Chapter 13

Property Transactions:

Section 1231 and Recapture

Learning Objectives• Identify Sec. 1231 property

• Understand the tax treatment for Sec. 1231 transactions

• Apply the recapture provisions of Sec. 1245

• Apply the recapture provisions of Sec. 1250

• Describe other recapture applications

Tax Treatment for Sec. 1231

• Sec.1231 gains are netted against Sec. 1231 losses

• Net Gains treated as LTCG • Net Losses – Treated as ordinary loss.• Five year Look-back rule – any net Sec. 1231

gain is ordinary to the extent of any non recaptured net Sec. 1231 losses from previous five years.

• Tax rate for Sec.1231 gain could be 15% or 5%

Section 1231 Defined

• Real property or depreciable property used in a trade or business for more than one year

• Certain types of property do not qualify as Sec. 1231 property– Musical composition– Inventory– Copyright– Letters or memorandum

Section 1231 Defined

• Congress extended Sec. 1231 treatment to transactions involving:– Timber– Coal– Livestock – Land with

unharvested crops

Involuntary Conversions

• Condemnations– Gains and losses from condemned

Sec. 1231 property and non-personal condemned capital asset treated as Sec. 1231 gains and losses

– Other involuntary conversions– A net gain from casualties and

theft is treated as Sec. 1231 gain– Net losses on Sec. 1231 property

from casualties and theft is treated as ordinary income

Procedure For Sec. 1231

• Following steps are necessary to determine Sec. 1231 treatment

• All non-personal casualty and theft gains are netted

– If net loss, there is ordinary treatment– If net gain, the amount is included in the

regular Sec. 1231 netting• Determine the net amount of Sec. 1231 gain or

loss, by including net gain from step 1• If this netting results in a net gain, the gain is

treated as a net long-term capital gain **** • If the netting results in a net loss, it is treated as

ordinary loss

Recapture Provisions Of Section 1245

• A gain from disposition of Sec. 1245 property is treated as ordinary to the extent of depreciation taken

• Purpose of Sec. 1245– To recapture ordinary deductions as

ordinary income– Sec. 1245 is a characterization

provision

Section 1245 Property

• Most common example of Sec. 1245 property is depreciable personal property

• Does apply to nonresidential real estate that qualified as recovery property under the ACRS rules

• Does not apply to nonresidential real property acquired after and 1986

Recapture Provisions Of Section 1250

• Purpose of Sec. 1250

– Convert a portion of the gain on sale of certain depreciable real property into ordinary income when real property is sold or exchanged

Recapture Provisions Of Section 1250

• Sec. 1250 defined– Depreciable real

property not covered by the Sec. 1245 recapture

– For non corporate taxpayers Sec. 1250 recapture is not required after 1986, since only straight-line depreciation allowed on such assets

Recapture Rules For Residential Rental Property

• All residential rental property is Sec. 1250 property– To qualify as residential rental

property 80% or more of the gross rental income from building or structure must be rental income from dwelling units

– Does not include hotel, motel, inn or other establishment if more than one-half of units are used on a transient basis

Recapture Rules For Nonresidential Real Estate

• Pre-ACRS is subject to Sec. 1250 recapture on all depreciation taken in excess of straight-line, limited by realized gain

• ACRS nonresidential real estate (acquired between 1-1-1981 and 12-31-1986) is subject to Sec. 1245 recapture, unless straight-line recovery was elected

Low Income Housing

• Qualified low-income housing may have less Sec. 1250 recapture than other residential rental property

Additional Recapture for Corporations

• Additional recapture under Sec. 291

• The additional amount Under Sec 291 is equal to 20% of the difference between the amount that would be recaptured if the property was Sec. 1245 property and the actual recapture amount under Sec. 1250

Recapture Provisions – Other Applications

• Gifts of property subject to recapture

• Transfer of property subject to recapture at death

• Charitable contributions

• Like-kind exchanges

• Involuntary conversions

Recapture Provisions

• Installment sales• Section 179• Conservation and land clearing

expenditures• Intangible drilling costs and

depletion• Gain on sale of depreciable

property between related parties

Tax Planning Considerations

• For non-corporate taxpayers, Sec. 1231 gains preferable to ordinary income

• Corporate taxpayers after 1986, it does not make a difference whether a gain is classified as Sec. 1231 gain or ordinary income

• Avoiding the recapture provisions

Compliance And Procedural Considerations

• Report Sec. 1231 gains and losses on Form 4797

• Report gains recaptured on ordinary income on Form 4797

• Report casualty or theft gain on Form 4684