Chapter 13: Property Transactions Sec 1231 And Recapture

Question 1

Section 1231 property

Answer 1

Primarily business property, real or depreciable, used in a trade or business with a holding period of more than one year

Timber, coal, or domestic iron ore
Livestock
Unharvested crops

Not investment property

Question 2

Net sec. 1231 gains

Answer 2

Treated as long term capital gains (and losses)

BUT portion may be treated as ordinary income due to 5-year look-back rule

Question 3

Net sec 1231 losses

Answer 3

Then section 1231 gains and losses treated as ordinary gains and losses

Means they’re fully deductible in the current year

Question 4

Five-year look-back rule

Answer 4

Any section 1231 gain is treated as ordinary gains to the extent of any nonrecaptured net sec 1231 losses from the previous five years

So section 1231 losses deducted as ordinary losses in the previous 5 years are recaptured by changing what would otherwise be a long term capital gain to ordinary income

Question 5

Section 1231 loss from a passive activity

Answer 5

Subject to passive activity loss rules

Question 6

Determining amount of nonrecaptured net section 1231 losses

Answer 6

Aggregate amount of net sec. 1231 losses for 5 preceding tax years
Vs
Any amounts recaptured as ordinary income in those tax years

Excess of nonrecaptured over previously recaptured is the net nonrecaptured loss

Question 7

Adjusted net capital gain

Answer 7

ANCG

Net capital gain determined without regard to
- 28% rate gain (collectables and some sec. 1202 gain)
- unrecaptured section 1250 gain

Question 8

Order in which net section 1231 gain is recharacterized as ordinary income under the 5-year lookback rule

Answer 8

1) net section 1231 gain in the 25% group (unrecaptured 1250 gain)
2) net section 1231 gain in the 20% or 15% group

Question 9

Depreciable property and real property used in a trade or business held for one year or less

Answer 9

Neither capital assets nor section 1231 property

All gains and losses ordinary

Question 10

Items specifically excluded from section 1231 property

Answer 10

Inventory
Government publications received other than by purchase
Patents
Inventions
Designs
Secret formulas
Copyrights
Literary, musical, or artistic compositions
Letters or memorandums
Property held by its creator

Question 11

Section 631

Answer 11

Allows taxpayers to ELECT to treat the cutting of timber as a sale or exchange of said timber IF:
- taxpayer owns the timber or holds the contract right on the first day of the year or for more than one year
- timber is cut for sale or for use in taxpayers trade or business

Question 12

Computing gain or loss on cutting of timber treated as sale of timber

Answer 12

Comparing timber’s adjusted basis for depletion with it’s FMV on the first day of the tax year in which it is cut

Any difference between this FMV and actual sale price is an ordinary gain or loss

Question 13

If election is made to treat the cutting of timber as sale or exchange

Answer 13

Timber is the section 1231 property and gains and losses are 1231 gains and losses

If no election tax treatment depends on if timber is held for sale in course of trade or business or if held for investment or for use in trade or business

Question 14

Disposal of coal or domestic iron ore

Answer 14

If disposed of while retaining an economic interest in it the disposal must be treated as sale of section 1231 property

Question 15

Economic interest in minerals

Answer 15

Owned when an individual acquired by investment any interest in mineral in pace and seeks a return of capital from the income derived from its extraction

Question 16

Livestock

Answer 16

ONLY MAMMALS

Question 17

When livestock is section 1231 property

Answer 17

Livestock held for 12 months or more for draft, breeding, dairy, or sporting purposes.

Cattle and horses must be held for more than 24 months from acquisition to be section 1231 property

Question 18

When are unharvested crops section 1231 property

Answer 18

Unharvested crop growing on land used in a trade or business IF both crop and land are sold at the same time to the same person and the land is held for more than one year

Not 1231 if seller retains any right or option to reacquire the land

Means that no deductions are allowed for expenses attributable to the production of the unharvested crops (cost of production must be capitalized)

Question 19

Involuntary conversions of property used in trade or business

Answer 19

Generally treated as section 1231 gains or losses

Includes involuntary conversions of capital assets held in connection with a trade or business or in a transaction entered into for profit

As long as held for over one year

Question 20

Condemnation of section 1231 property and capital assets

Answer 20

As long as held for over a year, treated as section 1231 gains and losses (as long as held in connection with trade, business, or a transaction entered into for profit)

Question 21

Gains or losses from involuntary conversion due to fire, storm, shipwreck, other casualty, or theft

Answer 21

If losses exceed gains: not classified as 1231 gains and losses (ordinary)

If gains exceed losses: classified as section 1231 gains and losses

Question 22

Steps for analyzing sec 1231 transactions

Answer 22

1) determine recognized gains or losses
2) determine if any gain must be recaptured under section 1245 and 1250 as ordinary income
3) determine if there are net sec 1231 gains or losses
4) if there is a net gain determined if there is any nonrecaptured net section 1231 loss

Question 23

Determining net section 1231 gain or loss

Answer 23

Net together
- net casualty and theft gains from section 1231 property/ non-personal-use property held over 1 year (if net loss is ordinary loss)
- gains and losses from sale or exchange of section 1231 property
- gains and losses resulting from the condemnation of section 1231 property and non-personal-use capital assets held more than one year

Question 24

Treatment of net section 1231 loss

Answer 24

All section 1231 gains and losses treated as ordinary losses and gains

Question 25

Treatment of net section 1231 gain

Answer 25

All gains and losses treated as long term capital gains

Portion may be required to be recaptured as ordinary income under 5-year lookback rule

Question 26

Section 1245 property

Answer 26

Certain property subject to depreciation, and in some cases, amortization.
- depreciable personal property
- automobiles
- livestock
- railroad grading
- single-purpose agricultural or horticultural structures
- intangible assets subject to amortization under sec 197

Generally not buildings (except for certain buildings placed into service between 1981-1986

Question 27

Section 1245 recapture provisions

Answer 27

Any gain received from the disposition of section 1245 property must be treated as ordinary income to the extent of the total amount of depreciation/ cost recovery deductions allowed since Jan 1 1962

(Generally makes entire gain ordinary income)

Changes character not amount of the gain

Question 28

Gain on 1245 property in excess of allowed or allowable depreciation

Answer 28

Receives section 1231 treatment

Question 29

Loss on section 1245 property

Answer 29

Recognized as section 1231 loss if fits requirements

Question 30

Sec 1245 and the Cost of depreciable property expensed under sec 179

Answer 30

Any section 179 expense treated as a depreciation deduction for purpose of section 1245

Question 31

Preferential treatment for certain amortized costs

Answer 31

• expensing of up to $15000 used to make business facility more accessable
• amortize pollution control facilities over 60 months
• amortize reforestation expenditures over 84 months

Question 32

Sec 1245 and Preferential treatment for certain amortized costs

Answer 32

If the special provisions were applied then section 1245 recapture applies to any gains resulting from the disposition of the property

Question 33

Limitations on section 1245 and real estate

Answer 33

Section 1235 does not apply to;

• residential real estate qualified as recovery property under ACRS rules unless taxpayer used straight line depreciation.
• depreciable real estate acquired after 1986

Question 34

Section 1250 property

Answer 34

Any depreciable real property other than section 1245 property

Includes nonresidential real estate place into service before 1981

Question 35

Section 1250 recapture

Answer 35

Converts section 1231 gain into ordinary income on the exchange or sale of real property to the extent of any additional/excess depreciation taken over depreciation that would be deductible under the straight-line methods

Question 36

How can noncorporate taxpayers avoid section 1250 recapture

Answer 36

-using straight line method of depreciation or cost recovery on section 1250 property
- holding section 1250 property for it’s entire useful life/recovery period

Question 37

Section 1250 and real property placed into service after 1986

Answer 37

Section 1250 is moot and depreciation recapture not required because real property placed into service after 1986 must use straight line depreciation

Question 38

Gain recognized as ordinary income under section 1250 recapture

Answer 38

Actual depreciation - straight line depreciation= maximum amount of gain to be recognized as ordinary income due to excess depreciation

Question 39

Unrecaptured section 1250 gain

Answer 39

The amount of long term capital gain which would be ordinary income IF section 1250 provided for the recapture of ALL depreciation, instead of just excess

Question 40

Tax treatment of unrecaptured section 1250 gain

Answer 40

Taxed at a maximum rate of 25%

“Any of the LTCG due to depreciation other than excess depreciation is unrecaptured section 1250 gain taxes at a maximum rate of 25%”

Question 41

Unrecaptured section 1250 gain for buildings placed into service after 1986

Answer 41

All section 1231 gain to the extent of depreciation is unrecaptured section 1250 gain (because only straight line depreciation is allowed)

Question 42

What determines tax treatment for depreciable real estate

Answer 42

• method of depreciation used
• when property was placed in service
• how property was used

Question 43

Residential rental property

Answer 43

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

But not if more than 1/2 units are used on a transient basis (hotel/motel/inn)

Question 44

When does section 1245 apply

Answer 44

If a building is placed into service after 1979 and before 1987, and
- accelerated cost recovery is allowed, and
- building is not used as residential rental property

Question 45

Tax rate for section 1250 recapture of excess depreciation

Answer 45

Rate for ordinary income

Question 46

Tax rate for section 1245 recapture of depreciation

Answer 46

Rate for ordinary income

Question 47

Tax rate for unrecaptured section 1250 gain

Answer 47

25%

Question 48

Tax rate for any portion of section 1231 gain that becomes adjusted net capital gain

Answer 48

Applicable Preferential capital gain rate

Question 49

Depreciable real property placed into service before 1981

Answer 49

Section 1250 property. So if elected accelerated depreciation (once it was available) may have sec 1250 ordinary income for excess depreciation and also unrecaptured section 1250 gain

Question 50

Gain due to excess depreciation for buildings used as residential rental property placed in service between 1981 and 1986

Answer 50

Section 1250 ordinary income

BUT all of these buildings are fully depreciated now so there is no excess depreciation

Question 51

Tax treatment for sale of non residential rental property buildings placed into service between 1981 and 1986

Answer 51

Accelerated cost recovery used: building is section 1245 property (all gain due to depreciation is ordinary income)

Straight line cost recovery method used: property is section 1350 property. None of the gain is ordinary income (for noncorporate taxpayers)

Question 52

Tax treatment for sale of real property placed into service after 1986

Answer 52

Only straight line depreciation allowed

= No section 1250 ordinary income but gain due to depreciation is unrecaptured 1250 gain subject to maximum tax of 25%

Question 53

Low income housing credit

Answer 53

Available to owners of qualified low-income housing projects for tax years after 1986

If housing unit held for 16 years and 8 month none of the additional depreciation is subject to recapture as ordinary income

Question 54

Additional recapture rules for corporations

Answer 54

Section 291

If depreciable real estate is sold or disposed must recapture as ordinary income 20% of the difference between the amount that would be recaptured if property was sec 1245 property and actual section 1250 recapture (latter is almost always 0)

Question 55

Hierarchy of section 1245 and 1250 provisions

Answer 55

Unless an exception is stated in section 1245 or 1250 these sections take precedence over other provisions of tax law

Question 56

Recapture for gifts of property

Answer 56

Gift does not result in recapture of depreciation BUT donee must consider recapture when disposing of property. Their recapture amount includes recapture amount attributable to donor

Question 57

Recapture for property transfered on death

Answer 57

Depreciation recapture does not occur at transfer NOR does potential for recapture carry over to the recipient

Question 58

Recapture provisions and charitable contributions

Answer 58

Since deduction for charitable contributions of ordinary income property limited to adjusted basis (FMV less gain that would have been recognized as ordinary income if sold at FMV) contribution deduction for recapture property already reflects ordinary income recognized

Question 59

Tax treatment of boot received in like-kind exchange of sec 1245 or 1250 property

Answer 59

Recognized gain = lesser of realized gain or boot received

Gain = ordinary income to the maximum amount of gain covered by recapture provisions

If no gain recognized then recapture potential carries over to the replacement property

Question 60

Involuntary conversion of section 1245 or 1250 property

Answer 60

Amount of gain considered to be ordinary income cannot be more than the recognized gain

Question 61

Recapture provisions for installment sales

Answer 61

Recapture income must be recognized in the year of sale, even if no payments are received

Any excess gain over the departure amount will be reported under the installment method.
- for the installment method the amount of recapture income recognized is added to the adjusted basis for the gross profit ratio

Question 62

Recapture of section 179 expensing election

Answer 62

If taxpayer elect to expense acquisition cost under section 179 and the property is subsequently converted to nonbusiness use tax benefits from the election must be recaptured and added to taxpayer’s income in the year of conversion

Recaptured amount = difference between amount expenses under sec 179 and what would have been claimed without sex 179

Question 63

Recapture of deducted conservation expenditures

Answer 63

Taxpayers engaged in business of farmer may deduct certain expenditures made for soil and water conservation that would otherwise be capital expenditures.

If land is held for less than 9 years before disposed of the taxpayer must recognize as a gain the lesser amount of the realized gain or the expenditures x recapture percentage

Recapture percentage is 100% if farmland disposed of within 5 years of acquisition and declines by 20% for each year held after that (so if disposed after 9 years no recapture)

Question 64

Recapture of intangible drilling and development costs

Answer 64

IDCs are either immediately expensed or capitalized and depleted

Gain on sale of oil and gas properties may be ordinary income to the extent of the lesser of IDC and depletion or the total gain, due to recapture

Question 65

Gain on sale of depreciable property between related parties

Answer 65

Sec 1239: All gains is ordinary income if property is subject to depletion in the hands of the transferee. (Doesn’t matter if sale is direct or indirect)

If subject to depreciation recapture under 1245 or 1250 those sections are considered first

Constructive ownership rules apply

Question 66

Ways to avoid recapture provisions

Answer 66

• holding property for a specified period
• disposing of property in like-kind exchange (without boot) (recapture deferred)
• used to offset losses that might otherwise expire
• transfer property at death

Question 67

Form to report gains and losses from sales or exchanges of assets used in trade or business

Answer 67

Form 4797

Also involuntary conversions other than casualties and thefts

Question 68

Order in which to complete parts of form 4797

Answer 68

Part III first, then I and II

Question 69

Form to report casualty or theft gain or loss

Answer 69

Form 4684