Chapter 13 Property Transactions: Section 1231 and Recapture

Learning Objectives Identify Sec property Understand the tax treatment for Sec transactions Apply the recapture provisions of Sec Apply the recapture provisions of Sec Describe other recapture applications

Tax Treatment for Sec Sec.1231 gains are netted against Sec losses Net Gains treated as LTCG Net Losses – Treated as ordinary loss. Five year Look-back rule – any net Sec gain is ordinary to the extent of any non recaptured net Sec losses from previous five years. Tax rate for Sec.1231 gain could be 15% or 5%

Section 1231 Defined Real property or depreciable property used in a trade or business for more than one year Certain types of property do not qualify as Sec property –Musical composition –Inventory –Copyright –Letters or memorandum

Section 1231 Defined Congress extended Sec treatment to transactions involving: –Timber –Coal –Livestock –Land with unharvested crops

Involuntary Conversions Condemnations –Gains and losses from condemned Sec property and non- personal condemned capital asset treated as Sec gains and losses –Other involuntary conversions –A net gain from casualties and theft is treated as Sec gain –Net losses on Sec property from casualties and theft is treated as ordinary income

Procedure For Sec Following steps are necessary to determine Sec treatment All non-personal casualty and theft gains are netted – If net loss, there is ordinary treatment – If net gain, the amount is included in the regular Sec netting Determine the net amount of Sec gain or loss, by including net gain from step 1 If this netting results in a net gain, the gain is treated as a net long-term capital gain **** If the netting results in a net loss, it is treated as ordinary loss

Recapture Provisions Of Section 1245 A gain from disposition of Sec property is treated as ordinary to the extent of depreciation taken Purpose of Sec –To recapture ordinary deductions as ordinary income –Sec is a characterization provision

Section 1245 Property Most common example of Sec property is depreciable personal property Does apply to nonresidential real estate that qualified as recovery property under the ACRS rules Does not apply to nonresidential real property acquired after and 1986

Recapture Provisions Of Section 1250 Purpose of Sec –Convert a portion of the gain on sale of certain depreciable real property into ordinary income when real property is sold or exchanged

Recapture Provisions Of Section 1250 Sec defined –Depreciable real property not covered by the Sec recapture –For non corporate taxpayers Sec recapture is not required after 1986, since only straight-line depreciation allowed on such assets

Recapture Rules For Residential Rental Property All residential rental property is Sec property –To qualify as residential rental property 80% or more of the gross rental income from building or structure must be rental income from dwelling units –Does not include hotel, motel, inn or other establishment if more than one-half of units are used on a transient basis

Recapture Rules For Nonresidential Real Estate Pre-ACRS is subject to Sec recapture on all depreciation taken in excess of straight-line, limited by realized gain ACRS nonresidential real estate (acquired between and ) is subject to Sec recapture, unless straight-line recovery was elected

Low Income Housing Qualified low- income housing may have less Sec recapture than other residential rental property

Additional Recapture for Corporations Additional recapture under Sec. 291 The additional amount Under Sec 291 is equal to 20% of the difference between the amount that would be recaptured if the property was Sec property and the actual recapture amount under Sec. 1250

Recapture Provisions – Other Applications Gifts of property subject to recapture Transfer of property subject to recapture at death Charitable contributions Like-kind exchanges Involuntary conversions

Recapture Provisions Installment sales Section 179 Conservation and land clearing expenditures Intangible drilling costs and depletion Gain on sale of depreciable property between related parties

Tax Planning Considerations For non-corporate taxpayers, Sec gains preferable to ordinary income Corporate taxpayers after 1986, it does not make a difference whether a gain is classified as Sec gain or ordinary income Avoiding the recapture provisions

Compliance And Procedural Considerations Report Sec gains and losses on Form 4797 Report gains recaptured on ordinary income on Form 4797 Report casualty or theft gain on Form 4684