13-1 ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-2 PROPERTY TRANSACTIONS: §1231 AND RECAPTURE (1 of 2)  History of §1231  Overview of basic tax treatment for §1231  §1231 property  Involuntary conversions  Procedure for §1231 treatment  Recapture provisions of §1245 ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-3 PROPERTY TRANSACTIONS: §1231 AND RECAPTURE (2 of 2)  Recapture provisions of §1250  Additional recapture for corporations  Recapture provisions—other applications  Tax planning considerations  Compliance and procedural considerations ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-4 History of §1231 (1 of 2)  1930s, business assets were capital assets  Owners retained assets that declined in value so they could get ordinary deductions  §1231-like rules to allow ordinary losses  Prior to 1987, 60% of LTCG excluded  Remaining 40% taxed at ordinary rates ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-5 History of §1231 (2 of 2)  TRA 1986 eliminated 60% exclusion  Replaced with max 28% tax rate  JGTRRA 2003 reduced max rate to 15%  5% if in 10% or 15% bracket ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-6 Overview of Basic Tax Treatment for §1231  Net gains  Net losses  Tax rate for net §1231 gain ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-7 Net Gains  §1231 gains netted against §1231 losses  Net Gains treated as LTCG  May be ordinary due to look-back rules ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-8 Net Losses  Treated as ordinary loss  5-year look-back rule  Any net §1231 gain ordinary to extent of any non-recaptured net §1231 losses from previous 5 years ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-9 Tax Rate for Net §1231 Gain  Max rate 15%  0% if in 10% or 15% tax bracket  Tax rate on unrecaptured §1250 property is 25% ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-10 §1231 Property (1 of 2)  §1231 property defined  Real property or depreciable property used in a trade or business for > 1 year  Timber, coal, livestock, and land with unharvested crops  Non §1231 property  Musical composition, inventory, copyright, letters or memorandum ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-11 §1231 Property (2 of 2)  Real or depreciable property used in a trade or business  If held for ≤ 1 year, not §1231 property and NOT a capital asset ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-12 Involuntary Conversions (1 of 2)  Condemnations  Gains and losses from condemned §1231 property and non-personal condemned capital asset treated as §1231 gains and losses ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-13 Involuntary Conversions (2 of 2)  Other involuntary conversions  Net gain from casualties and theft treated as §1231 gain  Net losses on §1231 property from casualties and theft treated as ordinary income ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-14 Procedure for §1231 Treatment (1 of 2) 1. All non-personal casualty and theft gains and losses netted  If net loss, ordinary treatment  If net gain, amount included in regular §1231 netting 2. Net all §1231 gains and losses  Include net gain from 1  Sale or exchange of §1231 property  Condemnations of §1231 property ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-15 Procedure for §1231 Treatment (2 of 2) 3. Treatment of net gain or loss from 2  If netting results in net gain, gain treated as LTCG  Consider 5-yr look-back rule  If netting results in net loss, treated as ordinary loss ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-16 Recapture Provisions of §1245 (1 of 2)  Gain from disposition of §1245 property treated as ordinary to extent of depreciation taken  Purpose of §1245  To recapture ordinary deductions as ordinary income  §1245 is a characterization provision ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-17 Recapture Provisions of §1245 (2 of 2)  §1245 property  Depreciable personal property  Not portion expensed under §179  §197 intangibles subject to amortization  Portion of real property expensed or amortized under special provisions  Nonresidential real estate depreciated under ACRS rules ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-18 Recapture Provisions of §1250  Purpose of §1250  Convert a portion of gain on sale of certain depreciable real property into ordinary income when real property is sold or exchanged  Not applied to most real property placed into service after 1986  Unrecaptured §1250 gain taxed at 25% ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-19 Additional Recapture for Corporations  Additional recapture under §291  Additional amount of §291 recapture  20% of difference between amount that would be recaptured if the property was §1245 property and the actual recapture amount under §1250  Actual recapture amount under §1250 usually $0 ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-20 Recapture Provisions— Other Applications (1 of 5)  Gifts of property subject to recapture  Recapture potential transfers to donee  Transfer of property subject to recapture at death  No recapture  Recapture does not transfer to donee ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-21 Recapture Provisions— Other Applications (2 of 5)  Charitable contributions  Contribution of LTCG property reduced by recapture amount  Like-kind exchanges  Gain recognized ordinary to extent of depreciation recapture  Remaining recapture carries over to replacement property ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-22 Recapture Provisions— Other Applications (3 of 5)  Involuntary conversions  Gain recognized ordinary to extent of depreciation recapture  Installment sales  All gain subject to recapture recognized in year of sale  Excess gain reported under installment rules ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-23 Recapture Provisions— Other Applications (4 of 5)  §179 expensing election  Portion recaptured if converted to nonbusiness use  Conservation and land clearing expenditures  Portion may be recaptured as ordinary income ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-24 Recapture Provisions— Other Applications (5 of 5)  Intangible drilling costs and depletion  Part of gain may be ordinary due to recapture of IDCs  Gain on sale of depreciable property between related parties  All gain ordinary if property subject to depreciation in hands of transferee ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-25 Tax Planning Considerations  For non-corporate taxpayers, §1231 gains preferable to ordinary income  Corporate taxpayers after 1986, tax rates on ordinary income and §1231 gains the same  However, net §1231 gain can be used to offset capital losses  Avoiding the recapture provisions ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13-26 Compliance and Procedural Considerations  Report §1231 gains and losses on Form 4797  Report gains recaptured on ordinary income on Form 4797  Report casualty or theft gain on Form 4684 ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business ©2009 Pearson Education, Inc. Publishing as Prentice Hall