570 Notes, 14-1
CHAPTER 14
PROPERTY TRANSACTIONS –
CAPITAL, § 1231, RECAPTURE
Code Subchapter P (§1201 - §1298)
Part I --Treatment Of Capital Gains [Secs. 1201-1202]
Part II --Treatment Of Capital Losses [Secs. 1211-1212]
Part III --General Rules For Determining Capital Gains And Losses [Secs. 1221-1223]
Part IV --Special Rules For Determining Capital Gains And Losses [Secs. 1231-1260]
Part V --Special Rules For Bonds And Other Debt Instruments [Secs. 1271-1288]
Part VI --Treatment Of Certain Passive Foreign Investment Companies [Secs. 1291-1298]
I.
Character of Gain or Loss
A. Overview:
Character
Capital
§1231
Ordinary
Definition
Tax
Form
Treatment
570 Notes, 14-2
B.
Classify the following assets as Capital, §1231, or ordinary:
Asset
Inventory
Type
Asset
Bldg. & Eqpt.
used in business
Accounts
Receivable
Investments in stocks,
bonds, etc.
Land used in
business
Land held for
investment
Personal
residence
Goodwill
C. Special Rules. (§1231 - §1260)
Asset
1. §1244 Stock
Type
Treatment
2. Nonbusiness Bad
Debt.
3. Worthless
Securities
4. Investment in bonds
Generally, any difference between the sales (or redemption) price of a
bond & purchase price is a capital gain.
Amortization of premium is elective for corporate bonds, required for
municipal bonds.
OID (Original Issue Discount) bonds.
5. Subdivided Real
Property
Capital gain treatment is allowed if:
(1) Taxpayer is not a regular (C) corporation.
(2) Taxpayer is not a real estate dealer.
(3) No substantial improvements made to the real estate.
(4) Owned for five years (except for inherited property).
However, in year in which the 6th lot is sold, some of the gain may be
ordinary income. (5% of sales revenue is ordinary income, but is
reduced by the selling expenses)
570 Notes, 14-3
Lapse – treated as a sale. Grantor has STCG if option is stock,
securities, commodities, or futures; ordinary income for everything
else. Grantee has capital loss.
6. Options
7. Patents
Exercise – Option price is added to the sales/purchase price of the
property.
§1231 if used in trade or business (being amortized).
8. Short Sales
Capital if considered a “holder” of patent. Holder is the individual (not a
corporation) who created the patent, or who purchased it from the
creator before it was “reduced to practice.”
Gain or loss is generally not recognized until the short sale is closed.
Property held LT that’s substantially identical to that sold short results
in LT treatment; otherwise, ST.
II.
Capital Gains & Losses (§1221 - §1223)
A.
Baskets (Individuals)
Basket
Type of property included
B. The Netting Process (Individuals):
(1)
STCGs
STCLs
LTCGs (25% type)
LTCGs (15% type)
LTCLs (15% type)
10,000
(16,000)
7,000
8,000
(3,000)
570 Notes, 14-4
(2)
C.
STCGs
STCLs
LTCGs (28% type)
LTCLs (28% type)
LTCGs (25% type)
LTCGs (15% type)
LTCLs (15% type)
8,000
(5,000)
4,000
(3,000)
12,000
6,000
(10,000)
Computing the Alternative CG Tax:
Order for computing LTCG Rates:
1.
25%
2.
28%
3.
15%
Examples: Assume the following rate structure:
TAXABLE
BUT NOT
TAX IS
INCOME
OVER:
OVER:
$
0
8,375
34,000
82,400
171,850
373,650
$ 8,375
34,000
82,400
171,850
373,650
…………
$
0
837.50
4,681.25
16,781.25
41,827.25
108,421.25
PLUS THIS
%
10%
15%
25%
28%
33%
35%
OF TAXABLE
INCOME OVER:
$
0
8,375
34,000
82,400
171,850
373,650
Ex. 1. $100,000 taxable income, including $20,000 of 15% LTCG.
Ex. 2. $100,000 taxable income, including $80,000 of 15% LTCG.
Ex. 3: $62,000 taxable income, including $19,000 of 15%& 13,000 of 25% LTCGs.
Ex. 4: $62,000 taxable income, including $19,000 of 15%& 6,000 of 25% LTCGs & $7,000 of
28% LTCGs.
570 Notes, 14-5
III.
§ 1231 Gains & Losses
NET CASUALTY
GAINS & LOSSES
FOR 1231 ASSETS
SALES OF 1231
ASSETS AT
GAINS
SALES OF 1231
ASSETS AT
LOSSES
COMBINE
§ 1231 GAINS
§ 1231 LOSSES
RECAPTURES
§1245, §1250
LOOKBACK
RULE
CAPITAL
(SCH. D)
ORDINARY
570 Notes, 14-6
A. Lookback Rule. If the taxpayer has had net Sec. 1231 losses in any of the previous five
taxable years, the current year's net Sec. 1231 gain may be treated as ordinary to the extent
of the previous unrecovered net Sec. 1231 losses.
Example: Company has net §1231 gains and losses as follows:
Net Gain
Net Loss
Classification
2005
(15,000)
______________
2006
(10,000)
______________
2007
(35,000)
______________
2008
10,000
______________
2009
30,000
______________
2010
35,000
______________
Suppose that $35,000 in 10 consists of $18,000 of 25% gain & $17,000 of 15% gain.
IV. Recapture Provisions of Sec. 1245
A. General Treatment
1. A gain from the disposition of Sec. 1245 property is treated as ordinary to the extent of
depreciation/cost recovery taken, limited by the realized gain. Sec. 1245 is a
characterization provision only (i.e. does not create or add to recognized gain) and
does not apply to losses.
Example: Taxpayer sells §1245 property for $275,000. Its original cost was $250,000, and
$150,000 of MACRS had been taken as of the sale.
B. Sec. 1245 Property
1. The most common example of Sec. 1245 property is depreciable PERSONAL property.
2. Commercial real property acquired between 1981 and 1986 which was subject to
ACRS is subject to Sec. 1245 recapture. If straight-line depreciation was elected for
this type of property Sec. 1250 recapture rules apply.
570 Notes, 14-7
V. Recapture Provisions of Sec. 1250
A. General Treatment
1. A gain from the disposition of Sec. 1250 property is ordinary gain to the extent of
EXCESS depreciation/cost recovery taken, limited by the realized gain.
Example: Taxpayer sells §1250 property for $275,000. Its original cost was $250,000,
and $150,000 of MACRS had been taken as of the sale. Straight-line depreciation
would have been $120,000.
B. Section 1250 Property Defined
1. §1250 property is depreciable REAL property not covered by §1245 recapture rules
C. Individuals - Unrecaptured Sec. 1250 Gain
1. After the §1250 recapture, the excess of what would have been recaptured under
§1245 over the actual §1250 recapture is “Unrecaptured §1250 gain” (25% rate) is
thrown into the Sec. §1231 netting process.
Continuing the Example: Of the §1231 gain from the preceding example, how much is
unrecaptured 1250 gain?
.
D. Corporations - Additional Recapture
1. Corporations have additional recapture under §291 equal to 20% of the excess of what
would be recaptured under Sec. 1245 over the actual Sec. 1250 recapture.
Back to the Example: If the taxpayer is a C corporation, how is the gain characterized?
570 Notes, 14-8
Comprehensive Practice Problem (adapted from CPA Exam)
Dawn is a cash-basis, calendar year taxpayer. She engaged in several property transactions relevant to
federal income taxes during 2010, for which the appropriate tax treatment must be determined. Dawn is
not a dealer in securities, real property, cars, or jewelry, nor is she in the business of lending money.

Dawn received a gift of 1,200 shares of Music common stock from her father on January 10, when its
FMV was $195 per share. No gift tax was paid. Dawn’s father purchased the stock in 2001 for
$252,000 ($210 per share). Dawn sold 200 of the shares on a national exchange for $190 each on
January 15.

On March 21, Music distributed 2 shares of preferred stock for each share of its common stock in a
nontaxable distribution. The FMV of the common on March 21 was $100 per share, and that of the
preferred was $75 per share.

Dawn sold all her Music common stock on October 9 for $125,000

Dawn exchanged 500 shares of common stock in Keys, Inc. for 1,000 shares of Tones, Inc. common
on April 30, when the FMV per share was $400 and $200 per share respectively. Both corporations
are in the business of manufacturing and wholesaling musical keyboards that interface with
computers, and both are listed on a national exchange. Dawn had purchased the Keys, Inc. stock for
$250,000 in 2006.

Dawn wrote off as wholly worthless the $25,000 balance of a personal loan made to a friend when the
friend received a discharge in bankruptcy in April.

Dawn’s mother gave her a diamond necklace, appraised at $90,000 on April 30. Gift tax of $21,000
was paid on the transfer. Her mother purchased the necklace for $60,000 in 2002. Dawn sold it for
$90,000 on October 9.

On September 7, Dawn received $60,000 insurance recovery on a small building used in her music
teaching business, which was destroyed by fire. Dawn had purchased the building 10 years earlier for
$67,000, and her adjusted basis just before the fire was $50,000. Dawn has decided t use rented
space rather than rebuild for at least the next five years.
Answer the following questions:
1. Amount and character of gain or loss recognized on the January 15 sale of Music common stock.
2. Basis in the Music preferred stock acquired in the March 21 distribution.
3. Amount and character of gain or loss recognized on the October 9 sale of Music common stock.
4. Amount and character of gain or loss recognized on the April 30 exchange of Keys common stock for
Tones common stock.
5. Treatment of the $25,000 debt written off.
6. Amount and character of gain or loss recognized on the October 9 sale of the necklace.
7. Amount and character of gain or loss recognized from the insurance proceeds on the building.