1231 ASSETS

1. § 1231 applies to the trade or business assets held greater than 1 year
net gain may be treated as long-term capital gain, and net loss is treated as ordinary loss;
2. Section 1231 property includes the following assets:
Depreciable or real property used in business
Timber, coal, or domestic iron ore.
Livestock held for draft, breeding, dairy, or sporting purposes.
Unharvested crops on land used in business.
patents and goodwill

3. Section 1231 property generally does not include the following:

Property not held for the long-term holding period.
Nonpersonal use property where casualty losses exceed casualty gains
Inventory
A patent, invention, model, or design; a secret formula or process; certain copyrights; literary, musical, or artistic
compositions; and certain U.S. government publications.
Accounts receivable and notes receivable
 The netting of the § 1231 asset and nonpersonal use capital asset casualty gains and losses contains only one item—
the $200 gain from the business building. Consequently, there is a net gain, and that gain is treated as a § 1231 gain
The gains from § 1231 transactions (Assets A and B and the § 1231 asset casualty gain) exceed the losses (Asset
C) by $1,100 [300+1100+200-500]. This excess is a long-term capital gain
Ross’s net long-term capital gain is $3,700 [3000+1100-400]. Ross’s net short-term capital gain is $800 [1000-
200]. The $3,700 net long-term capital gain portion is eligible for beneficial capital gain treatment [0%/15%/20% gain].
The $800 net short-term capital gain is ordinary income.
Ross treats the gain and loss from Assets D and E as ordinary gain and loss.
Ross will have personal use property casualty losses of $1,200. The $1,200 is not deductible because the losses are
not Federal disaster area losses and there are no personal use property casualty gains to offset these losses.

Assume the same facts as in Example 4, except that the loss from Asset C was $1,700 instead of $500.
The losses from § 1231 transactions now exceed the gains by $100[300+1100+200-1700]. As a result, the gains from
Assets A and B and the § 1231 asset casualty gain are ordinary income, and the loss from Asset C is a deduction for AGI
The $2,600 net long-term capital gain portion is eligible for beneficial capital gain treatment, and the $800 net short-
term capital gain is ordinary income.

Assume the same facts, except that Ross has a $700 nonrecaptured net § 1231 loss from 2018.
The 2019 net § 1231 gain of $1,100 is treated as ordinary income to nonrecaptured § 1231 loss of $700.
The remaining $400 net § 1231 gain is a long-term capital gain.
Ross’s net long-term capital gain is $3,000. Ross’s net short-term capital gain is still $800 ($1,000 2 $200).
Assume the same facts, except that Ross had a net § 1231 loss of $2,700 in 2017 and a net § 1231 gain of $300 in 2018.
The 2017 net § 1231 loss of $2,700 will have carried over to 2018 and been offset against the 2018 net § 1231 gain of
$300. Thus, the $300 gain will have been classified as ordinary income, and $2,400 of nonrecaptured 2017 net § 1231
loss will carry over to 2019. The 2019 net § 1231 gain of $1,100 will be offset against this loss, resulting in $1,100 of
ordinary income. The nonrecaptured net § 1231 loss of $1,300 ($2,400 2 $1,100) carries over to 2020.

A sculpture that Kane held for investment was destroyed in a flood. The sculpture was insured, and he had a $60,000
gain from this casualty. He also had a $17,000 loss from an uninsured antique vase that was destroyed by the flood.
The vase was also held for investment. He had no nonrecaptured § 1231 losses from prior years. Both the sculpture
and the vase had been held more than one year when the flood occurred. Compute Kane’s net gain or loss.
He has two nonpersonal use property casualties. The 60,000 gain is netted against the 17,000 loss and results in a
43,000 net casualty gain. He has 43,000 net 1231 gain and this gain is treated as a long-term capital gain.

Hara has the following net § 1231 results for each of the years shown. What would be the nature of the net gains in
2018 and 2019?

Combined nonrecaptured net 1231 loss (2014-2016) =93,000. The 93,000 loss is partially absorbed by $41,000 gain in
2017, and 30,000 gain in 2018. Thus, 22,000 of the nonrecaptured 1231 loss remains for offset against the 2018
41,000 gain.
In summary, the 2018 and 2019 net 1231 gain are affected by the lookback rule. The 2018 gain of 30,000 is treated as
ordinary income. The 2019 gain of 41,000 is treated as 22,000 of ordinary income and 19,000 of long-term capital
gain.

SECTION 1245 RECAPTURE

1. Section 1245 requires taxpayers to treat § 1231 gain be as ordinary gain to the extent of the depreciation taken
The loss will still be a § 1231 loss
2. Generally, § 1245 property includes all depreciable personal property (machinery and equipment)
 Amortizable personal property such as goodwill, patents, copyrights, and leaseholds of § 1245 property.

Professional baseball and football player contracts.

Certain depreciable tangible real property employed as an integral part of certain activities such as manufacturing and production (e.g., a natural

gas storage tank where the gas is used in the manufacturing process).

Pollution control facilities, railroad grading and tunnel bores, on-the-job training, and childcare facilities.

Single-purpose agricultural and horticultural structures and petroleum storage facilities (e.g., a greenhouse or silo).

nonresidential real estate for which accelerated cost recovery is used (placed in service after 1980 and before 1987).

Siena Industries sold three § 1231 assets during 2019.

a. Determine the amount and the character of the recognized gain or loss from the disposition of each asset.
Rack: 85,000-(100,000-62,000) =47,000 (all ordinary income due to 1245 recapture)
Forklift: 5000- (35,000-23,000) =7,000 (1231 loss)
Bin: 60,000- (87,000-34,000) = 7000 (all ordinary income due to 1245 recapture)
b. Siena has no nonrecaptured net § 1231 losses from prior years, analyze these transactions and determine the amount
(if any) that will be treated as a long-term capital gain.
none of the gains are treated as long-term capital gain.

Amber Industries sold three § 1231 assets during 2019.

a. Determine the amount and the character of the recognized gain or loss from the disposition of each asset.
Rick: 145,000-(100,000-100,000) =145,000 (100,000 ordinary income due to 1245 recapture; 45,000 1231 gain)
Forklift: 3000- (35,000-23,000) =9000 (1231 loss)
Bin: 60,000- (87,000-31,000) =4000 (all ordinary loss due to 1245 recapture)
b. Amber has $5,000 nonrecaptured net § 1231 losses from the five prior years, analyze these transactions and
determine the amount (if any) that will be treated as a long-term capital gain
He has a 36,000 (45,000-9000) net 1231 gain, but only 31,000 is treated as long-term capital gain because the 5000 of
nonrecaptured prior year’s 1231 loss causes 5000 of the current-year net 1231 gain to be treated as ordinary income.

Steve acquired nonresidential real estate on December 1, 1986, for $100,000. He used the required ACRS accelerated
method to compute the cost recovery. He sells the asset on January 15, 2019, for $120,000. The amount and nature of
Steve’s gain are computed as follows:
Adjusted basis=100,000-100,000=0 Realized and recognized gain=120,000.
Steve reports ordinary income of $100,000 and § 1231 gain of $20,000
How would you answer change if Steve had used s/l. Then it is 1250 property.
Gain=120,000-0=120,000. No 1250 gain as S/L is used. 1250 gain=excess of accelerated taken over the amount if S/L is
used
SECTION 1250 RECAPTURE
1. § 1250 property is depreciable real property (Land not included)
Nonresidential real property acquired after December 31, 1969, and before January 1, 1981, on which accelerated depreciation
was taken.
Residential rental real property acquired after December 31, 1975, and before January 1, 1987, on which accelerated
depreciation was taken.
2. Section 1250 recapture: depreciation in excess of straight-line depreciation
3. Any unrecaptured § 1250 gain is long-term capital gain, and subject to a 25 percent tax rate
4. The 25% gain is equal to the lesser of the depreciation taken or the recognized gain.
5. Special 25% Gain Netting Rules
any § 1231 loss first offsets the 0%/15%/20% portion of the § 1231 gain and then offsets the 25% gain portion of
the § 1231 gain. Also, any § 1231 lookback loss first recharacterizes the 25% gain portion of the § 1231 gain and
then recharacterizes the 0%/15%/20% portion of the § 1231 gain as ordinary income.
Bridget is a single taxpayer with 2019 taxable income of $120,000 composed of:
$100,000 ordinary taxable income,
$3,000 short-term capital loss,
$15,000 long-term capital gain from sale of stock, and
$8,000 § 1231 gain that is all unrecaptured § 1250 gain
The $3,000 short-term capital loss is offset against the $8,000 unrecaptured § 1250 gain, reducing that gain to $5,000.
Bridget’s total tax is $21,625
[$18,175 (tax on $100,000 other taxable income) + $1,200 ($5,000 unrecaptured § 1250 gain *24%) +$2,250 ($15,000
adjusted net capital gain *15%)].

On May 2, 1989, Hannah Weather acquired residential rental real estate for $450,000. Of the cost, $100,000 was
allocated to the land and $350,000 to the building. On August 20, 2018, the building, which then had an adjusted basis
of $0, was sold for $545,000 and the land for $200,000.
a. Determine the amount and character of the recognized gain from the sale of the building.
The gain on the sale of the building is not subject to 1250 depreciation recapture because it is residential real estate
acquired after 1986. The gain from the sale is 545,000: 0 is ordinary income due to 1250, and there is 545,000 1231
gain. The unrecaptured 1250 gain is 350,000 because that is the depreciation taken, and 350,000 is less than the gain
recognized.
b. Determine the amount and character of the recognized gain from the sale of the land.
The land is also a 1231 asset because it was part of the residential real estate. However, is was not depreciated. The
1231 gain from the sale of the land is 100,000

During 2019, the following transactions occurred:

Unimproved land adjacent to the store was condemned by the city. The condemnation proceeds were $15,000. The
land, acquired in 1986, had an allocable basis of $40,000.
15,000-40,000=25,000 realized and recognized 1231 loss
A truck used to deliver trampolines was sold on January 2 for $3,500. The truck was purchased on January 2, 2015,
for $6,000. On the date of sale, the adjusted basis was zero.
Realized gain=3500; Recognized gain=3500 ordinary income under 1245
 Larry sold an antique rowing machine at an auction. Net proceeds were $4,900. The rowing machine was purchased
as used equipment 17 years ago for $5,200 and is fully depreciated.
Realized and recognized gain is 4900 (ordinary income under Section 1245)
Larry sold an apartment building for $300,000 on September 1. The rental property was purchased on September 1,
2016, for $150,000 and was being depreciated over a 27.5-year life using the straight-line method. At the date of sale,
the adjusted basis was $124,783.
Realized gain=300,000-124,783=175,217 1231 gains. No 1250 recapture is recognized because the taxpayer used
the straight-line method of depreciation. Of the 175,217 1231 gains, 25,217 is unrecaptured 1250 gains because the
depreciation taken of 25,217 (150,000-124,783) is less than the 175,217 recognized gain.
Larry’s personal yacht was stolen on September 5. The yacht had been purchased in August at a cost of $25,000.
The fair market value immediately preceding the theft was $19,600. Larry was insured for 50% of the original cost,
and he received $12,500 on December 1.
Personal use property casualty losses are not deductible unless they offset personal use property casualty gains or
are losses arising in a Federal disaster area. As a result, the loss on the yacht is not deductible.
Larry sold a Buick on May 1 for $9,600. The vehicle had been used exclusively for personal purposes. It was
purchased on September 1, 2015, for $20,800.
9600-20800=11,200. The loss relates to a personal use asset. Therefore, it is not recognized.
Larry’s trampoline stretching machine (owned two years) was stolen on May 5, but the business’s insurance
company will not pay any of the machine’s value because Larry failed to pay the insurance premium. The machine
had a fair market value of $8,000 and an adjusted basis of $6,000 at the time of theft.
6000 business casualty loss is deducible for AGI. The casualty loss is measured by the adjusted basis of the
property at the time of theft.
Larry had AGI of $102,000 from sources other than those described above.
Larry has no nonrecaptured § 1231 lookback losses.
a. For each transaction, what are the amount and nature of recognized gain or loss?
b. What is Larry’s 2019 AGI?
Other sources=102,000
Ordinary income=3500+4900=8400
1231 and 25% gains= 175217-25,000=150217
Business casualty loss=6000
Adjusted AGI=254,617
“Special 25% Gain netting rules”
The 1231 loss of 25,000 will first offset the 0%15%20% portion of the 1231 gain which was 150,000. Therefore, for
purpose of the Net capital gain, alternative tax discussed in Chapter 16, there is only 125,000 of 1231 gains allocated
to the 0%15%20% category. The $25,217 is limited to a maximum rate of 25%.

CONSIDERATIONS COMMON TO §§ 1245 AND 1250

1. Gifts
Depreciation recapture potential carries over to the donee.
Wade gives his daughter, Helen, § 1245 property with an adjusted basis of $1,000. The amount of recapture potential is
$700. Helen uses the property in her business and claims further depreciation of $100 before selling it for $1,900.
Helen’s recognized gain is $1,000 ($1,900 amount realized- $900 adjusted basis), of which $800 is recaptured as ordinary
income. The remaining gain of $200 is § 1231 gain.
2. Death
Any depreciation recapture potential is eliminated when property passes from a decedent to an estate or heir.
Assume the same facts as in Example 15, except that Helen receives the property as a result of Wade’s death.
The $700 recapture potential from Wade is extinguished. Helen has a basis for the property equal to the property’s fair
market value at Wade’s death (assume that the FMV is $1,700).
Helen will have a $300 gain when the property is sold [$1,900 - $1,600]. Because of § 1245, $100 is ordinary income. The
remaining gain of $200 is § 1231 gain.

3. Charitable Transfers
Depreciation recapture potential reduces the amount of the charitable contribution deduction.
David contributes to charity some tangible personal property that he had used in his business and depreciated. At the
date of the donation, the property has a fair market value of $233,000 and an adjusted basis of zero; it was originally
acquired for $400,000. What is the amount of David’s charitable contribution?
When depreciable tangible property is contributed to charity, the contribution is limited to the FMV of the property
reduced by the 1245 depreciation recapture potential. Because the depreciation potential (400,000) is greater than the
fair market value at the date of gift (233,000), there is no charitable contribution deduction.

4. Certain Nontaxable Transactions

In certain transactions, the transferor’s adjusted basis of property carries over to the transferee.
If this is the case, any depreciation recapture potential also carries over to the transferee.
Nontaxable incorporations under § 351.
Certain subsidiary liquidations under § 332.
Nontaxable contributions to a partnership under § 721.
Nontaxable 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.

5. Like-Kind Exchanges (§ 1031) and Involuntary Conversions (§ 1033)

Realized gain is recognized to the extent of boot received in a like-kind exchange. Realized gain also will be
recognized to the extent the proceeds from an involuntary conversion are not reinvested in similar property. Any
recognized gain is subject to recapture as ordinary income under §§ 1245 and 1250. However, since only real property
can be the subject of a like-kind exchange, §1245 recapture is not likely because it generally only applies to tangible
personal property. Section 1250 recapture is also not likely because it infrequently applies to dispositions of real
property. On the other hand, unrecaptured § 1250 gain (25% gain) is likely to be present if depreciable real property
was the subject of the exchange. As a result, if gain is recognized on the exchange, there is likely
some 25% gain. The remaining recapture potential, if any, carries over to the property received in the exchange.
Realized losses are not recognized in like-kind exchanges but are recognized in involuntary conversions.