Calculate the amount of gain or loss recognized on the disposition of assets used in a trade or business.
Dispositions occur in the form of sales, trades, or other realization events.
Gain realized is the amount realized less the adjusted basis of an asset.
Amount realized is everything of value received in the transaction less any selling costs.
Adjusted basis is the historical cost or basis of an asset less any cost recovery deductions applied against the asset.
Gain is realized on every disposition; however, not all realized gains are recognized currently.
Describe the general character types of gain or loss recognized on property dispositions.
Recognized gains must be characterized as ordinary, capital, or §1231. An asset's character is a function of the asset's use and holding period.
Ordinary assets are derived from normal transactions of the business (revenues and accounts receivable), sale of short-term trade or business assets, and depreciation recapture.
Capital assets are assets that are held either for investment or for personal use (a taxpayer's principal residence).
§1231 assets consist of property used in a taxpayer's trade or business that has been held for more than one year.
Net §1231 assets receive the best of both worlds—net §1231 gains become capital and net §1231 losses become ordinary.
Explain the rationale for and calculate depreciation recapture.
§1231 assets, other than land, are subject to cost recovery deductions (depreciation), which generate ordinary deductions.
Gains that are created through depreciation deductions are subject to depreciation recapture. Any remaining gain is §1231 gain.
Depreciation recapture does not change the amount of the gain but simply converts or recharacterizes the gain from §1231 to ordinary.
Different recapture rules apply to tangible personal property (§1245) and real property (§291).
Describe the tax treatment of unrecaptured §1250 gains and determine the character of gains on property sold to related parties.
When individuals sell §1250 property at a gain, the portion of the gain generated by depreciation deductions is called unrecaptured §1250 gain.
This gain is a §1231 gain that, if treated as a capital gain after the netting process, is taxed at a maximum rate of 25 percent.
If a taxpayer sells an asset at a gain to a related party and the asset is a depreciable asset to the related party, the seller must characterize the entire gain as ordinary income.
Describe the tax treatment of §1231 gains or losses, including the §1231 netting process.
After applying the depreciation recapture rules, taxpayers calculate the net §1231 gain
or loss.
If a net §1231 loss results, the loss will become ordinary and offset ordinary income.
If a net §1231 gain results, the §1231 look-back rule must be applied.
After applying the look-back rule, any remaining net §1231 gain is a long-term capital gain.
Explain common exceptions to the general rule that realized gains and losses are recognized currently.
Like-kind exchanges involve trading or exchanging business assets for similar business assets. The gain is deferred unless boot or non-like-kind property is received.
Involuntary conversions are the losses on property through circumstances beyond taxpayers' control. Reasons include natural disasters, accidents, theft, or condemnation.
Installment sales occur when any portion of the amount realized is received in a year subsequent to the disposition.
§267 related-party losses are disallowed but the related-party buyer may be able to deduct the disallowed loss if she subsequently sells the property at a gain.
