Monday
Apr242017

§1231 Loss and Basis



 

Types of Tax Property

This tax year I encountered a different treatment of property under the IRC. A partnership a client was invested in chose to cease operations and dissolve to stop the losses. Receiving the K-1 his share of the loss was under IRC §1231. Under the IRC property is defined and named by code sections addressing the tax treatment of property; §1245, 1250, and 1231 to name a few of the code sections. The code section dealing with business property is §1231 and it has a few quirks when capital gains and losses come into play.

Identifying §1231 Property

Normally depreciable property and real estate are not capital assets. But depreciable personal property and real property used in a trade or business and held for more than one year which is not inventory or held for sale to customers or intangible property is capital property under §1231 and includes:

  • ·         Trade or business property held for more than one year and  compulsorily or involuntarily converted;
  • ·         Capital assets held for longer than one year in connection with a trade or business or a transaction entered into for profit and compulsorily or involuntarily converted;
  • ·         An unharvested crop on land used in a trade or business and held for more than one year, if the crop and land are sold, exchanged, or involuntarily converted at the same time to the same person;
  • ·         Certain livestock but not poultry; and
  • ·        

Gain Loss Treatment

Generally when §1231 gains exceed §1231 losses for a taxable year, all of the §1231 gains and losses are treated as long-term capital gains and losses. When §1231 gains do not exceed §1231 losses for a taxable year the gains and losses are not treated as gains and losses from sales and exchanges of capital assets. Or, §1231 losses exceed §1231 gains all of the §1231 losses and gains are treated as ordinary income and losses. Transactions where §1231 property is sold, exchanged, or involuntarily exchanged are reported on Form 4797. Unlike capital asset exchanges are not netted against each other but are reported as individual transactions.

Recapture

When §1231 property is subject to depreciation recapture, only the §1231 gain that exceeds the amounts recaptured and taxed at ordinary income tax rates. Gains or losses disallowed by other rules is not taken into account in determining §1231 gains and losses.

Recapture of Net §1231 Losses

A taxpayer with net §1231 gains that exceed losses for the year must recapture past net §1231 losses by treating the current year’s net §1231 gain as ordinary income to the extent of unrecaptured net §1231 losses for the five previous tax years on a first in, first out basis; i.e. starting with the oldest §1231 loss, the next oldest until the current year gain or prior year losses are used up.

Compulsory or Involuntary Conversion

The capital gain and ordinary loss rules of §1231 apply to gains and losses from the compulsory or involuntary conversion of §1231 property unless the non-recognition rules for involuntary conversions apply.

Summary

When dealing with business property or non-equity (stocks, bonds) be aware of the nature of the property and keep track of your prior losses and depreciation.  These can influence or eliminate a capital gain or at least reduce it. 

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