Chapter 17: Property Transactions: 1231 and Recapture Provisions

CHAPTER 17: PROPERTY TRANSACTIONS: 1231 AND RECAPTURE PROVISIONS

1. Section 1231 applies to the sale or exchange of business properties, but not to personal use activity casualties.a. Trueb. False

ANSWER:TrueRATIONALE:Section 1231 applies to the sale of business properties and to certain involuntary conversions such as casualties of nonpersonal use property.

2. Rental use depreciable machinery held more than 12 months is an example of a 1231 asset.a. Trueb. False

ANSWER: True

3. If there is a net 1231 loss, it is treated as an ordinary loss.a. Trueb. False

ANSWER:TrueRATIONALE:A net 1231 loss is treated as an ordinary loss.

4. Section 1231 property includes nonpersonal use property where casualty gains exceed casualty losses for the taxable year.a. Trueb. False

ANSWER:TrueRATIONALE:Section 1231 does include this property because when there is a net casualty gain from nonpersonal use property, the individual casualty gains and losses are treated as 1231 gains and losses.

5. Section 1231 property generally includes certain purchased intangible assets (such as patents and goodwill) that are eligible for amortization and held for more than one year.a. Trueb. False

ANSWER: True

6. Section 1231 property generally does not include artistic compositions.a. Trueb. False

ANSWER: True

7. Section 1231 property generally does not include accounts receivables arising in the ordinary course of business.a. Trueb. False

ANSWER: True

8. An individual business taxpayer owns land on which he grows trees for logging. The land has been held more than 10 years and the trees growing on the land were planted eight years ago. Normally, the timber would be inventory for this taxpayer, but the tax law allows the taxpayer to elect to treat cutting the timber as the disposition of a 1231 asset.a. Trueb. False

ANSWER:TrueRATIONALE:The election under 631(a) allows the taxpayer to elect to treat the cutting of timber as a sale or exchange and, if the election is made, to treat the sale as the disposition of a 1231 asset.

9. A sheep must be held more than 18 months to qualify as a 1231 asset.a. Trueb. False

ANSWER:FalseRATIONALE: Cattle and horses must be held 24 months or more to be 1231 assets, other farm animals more than 12 months.

10. Casualty gains and losses from nonpersonal use assets are not netted against casualty gains and losses from personal use assets.a. Trueb. False

ANSWER: True

11. If 1231 asset casualty gains and losses net to a gain, the gain is treated as a 1231 gain.a. Trueb. False

ANSWER: True

12. Involuntary conversion gains may be deferred if the proceeds of the involuntary conversion are reinvested.a. Trueb. False

ANSWER: True

13. Personal use property casualty gains and losses are not subject to the 1231 rules.a. Trueb. False

ANSWER: True14. In the General Procedure for 1231 Computation: Step 2. 1231 Netting, if the gains exceed the losses, the net gain is offset by the lookback nonrecaptured 1231 losses.a. Trueb. False

ANSWER: True

15. Nonrecaptured 1231 losses from the six prior tax years may cause current year net 1231 gain to be treated as ordinary income.a. Trueb. False

ANSWER:FalseRATIONALE:The lookback period is five years.

16. A personal use property casualty loss is generally deductible only to the extent it exceeds 10% of AGI.a. Trueb. False

ANSWER: True

17. The Code contains two major depreciation recapture provisions 1245 and 1250.a. Trueb. False

ANSWER: True

18. The maximum 1245 depreciation recapture generally equals the accumulated depreciation.a. Trueb. False

ANSWER:TrueRATIONALE:Section 1245 generally recaptures gain as ordinary income to the extent of the depreciation taken (accumulated depreciation) or the recognized gain, whichever is less.

19. Section 1245 may apply to amortizable 197 intangible assets.a. Trueb. False

ANSWER: True

20. For 1245 recapture to apply, accelerated depreciation must have been taken on the property.a. Trueb. False

ANSWER:FalseRATIONALE:Under 1245, any depreciation taken is subject to recapture.

21. Section 1250 depreciation recapture will apply when accelerated depreciation was used on property used outside the United States and the property is sold at a gain.a. Trueb. False

ANSWER: True

22. The maximum amount of the unrecaptured 1250 gain (25% gain) is the depreciation taken on real property sold at a recognized gain.a. Trueb. False

ANSWER: True

23. Section 1231 lookback losses may convert some or all of 1245 gain into ordinary income.a. Trueb. False

ANSWER:FalseRATIONALE:Section 1245 gain is treated as ordinary income and the gain does not need to be converted by 1231 lookback losses into ordinary income because it is already ordinary income.

24. Section 1245 depreciation recapture potential does not carryover from the deceased taxpayer to the beneficiary taxpayer.a. Trueb. False

ANSWER:TrueRATIONALE:Death extinguishes the 1245 depreciation recapture potential.

25. The 1245 depreciation recapture potential does not reduce the amount of the charitable contribution deduction under 170.a. Trueb. False

ANSWER:FalseRATIONALE:The 1245 depreciation recapture potential does reduce the amount of the charitable contribution deduction under 170.

26. Property sold to a related party purchaser that is depreciable by the purchaser may cause the seller to have ordinary gain.a. Trueb. False

ANSWER: True

27. Depreciation recapture under 1245 and 1250 is reported on Form 4797.a. Trueb. False

ANSWER: True

28. Part III of Form 4797 is used to report gains from the sale of depreciable business equipment sold at a gain and held more than one year.a. Trueb. False

ANSWER: True

29. White Company acquires a new machine for $75,000 and uses it in Whites manufacturing operations. A few months after White places the machine in service, it discovers that the machine is not suitable for Whites business. White had fully expensed the machine in the year of acquisition using 179. White sells the machine for $60,000 in the tax year after it was acquired, but held the machine only for a total of 10 months. What was the tax status of the machine when it was disposed of and the amount of the gain or loss?a. A capital asset and $60,000 gain.b. An ordinary asset and $60,000 gain.c. A 1231 asset and $60,000 gain.d. A 1231 asset and $60,000 loss.e. None of these.

ANSWER:bRATIONALE:The machine was depreciable property used in a business and held one year or less; so it was an ordinary asset. Since there was a zero basis, all of the $60,000 proceeds is taxable gain.

30. Which of the following assets held by a manufacturing business is a 1231 asset?a. Inventory.b. Office furniture used in the business and held less than one year.c. A factory building used in the business and held more than one year.d. Accounts receivable.e. All of these.

ANSWER:cRATIONALE:Inventory is an ordinary asset. Office furniture used in the business is a 1231 asset once it has been held more than a year. Accounts receivable are an ordinary asset.

31. Which of the following assets held by a cash basis accounting firm is a 1231 asset?a. An account receivable from a client.b. A desk used in the business and held more than one year.c. An investment in Orange Company common stock.d. A computer used in the business, held more than one year, but fully depreciated under 179 when acquired.e. b. and d.

ANSWER:eRATIONALE:An account receivable is an ordinary asset (option a.). A stock investment is a capital asset (option c.). Depreciable equipment held more than a year is a 1231 asset (options b. and d.) so choice e.

32. A barn held more than one year and used in a business is destroyed in a tornado. The barn originally cost $356,000 and was fully depreciated using straight-line depreciation. The barn was insured for its $543,000 replacement cost minus a deductible of $1,000. Which of the statements below is correct concerning these facts?a. The barn was a long-term personal use asset.b. There is a casualty loss from disposition of the barn.c. The recognized gain from disposition of the barn is $186,000.d. The recognized gain from disposition of the barn is subject to special netting rules.e. c. and d.

ANSWER:dRATIONALE:Property used in a business is a nonpersonal use asset and the gain due to casualty is not subject to 1250 depreciation recapture since straightline depreciation was used. The special netting rule for nonpersonal use property casualty gains and losses applies because there is casualty gain of $542,000 ($542,000 insurance proceeds $0 adjusted basis).

33. Which of the following would be included in the netting of 1231 gains and losses?a. Personal use property net casualty gain.b. Section 1231 loss.c. Section 1231 gain.d. All of the above.e. b. and c.

ANSWER:eRATIONALE:Personal use property net casualty gain is not netted with nonpersonal use property casualty gains and losses and, thus, cannot become 1231 gain.

34. Vertigo, Inc., has a 2014 net 1231 loss of $64,000 and had a $32,000 net 1231 gain in 2013. For 2014, Vertigos net 1231 loss is treated as:a. Ordinary loss.b. Ordinary gain.c. Capital loss.d. Capital gain.e. None of these.

ANSWER:aRATIONALE:Since there is a 2014 net 1231 loss, the loss is treated as an ordinary loss. Section 1231 lookback applies only if there is a current year 1231 gain.

35. Vertical, Inc., has a 2014 net 1231 gain of $67,000 and had a $22,000 net 1231 loss in 2013. For 2014, Verticals net 1231 gain is treated as:a. $45,000 long-term capital gain and $22,000 ordinary loss.b. $67,000 ordinary gain.c. $45,000 long-term capital gain and $22,000 ordinary gain.d. $67,000 capital gain.e. None of these.

ANSWER:cRATIONALE:The 2013 1231 loss is a lookback loss and converts $22,000 of the 2014 net 1231 gain into ordinary gain. The $45,000 remaining of the $67,000 2014 net 1231 gain is treated as longterm capital gain.36. Verway, Inc., has a 2014 net 1231 gain of $55,000 and had a $62,000 net 1231 loss in 2013. For 2014, Verways net 1231 gain is treated as:a. $55,000 ordinary loss.b. $55,000 ordinary gain.c. $55,000 capital loss.d. $55,000 capital gain.e. None of these.

ANSWER:bRATIONALE:Since the 2014 $55,000 net 1231 gain is less than the $62,000 2013 1231 lookback loss, the entire $55,000 is treated as ordinary gain.

37. The following assets in Jacks business were sold in 2014:

AssetHolding PeriodGain/(Loss)

Office Equipment6 years$1,100

Automobile8 months($ 800)

ABC Stock (capital asset)2 years$1,400

The office equipment had a zero adjusted basis and was purchased for $8,000. The automobile was purchased for $2,000 and sold for $1,200. The ABC stock was purchased for $1,800 and sold for $3,200. In 2014 (the year of sale), Jack should report what amount of net capital gain and net ordinary income?a. $1,700 LTCG.b. $600 LTCG and $300 ordinary gain.c. $1,400 LTCG and $300 ordinary gain.d. $2,500 LTCG and $800 ordinary loss.e. None of these.

ANSWER:cRATIONALE:The sale of the office equipment results in a $1,100 1245 gain. The sale of the auto results in an ordinary loss of $800 because the auto was not held for the longterm holding period. The 1245 gain of $1,100 offsets the $800 ordinary loss for a net ordinary gain of $300. The sale of the stock results in a $1,400 LTCG.

38. An individual had the following gains and losses during 2014 on property held for the long-term holding period: sale of Orange common stock ($8,000 gain) sale of real property used in the taxpayers business ($1,800 loss) destruction of real property used in the taxpayers business by fire ($1,000 loss). Which of the following statements is correct?a. The fire loss would reduce the real property sale loss.b. The fire loss would reduce the stock sale gain.c. The sale of real property loss would be netted against the stock sale gain.d. The sale of real property is a 1231 loss.e. None of these.

ANSWER:dRATIONALE:The sale of the Orange stock produces an $8,000 LTCG, which is fully includible in gross income. The real property sale results in a net 1231 loss of $1,800. The real property $1,000 fire loss is treated as an ordinary loss because there are no casualty gains against which it can be netted.

39. Which of the following is correct?a. Improperly classifying a 1231 loss as a capital loss might affect adjusted gross income.b. Improperly classifying a capital loss as a 1231 loss might affect adjusted gross income.c. Misclassifying a 1231 gain as a shortterm capital gain might affect adjusted gross income.d. Misclassifying a shortterm capital gain as a 1231 gain might affect adjusted gross income.e. All of these.

ANSWER:eRATIONALE:The key to understanding this question is the capital loss deduction. If a gain which should or should not be a capital gain is misclassified, the net capital gain or loss may be misstated and an improper amount of capital loss deduction may be taken. Similarly, misclassifying a loss also may affect the capital loss deduction.

40. Spencer has an investment in two parcels of vacant land. Parcel 1 is a capital asset and parcel 2 is a 1231 asset. Spencer already has shortterm capital loss for the year he would like to offset with capital gain. Spencer has 1231 lookback loss that exceeds the gain from the disposition of either land parcel. Spencer only wants to sell one land parcel and each of them would yield the same amount of gain. The gain that would be recognized exceeds the short- term capital loss Spencer already has. Which of the statements below is correct?a. Spencer will have a net capital loss no matter which land parcel he sells.b. Spencer will have a net capital loss if he sells parcel 2.c. Spencer will have a net capital loss if he sells parcel 1.d. Spencer will have a net capital gain if he sells either parcel 1 or parcel 2.e. None of these.

ANSWER:bRATIONALE:Since parcel 2 is a 1231 asset, its gain will be treated as ordinary income due to the 1231 lookback and none of the gain will be treated as long-term capital gain. Thus, the existing short-term capital loss will not be offset by any gain and a net capital loss will result. Selling parcel 1 will yield a capital gain that will more than offset the existing short-term capital loss, resulting in a net capital gain.

41. Copper Corporation sold machinery for $47,000 on December 31, 2014. The machinery had been purchased on January 2, 2011, for $60,000 and had an adjusted basis of $41,000 at the date of the sale. For 2014, what should Copper Corporation report?a. Ordinary income of $6,000.b. A 1231 gain of $3,000 and $3,000 of ordinary income.c. A 1231 gain of $6,000.d. A 1231 gain of $6,000 and $3,000 of ordinary income.e. None of these.

ANSWER:aRATIONALE:The recognized gain from the disposition of the machinery is $6,000 ($47,000 sale price $41,000 adjusted basis). Since the recognized gain is less than the depreciation taken of $19,000 ($60,000 cost $41,000 adjusted basis) and the asset is depreciable equipment used in a business, 1245 depreciation recapture applies.

42. Which of the following creates potential 1245 depreciation recapture and potential 1231 gain?a. Depreciable office furniture held more than one year and sold for more than its original cost.b. Amortizable goodwill held more than one year and disposed of for less than its adjusted basis.c. Land held more than one year and sold for more than was paid for it.d. A note receivable held more than one year and sold for less than was paid for it.e. None of these.

ANSWER:aRATIONALE:Depreciable equipment (the office furniture) is subject to 1245 depreciation recapture if it is sold at a gain. However, only the depreciation taken is subject to depreciation recapture and, if the equipment is sold for more than was paid for it, the excess gain is 1231 gain.

43. Blue Company sold machinery for $45,000 on December 23, 2014. The machinery had been acquired on April 1, 2012, for $69,000 and its adjusted basis was $34,200. The 1231 gain, 1245 recapture gain, and 1231 loss from this transaction are:a. $0 1231 gain, $10,800 1245 recapture gain, $0 1231 loss.b. $0 1231 gain, $0 1245 recapture gain, $14,800 1231 loss.c. $0 1231 gain, $34,200 1245 recapture gain, $0 1231 loss.d. $0 1231 gain, $10,800 1245 recapture gain, $34,200 1231 loss.e. None of these.

ANSWER:aRATIONALE:Since the machine was held more than 12 months and was depreciated, it was a 1231 asset. Since it was sold at a gain and the selling price did not exceed the original cost, all of the depreciation taken of $34,800 ($69,000 cost $34,200 adjusted basis), limited to the recognized gain of $10,800 ($45,000 amount realized $34,200 adjusted basis), is gain recaptured by 1245.

44. Red Company had an involuntary conversion on December 23, 2014. The machinery had been acquired on April 1, 2012, for $49,000 and its adjusted basis was $14,200. The machinery was completely destroyed by fire and Red received $10,000 of insurance proceeds for the machine and did not replace it. This was Reds only casualty or theft event for the year. As a result of this event, Red initially has:a. $10,000 1231 loss.b. $10,000 1245 recapture gain.c. $4,200 casualty loss.d. $4,200 1231 loss.e. None of these.

ANSWER:cRATIONALE:Since the machine was held more than 12 months and was depreciated, it was a 1231 asset. However, since it was disposed of at a $4,200 loss ($10,000 insurance proceeds $14,200 adjusted basis), all of the loss is initially a casualty loss.

45. Orange Company had machinery destroyed by a fire on December 23, 2014. The machinery had been acquired on April 1, 2012, for $49,000 and its adjusted basis was $14,200. The machinery was completely destroyed and Orange received $30,000 of insurance proceeds for the machine and did not replace it. This was Oranges only casualty or theft event for the year. As a result of this event, Orange has:a. $4,200 ordinary loss.b. $15,800 1245 recapture gain.c. $14,200 1245 recapture gain.d. $30,000 1231 gain.e. None of these.

ANSWER:bRATIONALE:Since the machine was held more than 12 months and was depreciated, it was a 1231 asset. However, since it was disposed of at a $15,800 gain ($30,000 insurance proceeds $14,200 adjusted basis), all of the gain is initially 1245 depreciation recapture gain and not casualty gain.

46. Which of the following events could result in 1250 depreciation recapture?a. Sale at a loss of a depreciable business building held more than one year.b. Sale at a gain of a business building held more than a year on which straight-line depreciation was taken.c. Sale at a loss of a depreciable business building held for 9 months.d. Sale at a gain of depreciable equipment held more than a year on which straight-line depreciation was taken.e. None of these.

ANSWER:eRATIONALE:Section 1250 recapture can only occur if the sale of real property was at a gain and accelerated depreciation was taken or the property was held a year or less. For 1231 and 1250 to apply, the building must be held for more than a year. Depreciable equipment is subject to 1245 depreciation recapture rather than 1250.

47. Which of the following real property could be subject to 1250 depreciation recapture?a. Property placed in service after 1986 on which straight-line depreciation was taken.b. A building on which 168(k) depreciation was taken.c. Equipment on which accelerated depreciation was taken.d. Land which was not depreciated.e. a. and b.

ANSWER:bRATIONALE:Section 1250 depreciation recapture requires a sale at a gain and additional depreciation that exceeds straight-line depreciation. A building on which 168(k) additional firstyear depreciation was taken could have depreciation that exceeds straight-line depreciation. A building acquired after 1986 is a MACRS building (i.e., straight-line method must be used).

48. Assume a building is subject to 1250 depreciation recapture because 168(k) was used to depreciate it. The building is destroyed in a hurricane and this is the taxpayers only casualty or theft for the year. In which of the following situations could there be a 1250 depreciation recapture gain?a. There is a loss because the insurance recovery is less than the adjusted basis.b. There is a gain because the insurance recovery exceeds the adjusted basis.c. Because of the length of time the building has been held, there is no remaining additional depreciation.d. There is no insurance recovery and the adjusted basis of the building is greater than zero.e. None of these.

ANSWER:bRATIONALE:In order for there to be 1250 depreciation recapture, the disposition must be at a gain, and total accelerated depreciation must exceed straight-line depreciation. Section 1250 depreciation recapture applies before the casualty and theft rules. Answers c. and d. both indicate there is no remaining additional depreciation. Only answer b. could have additional depreciation and there is a gain.

49. Lynne owns depreciable residential rental real estate which has accumulated depreciation (all from straight-line) of $65,000. If Lynne sold the property, she would have a $53,000 gain. The initial characterization of the gain would be:a. Section 1245 gain.b. Section 1231 gain.c. Section 1250 gain.d. Section 1239 gain.e. None of these.

ANSWER:bRATIONALE:The gain is 1231 gain. Since straightline depreciation was used, there is no 1250 recapture. Also, since Lynne is an individual, there is no ordinary gain adjustment under 291. Section 1239 would not apply because there is no reason to conclude that the property would be sold to a related taxpayer.

50. A retail building used in the business of a sole proprietor is sold on March 10, 2014, for $342,000. The building was acquired in 2004 for $400,000 and straight-line depreciation of $104,000 had been taken on the building. What is the maximum unrecaptured 1250 gain from the disposition of this building?a. $400,000b. $322,000c. $104,000d. $26,000e. None of these

ANSWER:cRATIONALE:The maximum unrecaptured 1250 gain is the $104,000 depreciation taken. That maximum is reduced to the $46,000 gain from the disposition [$342,000 sale price ($400,000 cost $104,000 depreciation taken)].

51. Which of the following statements is correct?a. When depreciable property is gifted to another individual taxpayer, the depreciation recapture potential is extinguished.b. When depreciable property is inherited by a taxpayer, the depreciation recapture potential is extinguished.c. When corporate depreciable property is distributed as a dividend, the depreciation recapture potential is generally not recognized.d. When depreciable property is contributed to charity, the depreciation recapture potential has no effect on the amount of the charitable contribution deduction.e. All of these are correct.

ANSWER:bRATIONALE:Depreciation recapture potential is extinguished when property is received as an inheritance, carries over when the property is received by gift, is recognized by the corporation when property is distributed by a corporation and a gain would have been recognized if the property had been sold, and reduces the charitable contribution deduction amount.

52. Which of the following would extinguish the 1245 recapture potential?a. An exchange of depreciable business equipment for like-kind business equipment with gain realized, but not recognized.b. A nontaxable incorporation under 351.c. A nontaxable contribution to a partnership under 721.d. A nontaxable reorganization.e. None of these.

ANSWER:eRATIONALE:All of the transactions involve a carryover of basis and do not extinguish the 1245 depreciation recapture potential.

53. Section 1239 (relating to the sale of certain property between related taxpayers) does not apply unless the property:a. Was depreciated by the transferor.b. Is depreciable in the hands of the transferee.c. Is a capital asset.d. Is real property.e. None of these.

ANSWER:bRATIONALE:Section 1239 produces the conversion of the transferors capital gain into ordinary income if the property is depreciable in the hands of the related transferee.

54. An individual has a $40,000 1245 gain, a $35,000 1231 gain, a $33,000 1231 loss, a $3,000 1231 lookback loss, and a $15,000 long-term capital gain. The net long-term capital gain is:a. $30,000.b. $40,000.c. $17,000.d. $15,000.e. None of these.

ANSWER:dRATIONALE:None of the 1231 gain survives to be treated as longterm capital gain. $33,000 of the $35,000 1231 gain is absorbed by the $33,000 1231 loss and the remaining $2,000 is treated as ordinary gain because of the $3,000 1231 lookback loss. The $40,000 of 1245 gain is ordinary income.

55. An individual has the following recognized gains and losses from disposition of 1231 assets (all the assets were vacant land): $15,000 gain, $10,000 loss, $25,000 gain, and $2,000 loss. The individual has a $5,500 1231 lookback loss. The individual also has a $16,000 net short-term capital loss from the disposition of stock. Which of the following statements is correct?a. The taxpayer has $5,500 ordinary gain and $6,500 net long-term capital gain.b. The taxpayer has $12,000 net long-term capital gain.c. The taxpayer has $28,000 ordinary gain and $16,000 net short-term capital loss.d. The taxpayer has $5,500 ordinary loss and $6,500 net long-term capital gain.e. None of these.

ANSWER:aRATIONALE:There is a net 1231 gain of $28,000 ($15,000 $10,000 + $25,000 $2,000). $5,500 of the gain is treated as ordinary gain due to the $5,500 1231 lookback loss and the balance of $22,500 is treated as a long term capital gain. The $22,500 is netted against the $16,000 net short-term capital loss and results in a $6,500 net long-term capital gain.

56. Section 1231 gain that is treated as long-term capital gain carries from the 2013 Form 4797 to the 2013 Form 1040, Schedule D, line.a. 8b. 9c. 10d. 11e. None of these

ANSWER:dRATIONALE:Line 11 of the 2013 Form 1040 Schedule D is labeled Gain from Form 4797, Part I .

57. Business equipment is purchased on March 10, 2013, used in the business until September 29, 2013, and sold at a $23,000 loss on October 10, 2013. The equipment was not suitable for the work the business had purchased it for. The loss on the disposition should have been reported in the 2013 Form 4797, Part:a. I.b. II.c. III.d. IV.e. This transaction would not be reported in the Form 4797.

ANSWER:bRATIONALE:The business equipment was an ordinary asset because it was not held more than 12 months. Gains and losses from disposition of ordinary assets are reported in Part II of the Form 4797.

58. A business taxpayer sold all the depreciable assets of the business, calculated the gains and losses, and would like to know the final character of those gains and losses. The taxpayer had $353,000 of adjusted gross income before considering the gains and losses from sale of the business assets. The taxpayer had unrecaptured 1231 lookback loss of $22,000. What is the treatment of the gains and losses summarized in the chart below after all possible netting and reclassification has been completed? What is the taxpayers adjusted gross income? (Ignore the selfemployment tax deduction.)

AssetPurchase DateSale DateDepreciationGain (Loss)

Machine #110/10/1211/11/14$323,000$66,000

Machine #210/02/1111/11/1465,000(15,000)

Machine #309/23/1011/11/14183,00023,000

Machine #409/23/1011/11/1428,00034,000

ANSWER:The taxpayer has adjusted gross income of $461,000 after including the effect of the property transactions. Machine #1s $66,000 gain is all ordinary income due to 1245 depreciation recapture. Machine #3s $23,000 gain is all ordinary income due to 1245 depreciation recapture. Machine #4 has $28,000 of ordinary income due to 1245 depreciation recapture (equals depreciation taken) and $6,000 1231 gain ($34,000 $28,000). Machine #2s $15,000 loss is a 1231 loss. There is a $9,000 net 1231 loss ($6,000 gain $15,000 loss) for the year. The net ordinary gain for the year is $108,000 ($66,000 + $23,000 + $28,000 $9,000). There is no net 1231 gain, so the $22,000 1231 unrecaptured lookback loss does not affect the character of the current years gains. Adjusted gross income is $461,000 ($353,000 + $108,000).

59. A business taxpayer sold all the depreciable assets of the business, calculated the gains and losses, and would like to know the final character of those gains and losses. The taxpayer had $353,000 of adjusted gross income before considering the gains and losses from sale of the business assets. The taxpayer had unrecaptured 1231 lookback loss of $12,000. What is the treatment of the gains and losses summarized in the chart below after all possible netting and reclassification has been completed? What is the taxpayers adjusted gross income? (Ignore the selfemployment tax deduction.)

AssetPurchase DateSale DateDepreciationGain (Loss)

Machine #110/10/1211/11/14$323,000$66,000

Machine #210/02/1211/11/1465,000(15,000)

Machine #309/23/1011/11/14183,00023,000

Machine #409/23/1011/11/1428,00064,000

ANSWER:The taxpayer has adjusted gross income of $491,000 after including the effect of the property transactions. Machine #1s $66,000 gain is all ordinary income due to 1245 depreciation recapture. Machine #3s $23,000 gain is all ordinary income due to 1245 depreciation recapture. Machine #4 has $28,000 of ordinary income due to 1245 depreciation recapture (equals depreciation taken) and $36,000 1231 gain ($64,000 $28,000). Machine #2s $15,000 loss is a 1231 loss. There is a $21,000 net 1231 gain ($36,000 gain $15,000 loss) for the year. The $12,000 1231 unrecaptured lookback loss converts $12,000 of this gain to ordinary income, leaving $9,000 of the net 1231 gain to be treated as long-term capital gain. The net ordinary gain for the year is $129,000 ($66,000 + $23,000 + $28,000 + $12,000). Adjusted gross income is $491,000 ($353,000 + $129,000 + $9,000).

60. A business machine purchased April 10, 2012, for $98,000 was fully depreciated in 2012 using 179 immediate expensing. On August 15, 2014, the machine was sold for $67,000. What is the amount and nature of the gain or loss from disposition of the machine?ANSWER:The machine was a 1231 asset because it was held for more than 12 months. However, all of the $67,000 ($67,000 sales price $0 adjusted basis) gain is ordinary gain due to 1245 depreciation recapture.

61. An individual taxpayer has the gains and losses shown below. There are $3,000 of 1231 lookback losses. What is the net long-term capital gain?

Holding Period/PropertyCharacter of Gain or LossAmount

5 years/vacant land 1231 gain$7,000

2 years/business equipment 1245 gain3,200

3 years/publicly traded stockLong-term capital gain890

8 months/publicly traded stockShort-term capital loss(1,870)

ANSWER:The taxpayer has a net long-term capital gain of $4,890 and a net short-term capital loss of $1,870. The $3,200 of 1245 gain is ordinary income and does not affect the net longterm capital gain computation. Since there is $3,000 of 1231 lookback loss, $3,000 of the $7,000 1231 gain is treated as ordinary income and the remaining $4,000 of 1231 gain is treated as longterm capital gain. The $1,870 of short term capital loss offsets the $4,890 of long-term capital gain, resulting is a net capital gain of $3,020 (0%/15%/20% gain).

62. Vanna owned an office building that had been held more than one year when it was sold for $567,000. The real estate had an adjusted basis of $45,000 for the land and $233,000 for the building. Straight-line depreciation of $162,000 had been taken on the building. What is the amount and initial character of the gain or loss from disposition of the real estate? Is any of the gain unrecaptured 1250 (25%) gain?ANSWER:The real estate was used in business and held more than one year. Therefore, the property was a 1231 asset. Since straightline depreciation was taken, there is no 1250 depreciation recapture because no accelerated depreciation was taken. The entire gain of $289,000 [$567,000 sale price ($45,000 land adjusted basis + $233,000 building adjusted basis)] is 1231 gain. Since the recognized gain is greater than the $162,000 of depreciation, there is $162,000 of unrecaptured 1250 gain in the $289,000 recognized gain.63. The chart below describes the 1231 assets sold by the Ecru Company (a sole proprietorship) this year. Compute the gain or loss from each asset disposition and determine the net 1231 gain treated as longterm capital gain for the year. Assume there is a 1231 lookback loss of $4,000.

AssetAcquiredSoldCostDepreciationSale Price

Stamping3/10/108/10/2014$40,000$29,736$32,000

machine

Factory2/12/077/23/201480,00018,83890,000

building

Tractor5/16/0911/13/201452,00052,00030,000

Overhead11/12/032/25/201474,00074,00018,000

crane

ANSWER:The stamping machine ($21,736), tractor ($30,000), and overhead crane ($18,000) are each sold at a gain and the gain is ordinary due to 1245 depreciation recapture. The factory building yields a 1231 gain of $28,838. There is no 1250 depreciation recapture because straightline depreciation was used (i.e., the building was placed in service after 1986). $4,000 of the $28,838 gain is treated as ordinary income because of the $4,000 1231 lookback loss. Consequently, the net 1231 gain treated as longterm capital gain is $24,838 ($28,838 $4,000). The chart below provides detail on the computations:

AssetAcquiredSoldCostDepreciationBasisSale PriceGain(Loss)Stamping machine3/10/108/10/2014 $40,000$29,736$10,264$32,000$21,736

Factory building2/12/077/23/2014 80,00018,83861,16290,00028,838

Tractor5/16/0911/13/2014 52,00052,000030,00030,000

Overhead crane11/12/032/25/2014 74,00074,000018,00018,000

64. The chart below describes the 1231 assets sold by the Tan Company (a sole proprietorship) this year. Compute the gain or loss from each asset disposition and determine the net 1231 gain treated as longterm capital gain for the year. Assume there is a 1231 lookback loss of $14,000.

AssetAcquiredSoldCostDepreciationSale Price

Stamping machine3/10/108/10/2014$40,000$29,736$ 2,000

Factory building2/12/077/23/201480,00018,83890,000

Tractor5/16/0911/13/201452,00052,00060,000

Overhead crane11/12/032/25/201474,00074,00018,000

ANSWER:The stamping machine is sold at an $8,264 loss which is a 1231 loss. The factory building yields a 1231 gain of $28,838. There is no 1250 depreciation recapture because straightline depreciation was used (i.e., the building was placed in service after 1986). The tractor has $60,000 of gain, $52,000 of ordinary gain due to 1245 depreciation recapture (equal to the deprecation taken) and $8,000 of 1231 gain. The $18,000 gain on the overhead crane is ordinary due to 1245 depreciation recapture. $14,574 of net 1231 gain ($28,838 + $8,000 $8,264 $14,000 1231 lookback loss) is treated as longterm capital gain. The chart below provides details on the computations:

AssetAcquiredSoldCostDepreciationBasisSalePriceGain(Loss)

Stampingmachine3/10/108/10/2014$40,000$29,736$10,264$ 2,000($ 8,264)

Factorybuilding2/12/077/23/201480,00018,83861,16290,00028,838

Tractor5/16/0911/13/201452,00052,000060,00060,000

Overheadcrane11/12/032/25/201474,00074,000018,00018,000

65. Residential real estate was purchased in 2011 for $345,000, held as rental property, and depreciated straight-line. Assume the land cost was $45,000 and the building cost was $300,000. Depreciation totaled $34,089. The building and land were sold on June 10, 2014, for $683,000 total. What is the tax status of the property, the nature of the gain from the disposition, and is any of it 1250 depreciation recapture gain or unrecaptured 1250 gain?ANSWER:The adjusted basis of the property at the date of sale is $310,911 ($345,000 cost $34,089 depreciation). The asset is a 1231 asset because it was depreciable property or real property used in business (rental is a form of business) and it was held more than one year. The recognized gain is $372,089 ($683,000 sale price $310,911 adjusted basis) and it is all 1231 gain since only straightline depreciation was taken on the building. Thus, there is no 1250 depreciation recapture because there was no additional depreciation due to accelerated depreciation. However, there is potential unrecaptured 1250 gain of $34,089 because the depreciation taken is less than the recognized gain. The $338,000 ($372,089 $34,089) balance of the gain is potential 0%/15%/20% long-term capital gain.

66. Williams owned an office building (but not the land) that was destroyed by a fire. The building was insured and Williams has a $156,000 gain because his insurance recovery exceeded his adjusted basis for the building. Williams may replace the building. Williams had taken $145,000 of depreciation on the building, has no 1231 lookback loss, has no other 1231 transactions for the year, and has no Schedule D transactions for the year. What is the final nature of Jamisons gain for the year and what tax rate(s) apply to the gain if:(a) He does reinvest the insurance proceeds?(b) If he doesnt reinvest the insurance proceeds?ANSWER:(a) Williams initially has a casualty gain of $156,000 from business use property. If he reinvests the insurance proceeds, he will be able to postpone this gain.(b) If he does not reinvest, he will have a recognized gain. Since he has a net casualty gain, the gain is treated as 1231 gain and that gain is treated as a longterm capital gain because he has no 1231 lookback loss. Williams has a net long-term capital gain of $156,000 because he has no other Schedule D transactions. The unrecaptured 1250 portion of the gain is $145,000 (equal to the depreciation taken on the destroyed property). That portion of the gain is subject to an alternative tax rate of 25%. The $11,000 ($156,000 $145,000) remaining gain is subject to the 0%/15%/20% alternative tax rate.

67. A business machine purchased April 10, 2013, for $62,000 was fully depreciated in 2013 using 179 immediate expensing. On August 15, 2014, the sole proprietor who owned the machine gave it to his son. On that date, the machines fair market value was $57,000. The son did not use the machine in business or hold it as inventory and the machine was sold on November 22, 2014, for $53,000.What is the amount and nature of the gain or loss from disposition of the machine? Where is it reported in the sons tax return?ANSWER:A gift does not extinguish potential 1245 depreciation recapture potential. The son that received the machine had a $0 basis for the asset because he has a carryover basis from the donor. The fathers holding period tacks to the sons holding period therefore, the son had a longterm holding period on the date of the gift and potential 1245 depreciation recapture of $57,000 [the lesser of the depreciation taken ($62,000) or the realized gain at the date of the gift ($57,000)]. However, since the machine was sold for only $53,000, there is only $53,000 of 1245 depreciation recapture gain. The son should complete Form 4797 Part III for this transaction and then carry the gain to Part II as ordinary income.

68. Betty, a single taxpayer with no dependents, has the gains and losses shown below. Before considering these transactions, Betty has $45,000 of other taxable income. What is the treatment of the gains and losses and what is Bettys taxable income?

1245 gain #1$18,000

1245 gain #25,000

Business equipment long-term casualty loss(8,000)

Business real property long-term casualty gain12,000

1231 gain13,000

1231 lookback loss(2,000)

ANSWER:The 1245 recapture gains are combined and result in a $23,000 ordinary gain. The nonpersonal use property casualty gain and loss are combined and result in a $4,000 net gain. The net gain is treated as a 1231 gain and when combined with the other $13,000 1231 gain results in a $17,000 net 1231 gain. Due to the $2,000 1231 lookback loss, $2,000 of the net 1231 gain is an ordinary gain and the $15,000 balance of the gain is treated as a long-term capital gain. Since this is the only capital gain or loss, there is a $15,000 net long-term capital gain.

Other taxable income$45,000

Ordinary gain due to recapture23,000

Ordinary gain due to 1231 look back2,000

Net long-term capital gain 15,000

Taxable income$85,000

69. In 2014 Angela, a single taxpayer with no dependents, disposed of for $44,000 a business building which cost $100,000. $60,000 of depreciation had been taken on the building. Angela has a short-term capital loss of $3,000 this year. She has taxable income (not related to property transactions) of $125,000. She has no 1231 lookback loss. What is the amount and nature of the gain or loss, what is Angelas taxable income, and what is her tax on the taxable income?ANSWER:The adjusted basis of the building is $40,000 ($100,000 cost $60,000 depreciation). The building is sold for a gain of $4,000 ($44,000 sale price $40,000 adjusted basis). Since the building was held more than one year, it is a 1231 asset and the gain is a 1231 gain. Angela has a $4,000 net 1231 gain treated as a long-term capital gain. The gain is netted against her $3,000 short-term capital loss, resulting in a $1,000 net long-term capital gain. Since the other taxable income is $125,000, the taxable income after adding this gain is $126,000 ($125,000 + $1,000). The tax on her $125,000 regular taxable income is $28,293. All of the gain included in her taxable income is unrecaptured 1250 gain because the depreciation on the building exceeded the gain included in her taxable income. Consequently, the tax on the $1,000 net long-term capital gain is $250 ($1,000 .25). Her total tax is $28,543 ($28,293 + $250).

70. Charmine, a single taxpayer with no dependents, has already incurred a $10,000 1231 gain in 2014 and has no 1231 lookback losses. The taxpayer purchased a business machine for $100,000 five years ago, $70,000 of depreciation has been taken on it, and the machine is now worth $90,000. How will the net 1231 gain or loss be affected if the taxpayer trades in the business machine for a like-kind business machine and pays an additional $12,000 in cash to obtain the replacement machine? If Charmine already has $322,000 of taxable income which does not include a $10,000 1231 gain or any capital gains or losses, what is her taxable income?ANSWER:The current year 1231 gain will not be affected because no gain or loss is recognized on the exchange of the machine. A likekind exchange causes recognized gain only when boot is received. No boot was received in the exchange, so the potential 1245 depreciation recapture of $70,000 carries over to the replacement machine. The taxable income is $322,000 + $10,000 = $332,000.71. Why is it generally better to have a net 1231 gain year followed by a net 1231 loss year rather than a net 1231 loss year followed by a net 1231 gain year?ANSWER:It is generally better to have a net 1231 gain year followed by a net 1231 loss year rather than a net 1231 loss year followed by a net 1231 gain year because the 1231 lookback loss rules will be avoided. The net 1231 gain in the first year is treated as a longterm capital gain and, therefore, potentially eligible for the reduced long-term capital gain rates. The second year net 1231 loss is deductible for AGI as an ordinary deduction.72. Describe the circumstances in which the potential 1245 depreciation recapture is extinguished.ANSWER:Section 1245 depreciation recapture potential is extinguished in at least two circumstances: (1) when the property with the depreciation recapture potential is sold at a loss and (2) when the owner of the property with the depreciation recapture potential dies.

73. Describe the circumstances in which the maximum unrecaptured 1250 gain (25% gain) does not become part of the Schedule D netting process for an individual taxpayer?ANSWER:Unrecaptured 1250 gain (25% gain) is some or all of the 1231 gain that is treated as longterm capital gain and relates to a sale of depreciable real estate. The maximum amount of this 25% gain is the depreciation taken on the real property sold at a gain. That maximum amount is reduced in one or more of the following ways: The gain recognized from disposition is less than the depreciation taken. The 25% gain is reduced to the gain amount. There is 1250 depreciation recapture because the property was depreciated using 179 and/or 168(k) and, therefore, accelerated depreciation was taken. The 1250 recapture reduces the 25% gain. There is 1245 depreciation because the property is nonresidential real estate acquired in 19811986 on which accelerated depreciation was used. There will be no 25% gain left because 1245 will recapture all the depreciation or the gain, whichever is less. Refer to Example 12. There was $100,000 of depreciation taken, but all of it was recaptured as ordinary income by 1245. Thus, there is no remaining potential 25% gain. The entire $20,000 1231 gain in Example 12 is potential 0%/15%/20% gain. Section 1231 loss from disposition of other 1231 assets held longterm reduced the gain from real estate. According to the IRS, 1231 losses first absorb potential 0%/15%/20% 1231 gain and then 25% 1231 gain. Section 1231 lookback losses convert some or all of the 25% gain to ordinary income. According to the IRS, 1231 lookback losses first absorb 28% net 1231 gain, then 25% 1231 gain, and then 0%/15%/20% 1231 gain.

74. Depreciable personal property was sold at a gain in 2013. On what 2013 form would this transaction be reported, where initially in that form, and what will the form most likely do with the gain?ANSWER:The transaction will initially be reported on Form 4797, Part III. In that Part, the gain recaptured by 1245 will be determined. Most likely, all of the gain will be treated as an ordinary gain because the gain does not exceed the original cost of the property. 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.