpayers net 1231 gain of $16,000 will

be treated as $14,000 of ordinary income and
$2,000 of long-term capital gain
53
Section 1231 Netting Procedure
54
Depreciation Recapture
(slide 1 of 3)
Assets subject to depreciation or cost recovery

may be subject to depreciation recapture when
disposed of at a gain
Losses on depreciable assets receive 1231
treatment
No recapture occurs in loss situations
55
(slide 2 of 3)
Depreciation recapture characterizes gains that

would appear to be 1231 as ordinary gain
The Code contains two major recapture provisions
1245
1250
56
(slide 3 of 3)
Depreciation recapture provisions generally

override all other Code Sections
There are exceptions to depreciation recapture rules,
for example:
In dispositions where all gain is not recognized
E.g., like-kind exchanges, involuntary conversions
Where gain is not recognized at all
E.g., gifts and inheritances
57
1245 Recapture
(slide 1 of 3)
Depreciation recapture for 1245 property

Applies to tangible and intangible personalty, and
nonresidential realty using accelerated methods of
ACRS (placed in service 1981-86)
Recapture potential is entire amount of accumulated
depreciation for asset
Method of depreciation does not matter
58
1245 Recapture
(slide 2 of 3)
When gain on the disposition of a 1245 asset is

less than the total amount of accumulated
depreciation:
The total gain will be treated as depreciation
recapture (i.e., ordinary income)
59
1245 Recapture
(slide 3 of 3)
When the gain on the disposition of a 1245

asset is greater than the total amount of
accumulated depreciation:
Total accumulated depreciation will be recaptured (as
ordinary income), and
The gain in excess of depreciation recapture will be
1231 gain or capital gain
60
The Big PictureExample 46
1245 Recapture (slide 1 of 2)
Alices husband, Jeff, purchased depreciable
business equipment for $50,000
He deducted $35,000 of depreciation on this
equipment
Equipments adjusted basis is $15,000
$50,000 cost $35,000 depreciation taken
61
1245 Recapture (slide 2 of 2)
If Jeff sold the equipment for $45,000, his gain
would have been $30,000
$45,000 amount realized $15,000 adjusted basis
Section 1245 treats as ordinary income (not as
1231 gain) any gain to the extent of
depreciation taken
Here, the entire $30,000 gain would be ordinary
income
62
1245 Recapture
Continuing with the facts of Example 46
If Jeff sold the equipment for $60,000, he would
have a gain of $45,000
The 1245 gain would be $35,000
The remaining gain of $10,000 would be 1231 gain
Equal to the excess of the sales price over the original cost
63
1245 Recapture
Continue with the facts of Example 47, except
that Jeff sold the equipment for $8,000 instead
of $45,000
Jeff would have a loss of $7,000
Because there is a loss, there is no depreciation
recapture
All of the loss is 1231 loss
64
Observations on 1245
(slide 1 of 3)
Usually total depreciation taken will exceed the

recognized gain
Therefore, disposition of 1245 property usually
results in ordinary income rather than 1231 gain
Thus, generally, no 1231 gain will occur unless the
1245 property is disposed of for more than its
original cost
65
(slide 2 of 3)
Recapture applies to the total amount of

depreciation allowed or allowable regardless of
The depreciation method used
The holding period of the property
If held for < the long-term holding period the entire
recognized gain is ordinary income because 1231 does not
apply
66
(slide 3 of 3)
Section 1245 does not apply to losses which

receive 1231 treatment
Gains from the disposition of 1245 assets may
also be treated as passive activity gains
67
1250 Recapture
(slide 1 of 3)
Depreciation recapture for 1250 property

Applies to depreciable real property
Exception: Nonresidential realty classified as 1245 property
(i.e., placed in service after 1980 and before 1987, and
accelerated depreciation used)
Intangible real property, such as leaseholds of 1250
property, is also included
68
1250 Recapture
(slide 2 of 3)
Section 1250 recapture rarely applies since only

the amount of additional depreciation is subject
to recapture
To have additional depreciation, accelerated
depreciation must have been taken on the asset
Straight-line depreciation is not recaptured (except for
property held one year or less)
Depreciable real property placed in service after 1986
can generally only be depreciated using the straight-
line method
Therefore, no depreciation recapture potential for such
property
1250 does not apply if the real property is sold at a
loss
69
1250 Recapture
(slide 3 of 3)
The 1250 recapture rules also apply to the

following property for which accelerated
depreciation was used:
Additional first-year depreciation [ 168(k)] exceeding
straight-line depreciation taken on leasehold
improvements, qualified restaurant property, and
qualified retail improvement property
Immediate expense deduction [ 179(f)] exceeding
straight-line depreciation taken on leasehold
improvements, qualified restaurant property, and
qualified retail improvement property
70
Real Estate 25% Gain
(slide 1 of 2)
Also called unrecaptured 1250 gain or 25%

gain
25% gain is some or all of the 1231 gain treated as
long-term capital gain
Used in the alternative tax computation for net capital
gain
71
Real Estate 25% Gain
(slide 2 of 2)
Maximum amount of 25% gain is depreciation

taken on real property sold at a recognized gain
reduced by:
Certain 1250 and 1245 depreciation recapture
Losses from other 1231 assets
1231 lookback losses
Limited to recognized gain when total gain is
less than depreciation taken
72
Related Effects of Recapture
(slide 1 of 5)
Gifts
The carryover basis of gifts, from donor to donee, also
carries over depreciation recapture potential
associated with asset
That is, donee steps into shoes of donor with regard
to depreciation recapture potential
73
(slide 2 of 5)
Inheritance
Death is only way to eliminate recapture potential
That is, depreciation recapture potential does not
carry over from decedent to heir
74
(slide 3 of 5)
Charitable contributions
Recapture potential reduces the amount of charitable
contribution deductions that are based on FMV
75
(slide 4 of 5)
Nontaxable transactions
When the transferee carries over the basis of the
transferor, the recapture potential also carries over
Included in this category are transfers of property pursuant to
the following:
Nontaxable incorporations under 351
Certain liquidations of subsidiary corporations under 332
Nontaxable contributions to a partnership under 721
Nontaxable corporate reorganizations
Gain may be recognized in these transactions if boot
is received
If gain is recognized, it is treated as ordinary income to the
extent of the recapture potential or recognized gain,
whichever is lower
76
(slide 5 of 5)
Like-kind exchanges and involuntary

conversions
Property received in these transactions have a
substituted basis
Basis of former property and its recapture potential is
substituted for basis of new property
Any gain recognized on the transaction will first be
treated as depreciation recapture, then as 1231 or
capital gain
Any remaining recapture potential carries over
77
Refocus on the Big Picture (slide 1 of 5)
The land, stock, franchise, and home owned by
Alice are all capital assets and will produce the
following capital gain or loss when sold
Long-term capital gain of $48,000 from the sale of the
land,
Long-term capital gain of $6,000 from the sale of 300
shares of inherited AppleCo stock,
Short-term capital loss of $4,000 from the sale of the
other 200 shares of AppleCo stock,
A short-term capital gain of $1,000 from the sale of
the franchise, and
$125,000 of long-term capital gain from the sale of
the house
78
For the patent, since Alice is a holder of the
patent, it will qualify for the beneficial capital gain
rate regardless of the holding period if the patent
should produce income in excess of her $50,000
investment
However, if she loses money on the investment, she will be
able to deduct only $3,000 of the loss per year (assuming no
other capital gains)
79
The depreciable property owned by Alices
husband is 1231 property
The $45,000 gain from the sale of the property
($60,000 amount realized - $15,000 basis) is subject
to depreciation recapture under 1245
Accordingly, the first $35,000 of the gain (up to the
amount of depreciation taken on the property) is
taxed as ordinary income
The remaining $10,000 is given long-term capital gain
treatment
80
As a result of these transactions, Alice and her
husband have:
A net long-term capital gain of $189,000 ($48,000 +
$6,000 + $125,000 + $10,000), and
A net short-term capital loss of $3,000
The long-term capital gain and short-term capital
loss are netted, so the final result is a net capital
gain of $186,000, which is taxed at the 15
percent or 20 percent tax rate
Alice and her husband also report $35,000 of
ordinary income on their joint income tax return
because of the depreciation recapture provisions
81
What If?
What if the depreciable business property was
worth only $10,000 when it was sold?
In this case, there is no depreciation recapture, and
the $5,000 loss is deductible as an ordinary loss
under 1231
82
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Dr. Donald R. Trippeer, CPA

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SUNY Oneonta
83

Chapter 8

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Chapter 8

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CHAPTER

1221 defines capital assets as everything

1221 defines capital assets as everything

Thus, capital assets usually include:

Real property subdivided for sale

For the grantee of the option, if the property

Exercise of an option by a grantee

1231 assets defined

1231 property does not include the following:

If transactions involving 1231 assets result in:

Provides the best of potential results for the

Taxpayer had the following net 1231 gains

In 2016, taxpayers net 1231 gain of $16,000 will

Assets subject to depreciation or cost recovery

Depreciation recapture characterizes gains that

Depreciation recapture provisions generally

Depreciation recapture for 1245 property

When gain on the disposition of a 1245 asset is

When the gain on the disposition of a 1245

Usually total depreciation taken will exceed the

Recapture applies to the total amount of

Section 1245 does not apply to losses which

Depreciation recapture for 1250 property

Section 1250 recapture rarely applies since only

The 1250 recapture rules also apply to the

Also called unrecaptured 1250 gain or 25%

Maximum amount of 25% gain is depreciation

Like-kind exchanges and involuntary

Dr. Donald R. Trippeer, CPA

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