Tax Consequences of Disposed Assets Flashcards
(22 cards)
What are Section 1231 assets?
Depreciable property and real estate used in a trade or business, held for more than one year.
What types of property are included as Section 1231 assets?
Buildings, structures, machinery, equipment, vehicles, furniture, timber, coal, iron ore, certain livestock, unharvested crops, and some purchased intangibles used in business.
How are net Section 1231 losses treated?
As ordinary losses, fully deductible against ordinary income (not subject to the $3,000 capital loss limitation).
What property is NOT a Section 1231 asset?
Inventory, property held for sale to customers, and certain intangibles like copyrights created by the taxpayer.
What property does Section 1245 recapture apply to?
Tangible and intangible personal property (e.g., equipment, machinery, vehicles).
How are net Section 1231 gains taxed?
As long-term capital gains, eligible for lower capital gains rates.
Why is Section 1231 treatment favorable?
Ordinary losses can offset all income, and long-term capital gains are taxed at preferential rates.
How is gain on Section 1245 property taxed?
All gain up to the amount of depreciation taken is recaptured as ordinary income; any remaining gain is Section 1231 gain (long-term capital gain).
What property does Section 1250 recapture apply to?
Depreciable real property (e.g., commercial buildings).
How is gain on Section 1250 property taxed?
For property placed in service after 1986, gain up to the amount of straight-line depreciation is taxed at a maximum 25% rate as “unrecaptured Section 1250 gain.” Any excess is long-term capital gain.
How is excess depreciation over straight-line handled for pre-1987 property?
Excess depreciation is recaptured as ordinary income; the rest is unrecaptured Section 1250 gain.
How are Section 1231 gains and losses netted?
All Section 1231 gains and losses for the year are combined.
What is the Section 1231 lookback rule?
If you had Section 1231 losses in the previous five years deducted as ordinary losses, any current-year Section 1231 gain is recharacterized as ordinary income to the extent of those prior losses.
Bought equipment for $20,000, took $4,500 depreciation, sold for $21,000. Tax treatment?
Adjusted basis: $15,500. Gain: $5,500. $4,500 is ordinary income (1245 recapture), $1,000 is Section 1231 gain.
Buy rental property for $550,000, take $40,000 straight-line depreciation, sell for $650,000. Tax treatment?
Adjusted basis: $510,000. Gain: $140,000. $40,000 is unrecaptured Section 1250 gain (25% max), $100,000 is long-term capital gain.
Buy machinery for $100,000, depreciate $30,000, sell for $60,000. Tax treatment?
Adjusted basis: $70,000. Loss: $10,000. Entire loss is ordinary and fully deductible.
Buy commercial pizza oven for $50,000, depreciate $25,000, sell for $60,000. Tax treatment?
Adjusted basis: $25,000. Gain: $35,000. $25,000 is ordinary income (1245 recapture), $10,000 is Section 1231 gain.
Buy commercial building for $1,000,000, depreciate $250,000 (all straight-line), sell for $1,200,000. Tax treatment?
Adjusted basis: $750,000. Gain: $450,000. $250,000 is unrecaptured Section 1250 gain (25%), $200,000 is long-term capital gain.
Buy building for $100,000, depreciate $30,000 (should have been $20,000 straight-line), sell for $110,000. Tax treatment?
Adjusted basis: $70,000. Gain: $40,000. $10,000 is ordinary depreciation recapture, $20,000 is unrecaptured Section 1250 gain (25%), $10,000 is long-term capital gain.
What are the key differences between Section 1231, 1245, and 1250?
Section 1231: Governs overall tax treatment-net gains = LTCG, net losses = ordinary loss.
Section 1245: Recaptures all depreciation on personal property as ordinary income.
Section 1250: Recaptures excess depreciation on real property as ordinary income; straight-line depreciation taxed at up to 25% as unrecaptured Section 1250 gain.
What should you always check when disposing of business assets?
Asset type, holding period, depreciation taken, and prior Section 1231 losses (lookback rule).
Why is understanding depreciation recapture important for planning?
It affects the amount and character of gain (ordinary vs. capital) and thus the tax owed on asset sales.
