Federal Taxation 2003 Chapter 13 Property Transactions Section 1231 & Recapture I. Section 1231 Property (favored capital gain treatment and ordinary loss treatment) a. Real or depreciable property used in a trade or business held for more than a year. i. Held for less than 1 year provides ordinary gain or loss. b. Timber, Coal, Domestic iron ore, livestock, and unharvested crops. II. Involuntary Conversions a. Gains and losses from condemnations of Sec. 1231 property and capital assets used in a trade or business held more than 1 year are Sec. 1231 gain and losses. b. Gains and losses from casualty or theft (fire, hurricane, etc.) require a netting computation. i. If these recognized losses exceed recognized gains then treated as ordinary gains and losses. ii. If these recognized gains exceed recognized losses then they are classified as Sec. 1231 gains and losses. iii. P -13-38 III. Section 1231 Netting – See separate handout. a. P 13-33,36 b. Mitigation of 1231 benefit of capital gain favorable treatment and ordinary loss treatment. i. Section 1245 recapture avoids the double advantage of depreciating property and taxing the gain at a special capital gain rate. 1 1. Sec 1245 property includes: depreciable personal property like equipment, automobiles, livestock, intangibles subject to amortization. 2. Sec 1245 property realized gain (doesn’t apply to losses) is ordinary to the extent of depreciation, any remaining gain is 1231 gain (capital gain treatment) 3. Non-residential real estate placed in service between 1981 and 1986 is Sec. 1245 property subject to recapture of only ACRS (not straight-line) depreciation. 4. P 13-42 ii. Section 1250 property 1. All depreciable real property (except # 3 above). 2. Section 1250 property realized gain is ordinary to the extent of excess depreciation taken, any remaining gain is 1231 gain (capital gain treatment) a. Post 1986 real property MACRS requires straight-line so no excess depreciation. 3. Unrecaptured Section 1250 gain is Sec. 1231 gain to the extent of straight-line depreciation. This gain is taxed at a maximum of 25% while the capital gain rate is 20% or 10%. a. So, for Section 1250 property i. Recapture excess depreciation of realized gain as ordinary income. 2 ii. Unrecaptured Section 1250 gain is Section 1231 gain subject to 25% maximum tax rate to the extent of straight- line depreciation. (Post 5-6- 1977) iii. Remainder or selling price > cost is Section 1231 gain or LTCG. iv. P 13-53-54 b. Real Estate Transition Periods. i. Residential Rental Property 1. 1250 recapture excess depreciation after 1975. 2. Low-Income Housing provides a reduced recapture % (1% reduction per month held. iii. Five-year lookback rule defeats the timing strategy of taking all capital gain treatment one year and all ordinary loss treatment the next year. 1. Any net Sec. 1231 gain is ordinary gain to the extent of nonrecaptured Sec. 1231 losses from the previous five years. 2. P 13-39 IV. Recapture Provision- Special issues a. Gifts- Donor passes the recapture to donee. b. Recapture dies with owner-not transferred by estate. 3 c. Charitable Contributions deductibility is reduced by recapture. d. Like-kind-exchange can be used to defer recapture. Any boot received triggering gain will first be recaptured as ordinary income. e. Involuntary conversion-any unreinvested amount realized will trigger gain and recapture. f. Installment sales- recall that any recaptured gain in recognized in year of sale. g. Sec 179- First year expensing assets converted to personal use requires taxpayer to recognize income of excess depreciation. h. Conservation and Land Clearing Expenditures- the special expensing of these costs need to be recaptured if disposed of before 9 years. i. P 13-59 i. Intangible Drilling Costs and Depletion are recaptured to the extent of realized gain- on sale of property. i. P 13-61 j. Related party property sales. i. If property is depreciable the gain recognized is ordinary. Prohibits related parties from getting 1231 gain treatment and a step-up in basis. 4
"section 1250 property"