Recapture 1

Extra Recapture Materials. Property

Transactions: §1231 and Recapture

Provisions

Recapture 2

Note from Instructor-1

Capital losses can be deducted from capital gains, if you have capital gains.

It is critical for us to understand that capital loss deductions (from ordinary income) are limited to $3,000 per year for individuals and to zero for corporations.

In a depression, a corporation may need to sell (or abandon) excess factories and equipment. If the loss on the sale is subject to the capital loss limit, the deduction is of no value during a depression.

Recapture 3

Note from Instructor-2Therefore, the corporation wants production assets to be classified as ordinary assets (not capital assets) so the loss on the sale can be deducted, possibly creating a net operating loss to be carried back to another year-resulting in a refund of back taxes and a source of much needed cash.

So, businesses want buildings and equipment to be “non” capital assets.

Recapture 4

Note from Instructor-3The situation changes in boom times when equipment is being sold at a gain.Then, individuals want such assets to be classified as capital assets so they can take advantage of the 15% maximum rate on capital gains.Corporations want the assets to generate capital gains because they may have accumulated capital losses that will offset the capital gains.

Recapture 5

Note from Instructor-4Congress has listened to the lobbyists, and showed their appreciation for the campaign contributions.Buildings and equipment used in a business, as well as land, are not capital assets. (Sec. 1221)However, if you have net gains from the sale of these assets you are allowed to “pretend” the assets are capital assets, and report the gains as capital gains. (Sec. 1231)

Recapture 6

Note from Instructor-5This creates a loophole. Buy a $400,000 machine. Depreciate it very fast – claiming deprec. of say $100,000. That leaves a book value of $300,000. Now lets assume you sell it for $400,000.You have a $100,000 gain. It is capital gain, but.!!

(Sec. 1245) Congress said that to the extent a gain represents depreciation on personal property-- that much of the gain is ordinary income-- and any additional gain is capital gain. This company will report $100,000 ordinary income (recaptured) on the sale of the asset.

If they sell the asset for $410,000, there is capital gain of $10,000. The remaining $100,000 gain is reported as ordinary income.

Recapture 7

Note from Instructor-6(Sec. 1250) It is more complicated with buildings, because we may be recapturing only the excess of actual depreciation taken over what would have been taken with straight-line method.Since the law has only allowed straight-line depreciation on real estate since 1986, our main focus is on buildings on which straight-line depreciation has been claimed.

It is more complicated for Corporations selling buildings because they have extra recapture under Sec. 291.Compare actual depreciation recapture under Sec. 1250 (probably zero) with what would have been recaptured under Section 1245 (gain up to amount of depreciation claimed). Subtract 1250 recapture from hypothetical 1245 recapture, and take 20% of this difference. This computation gives you corporate recapture amount under Sec. 291.

Recapture 8

Cost: Machine INDIV:Machine-S.Price: $410,000.

$400,000 or Bldg Amount Tax Rate

Accum. Total Gain $110,000

Deprec. Deprec. Ordinary $100,000 Ord. Rate

$100,000 (St. Line) Cap. Gain $10,000 15%

INDIV:Building-S.Price: $410,000.Book Val. Book Amount Tax Rate$300,000 Value Total Gain $110,000

Ordinary $0Cap. Gain $100,000 25%Cap. Gain $10,000 15%

Individual T/P is single with Tax. income of $500,000 before sale.

Recapture 9

Cost: Machine CORP:Machine-S.Price: $410,000.

$400,000 or Bldg Amount Tax Rate

Accum. Total Gain $110,000Deprec. Deprec. Sec. 1245 $100,000 Ord. Rate

100,000$ (St. Line) Cap. Gain $10,000 Ord. Rate

Corp:Building-S.Price: $410,000.Book Amount Tax Rate

Book Val. Value Total Gain $110,000$300,000 Sec. 291 $20,000 Ord. Rate

Cap. Gain $90,000 Ord. Rate

Corp. T/P has Taxable income of $500,000 before this sale.Sec. 291 recapture is 20% of the unrecaptured depreciation.

Recapture 10

Note from Instructor-7

1221 Depreciable property used in a trade or business, & real property used in a trade or bus. are not capital assets.Capital gain treatment is given to sales, exchanges, or involuntary conversions of depreciable or real property used in a trade or business, if there is a net gain during the year. (but note rule on non-recaptured sec. 1231 losses)

1231

DEPRECIATION RECAPTURE

Recapture 11

Note from Instructor-8

(Exception to Sec. 1231)

Applies generally to depreciable personal property. Non-residential real property is also covered if accelerated depreciation is used.All depreciation taken is recaptured(treated as ordinary gain) up to amount of gain.

1245

DEPRECIATION RECAPTURE

Recapture 12

Note from Instructor-9

1250 Generally applies to depreciable real estate. Only excess of actual depreciation over S/L is recaptured. If S/L is taken, no depreciation is recaptured.(Note rule on non-recaptured sec. 1250 (Gain up to unrecaptured depreciation had 25% tax rate.)

DEPRECIATION RECAPTURE

Recapture 13

Note from Instructor-10

Section 291 Recapture291 An exception to Sec. 1250.

Compare depreciation recaptured under sec. 1250 with the depreciation that would be recaptured under 1245 -- if that applied. 20% of the excess of what would be recaptured underSec.1245 over actual 1250 recapture is also recaptured. Sec. 291 only applies to corporations.

Recapture 14

Lookback Example

Taxpayer had the following §1231 gains and losses:

2007 $ 4,000 loss2008 10,000 loss2009 16,000 gain

– In 2009, taxpayer’s net §1231 gain of $16,000 will be treated as $14,000 of ordinary income and $2,000 of long-term capital gain

Recapture 15

Lookback Provision - More

Yr. 1 Yr. 2 Yr. 3 Yr. 4$50,000 -45,000 $40,000 $15,000

a.b.c.d.

Pam had these Section 1231 gains & losses:

$5,000 $10,000 $15,000

$0

$10,000 $5,000

$0 $15,000

YearSec. 1231 gain

How will Pam report the $15,000 gain in year 4?Capital GainOrdinary Income

Recapture 16

§1245 RecaptureCorp. sells for $240,000, equipment which it had placed in service two years earlier. The equipment had cost $250,000, and depreciation deductions of $30,000 had been taken on the equipment. The results of the sale are

a. Ordinary income of $20,000.

b. Sec. 1231 gain of $20,000.

c. Capital gain of $20,000.

d. None of the above.

Recapture 17

§1245 Recapture

Selling Price ($000) $240Cost 250Acc. Depreciation (30)Book Value 220Gain 20

Ordinary Income $20Capital Gain

How is gain reported if this asset is sold for $260,000?What is the deduction, if the asset is given to charity?

Recapture 18

§1245 Recapture• Notice on the preceding slide that

all gain was recaptured.

• This is because all gain represented recapture of prior depreciation.

• You would have to sell the equipment for more than $250,000 to get any capital gain under Section 1231.

Recapture 19

§1245 RecaptureTaxpayer sold equipment used in his business for $11,000. The equipment cost $10,000. TP had properly claimed ACRS deductions totaling $4,000. Straight-line depreciation, if it had been used, would have been $2,500. What is the amount of gain that should be reported under sections 1231 and 1245? Section 1231 Section 1245a. $5,000 $0b. $3,500 $1,500c. $1,000 $4,000d. $0 $5,000

Recapture 20

§1245 Recapture

Selling Price $11,000 Cost $10,000 Dep.-SL (2,500) Dep.-Excess (1,500) Book Value 6,000 Gain $5,000

Ord. Income $4,000Capital Gain $1,000

Recapture 21

Recapture Review - 1

Selling Price 430,000$ Original Cost 400,000$

St.-Line ExcessAccum. Depreciation 100,000 100,000 Book Value 300,000 Gain 130,000$

1245 1250 1250Machine Apartment Office Bld.

Ordinary income - 1245Ordinary income - 1250Cap. gain -Unrecaptured (25%)Cap. gain -Regular CG Rates

Depreciation Recapture - Individuals

Recapture based on asset type

Recapture 22

Recapture Review - 2

Selling Price 430,000$ Original Cost 400,000$

St.-Line ExcessAccum. Depreciation 100,000 100,000 Book Value 300,000 Gain 130,000$

1245 1250 1250Machine Apartment Office Bld.

Ordinary income - 1245 100,000$ N/A N/AOrdinary income - 1250 N/ACap. gain - Unrecaptured (25%) 100,000$ 100,000$ Cap. gain - Regular CG Rates 30,000$ 30,000$ 30,000$

Depreciation Recapture - Individuals

Recapture based on asset type