Related Parties, Business Property, and Installment Sales Flashcards
During 2019, Judy sold a pleasure boat that had an adjusted basis to her of $60,000 to Terry for $100,000. Terry paid $20,000 as a down payment and agreed to pay $20,000 per year plus interest for the next 4 years. What is the amount of gain to be included in Judy’s gross income for 2019? A. $8,000 B. $24,000 C. $20,000 D. $16,000
$8,000
Answer (A) is correct.
The amount of gain under Sec. 453 is the proportion of the payments received in the year that the gross profit bears to the total amount the seller will ultimately collect from the buyer. Judy’s gross profit is $40,000 ($100,000 sales price – $60,000 adjusted basis). Since $20,000 was received in the year of sale, the gain is $8,000.
$40,000 gross profit / $100,000 contract price * $20,000 = $8,000
Mr. Pickle purchased property from Mr. Apple by assuming an existing mortgage of $12,000 and agreeing to pay an additional $6,000, plus interest, over the next 3 years. Mr. Apple had an adjusted basis of $8,800 in the building and paid selling expenses totaling $1,200. What were the sales price and the contract price in this transaction?
Sales Price
Contract Price
A. $18,000 $6,000 B. $6,000 $12,000 C. $18,000 $9,200 D. $18,000 $8,000
$18,000
$8,000
Answer (D) is correct.
The sales price includes any cash paid, relief of seller’s liability by buyer, and any installment note given by the buyer. Here, the sales price is $18,000 ($12,000 relief of liability + $6,000 installment note). The contract price is the total amount the seller will ultimately collect from the buyer. However, if an existing mortgage assumed by the buyer exceeds the adjusted basis of the property, such excess (reduced by selling expenses) is treated as a payment and must be included both in the contract price and in the first year’s payment received. The contract price is $8,000 ($6,000 note + $3,200 mortgage in excess of basis – $1,200 selling expenses).
Robert sold his Lebec Corporation stock to his sister Karen for $8,000. Robert’s cost basis in the stock was $15,000. Karen later sold this stock to Dana, an unrelated party, for $15,500. What is Karen’s realized gain? A. $500 B. $7,000 C. $0 D. $7,500
$7,500
Answer (D) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Brothers and sisters are related parties. Robert realized a $7,000 ($15,000 cost basis in stock – $8,000 sales price to Karen) loss on the sale but may not deduct it. On the subsequent sale, Karen realized a $7,500 gain ($15,500 sales price – $8,000 basis). However, she does not have to recognize the entire gain because the Sec. 267(d) disallowed loss is used to offset the subsequent gain on the sale of the property. Karen would recognize a $500 gain.
Bob and Naomi (husband and wife) sold their boat for $75,000, with a gross profit of $25,000. What is Bob and Naomi’s gross profit percentage for this sale? A. 33 1/3% B. 3% C. 30% D. 25%
33 1/3%
Answer (A) is correct.
To calculate the gross profit percentage, the taxpayer should take the profit realized from the sale and divide by the sale price. In this example, Bob and Naomi’s gross profit percentage from this sale is 33 1/3% ($25,000 ÷ $75,000).
In January Year 1, Mr. Chow purchased a $13,000 car to use 100% in his accounting business. His MACRS deductions for the car were $2,600 in Year 1 and $4,160 in Year 2. He did not take the Sec. 179 deduction or additional first-year depreciation on the car. In Year 3, he took $1,248 (1/2 year) MACRS depreciation and sold the car in May for $6,500. What is the amount and character of Mr. Chow’s gain on the sale? A. $1,508 capital gain. B. $4,992 ordinary income. C. $8,008 capital gain. D. $1,508 ordinary income.
$1,508 ordinary income.
Answer (D) is correct.
Under Sec. 1001, the gain realized and recognized on the sale of property is the excess of the amount realized over its adjusted basis. Mr. Chow’s adjusted basis is $4,992 ($13,000 cost – $8,008 depreciation). The gain realized on the sale is $1,508 ($6,500 sales price – $4,992 adjusted basis). Sec. 1245 requires the recapture of ordinary income up to the amount of depreciation taken. Because the amount of realized gain is less than the amount of depreciation, the entire gain is recaptured and is ordinary income.
Dennis and Martha sell their lake house (which they have owned for 10 years and spend each summer in) for $250,000. Their original cost was $175,000, and they had improvements of $25,000. They have never used the house as a business or rental property. They agreed to take $50,000 down and finance the balance. Monthly payments are to begin next year. How much capital gain must they report in the year of sale? A. $10,000 B. $50,000 C. $0 D. $15,000
$10,000
Answer (A) is correct.
The amount of gain under Sec. 453 is the proportion of the payments received in the year that the gross profit bears the total amount to the seller. Gross profit, $50,000, is found by subtracting the adjusted basis, $200,000 ($175,000 original cost + $25,000 improvements) from the sales price, $250,000. Next, the gross profit percentage, 20%, is found by dividing the gross profit, $50,000, by the sales price ($250,000). The capital gain is found by multiplying the gross profit percentage, 20%, by the down payment, $50,000. The capital gain is $10,000.
A gain on the disposition of Sec. 1245 property is treated as ordinary income to the extent of
A. The difference between the amount realized over the cost of the property.
B. Excess of the accelerated depreciation allowed or allowable over the depreciation figured for the same period using the straight-line method.
C. Depreciation allowed or allowable.
D. Excess of the appreciated value over depreciation allowed or allowable using the straight-line method.
Depreciation allowed or allowable.
Answer (C) is correct.
A gain on the disposition of Sec. 1245 property is treated as ordinary income to the extent of the total amount of depreciation allowed or allowable. The recaptured gain cannot exceed the amount of the realized gain.
In an installment sale, if the buyer assumes a mortgage that is greater than the installment sale basis of the property sold,
A. There is never a profit or a loss.
B. The gross profit percentage is always 100%.
C. The gain is treated as short-term capital gain.
D. The transaction is disqualified as an installment sale.
he gross profit percentage is always 100%.
Answer (B) is correct.
In an installment sale when the buyer assumes a mortgage that is greater than the basis of the asset, the seller is required to recognize the excess mortgage as a payment in year of sale and also increase the contract price by the amount of the excess. If the contract price was not increased, the gross profit percentage would be greater than 100%. The amount of increase in the contract price will make the contract price equal to the gross profit, thus giving a gross profit percentage of 100%.
During the current year, Mr. Boyette built and occupied a manufacturing plant for use in his business. All of the following assets located in the building are Sec. 1245 property EXCEPT
A. The office furniture.
B. The packaging machine in the shipping department.
C. The large mainframe computer system used by Boyette’s research department.
D. The elevators and escalators.
The elevators and escalators.
Answer (D) is correct.
Section 1245 property is property depreciable under Sec. 167 or 168 which is either personal property, specified real property, or most recovery property under Sec. 168. Whether a building is Sec. 1245 property depends on the year it is placed in service, whether it is commercial or residential, and the method of its depreciation. Elevators and escalators placed in service after 1986 are not Sec. 1245 property and are treated as part of the building, which is Sec. 1250 property.
Belle Corporation, a cash-basis taxpayer, sold King Company some equipment on February 1, Year 1, which had been used in Belle’s business operations. The selling price was $50,000 to be paid in two equal installments – the first on January 1, Year 2 and the second on December 1, Year 2. The adjusted basis of the equipment was $40,000 after considering depreciation taken to the date of sale of $5,000. Belle made no election regarding the sale on its Year 1 return. The amount and character of the gain Belle will report on its Year 1 federal income tax return is
A. No gain or loss.
B. A $5,000 gain, of which $2,500 is Sec. 1231 gain and $2,500 is ordinary income.
C. A $10,000 gain, of which $5,000 is ordinary income and $5,000 is Sec. 1231 gain.
D. A $5,000 gain, of which all $5,000 is ordinary income.
A $5,000 gain, of which all $5,000 is ordinary income.
Answer (D) is correct.
The realized gain from the sale of the equipment is $10,000. Since the equipment is Sec. 1245 property, the realized gain is characterized as ordinary income to the extent of any depreciation that has been taken and must be fully recognized in the year of sale without regard to the timing of payments [Sec. 453(i)]. $5,000 of depreciation was taken, so $5,000 of the realized gain must be recognized as ordinary income in Year 1. All of the remaining gain is Sec. 1231 gain, and will be recognized when payments are received (the installment method is required absent an election not to use it).
Sales proceeds
$ 50,000
Less: Adjusted basis
(40,000)
Realized gain
$ 10,000
Recognized gain in Year 1 is Sec. 1245 recapture of $5,000.
Cheryl sold a boat, which had cost her $3,600, for $6,000. The boat was not used in a trade or business or held for rent. Cheryl accepted a $1,800 down payment and an installment obligation calling for 30 monthly payments of $140, plus interest. After receiving 8 months’ payments, Cheryl sold the installment obligation for $2,500. What was Cheryl’s gain or loss on the disposition of the installment obligation? A. $(420) B. $652 C. $2,192 D. $820
$652
Answer (B) is correct.
Section 453B provides that, when an installment obligation is disposed of, gain or loss is recognized to the extent of the difference between the basis of the obligation and the amount realized (or the fair market value of the obligation if disposed of other than by sale or exchange). The adjusted basis of the obligation is equal to the face amount of the obligation reduced by the gross profit that would be realized if the holder collected the face amount [Sec. 453B(b)]. The face amount is $3,080 [($140 × 30) – ($140 × 8)]. The basis is $1,848 [$3,080 face amount × (100% – 40% gross profit percentage)].
Since Cheryl sold the installment obligation, the excess of the amount realized over Cheryl’s basis in the obligation is recognized as income on the transfer. This amount of income is $652 ($2,500 amount realized – $1,848 basis). The gain is treated as resulting from the sale or exchange of the property in respect of which the installment obligation was originally held.
Mr. X acquired a machine for use in his business, on January 5, Year 1, for $30,000. Depreciation was taken on the asset using the MACRS rules in the following amounts: Year 1 $6,000 Year 2 $9,600 Year 3 $2,880 Mr. X sold the machine on January 26, Year 3, for $32,000. What is the amount and character of X’s gain on the disposition of the asset?
Sec. 1231 Gain
Sec. 1245 Gain
A.
$20,480
$0
B.
$2,000
$18,480
C.
$0
$20,480
D.
$18,480
$2,000
$2,000
$18,480
Answer (B) is correct.
The realized gain from the sale of the machine is $20,480 [$32,000 sale price – ($30,000 cost – $18,480 total depreciation)]. Because the machine is Sec. 1245 property, the recognized gain is characterized as ordinary to the extent of any depreciation that has been taken. Thus, $18,480 will be classified as ordinary income due to depreciation recapture, and the remaining gain of $2,000 ($20,480 realized gain – $18,480 ordinary income) will be classified as Sec. 1231 gain.
Which of the following items is NOT Sec. 1245 property? (All have been subject to an allowance for depreciation.)
A. Storage facility used in connection with the distribution of petroleum products.
B. Storage facility used for the bulk storage of fungible commodities.
C. Amortized certified pollution control facility.
D. Storage facility used to store oranges that have been sorted and boxed.
Storage facility used to store oranges that have been sorted and boxed.
Answer (D) is correct.
Section 1245 property generally includes depreciable personal property, but not most buildings. Some real property is included as Sec. 1245 property, especially certain storage facilities. A storage facility used to store oranges that have been sorted and boxed is not Sec. 1245 property. It is Sec. 1250 property because it is not listed in Sec. 1245(a)(3).
All of the following statements with respect to the disposition of Sec. 1245 depreciable property are true EXCEPT
A. In figuring the deductions affecting the recomputed basis of Sec. 1245 property, it is necessary to include any basis adjustment that was made for the investment credit.
B. Amounts deducted under the Sec. 179 deduction are recovered as ordinary income to the extent of any gain on a sale or disposition.
C. Section 1245 property includes an elevator or escalator placed in service before 1987.
D. Gain is treated as ordinary income to the extent of excess depreciation over the depreciation that would have been available under the straight-line method.
Gain is treated as ordinary income to the extent of excess depreciation over the depreciation that would have been available under the straight-line method.
Answer (D) is correct.
The method of depreciation makes no difference in the calculation of ordinary income. Any depreciation taken must be recaptured as ordinary income.
Allen purchased a trademark on January 1 of last year for $150,000 and began amortizing it over the required 15-year period. On January 2 of this year, Allen sold the trademark for $200,000. How much of Allen’s gain on the sale of the trademark is Sec. 1245 gain? A. $10,000 B. $5,000 C. $60,000 D. $50,000
$10,000
Answer (A) is correct.
Under Sec. 197, a trademark is an intangible asset that is amortizable over a 15-year period, beginning in the month of acquisition. Total amortization for the period January 1 of last year through January 2 of this year equals $10,000 ($150,000 ÷ 15). Allen’s realized gain is $60,000 [$200,000 sales price – ($150,000 cost – $10,000 amortization)]. Section 1245 requires the gain to be recognized as ordinary income to the extent of the amortization taken. Therefore, $10,000 of the $60,000 gain is Sec. 1245 gain [Sec. 1245(a)(3)].
You sold a residential lot 2 years ago and reported the $20,000 capital gain on the installment method. In the third year of payments, the buyer defaulted and you had to repossess the lot. In the first year you reported $5,000 ($10,000 × 50%) and $3,000 ($6,000 × 50%) in the second year. No payments were received in the third year, and you spent $2,500 in legal fees to repossess the property. What is the taxable gain you must report on the repossession? A. $8,000 B. $9,500 C. $0 D. $4,000
$8,000 Answer (A) is correct. If you repossess your property after making an installment sale, you must figure the following amounts: (1) Your gain (or loss) on the repossession and (2) your basis in the repossessed property. The rules for figuring these amounts depend on the kind of property you repossess. The rules for repossessions of personal property differ from those for real property. The taxable gain for the repossession of real property is figured using the following schedule. 1) Payments received before repossession $16,000 2) Minus: Gain reported 8,000 3) Gain on repossession $ 8,000 4) Gross profit on sale $20,000 5) Gain reported (line 2) $8,000 6) Plus: Repossession costs 2,500 10,500 7) Subtract line 6 from line 4 $ 9,500 8) Taxable gain (lesser of line 3 or 7) $ 8,000
You purchased a heating, ventilating, and air conditioning (HVAC) unit for your rental property on December 15. It was delivered on December 28 and was installed and ready for use on January 2. When should the HVAC unit be considered placed in service? A. January 2. B. December 15. C. December 31. D. December 28.
January 2.
Answer (A) is correct.
Publication 946 states, “You place property in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity.”
Larry sold stock with a cost basis of $10,500 to his son for $8,500. Larry cannot deduct the $2,000 loss. His son sold the same stock to an unrelated party for $15,000, realizing a gain. What is his son’s reportable gain? A. $2,000. B. $6,500. C. $4,500. D. No gain.
$4,500.
Answer (C) is correct.
Under Sec. 267(a)(1), losses are not allowed on sales or exchanges of property between related parties. Related parties include a father and a son. Larry realized a $2,000 loss on the sale but may not deduct it. On the subsequent sale, his son realized a $6,500 gain. However, he recognizes only a $4,500 reportable gain. The disallowed loss is used to offset the subsequent gain on the sale of the property ($6,500 realized gain – $2,000 disallowed loss).
Sue sold land to her brother Sam for $6,000. Sue’s basis in the land was $7,000. She cannot deduct the $1,000 loss. Sam sold the same land to an unrelated party for $5,500, realizing a loss of $500. What amount of loss can Sam deduct? A. $0 B. $1,000 C. $500 D. $1,500
$500
Answer (C) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Related parties include an individual and a corporation in which the individual owns more than 50% of the outstanding stock. Loss realized on a subsequent sale to a third party is recognized, but the previously disallowed loss is not added to it. Sam’s basis in the property is the sale price of $6,000. He is permitted a loss of $500; however, Sue’s unrecognized loss of $1,000 is not.
During 2019, Marcus sold real property that had an adjusted basis to him of $120,000 to Andrew for $250,000. On the sale, Marcus had depreciation recapture of $20,000, which he correctly reported as ordinary income. Andrew paid $50,000 as a down payment and agreed to pay $25,000 per year plus interest for the next 8 years beginning January 9, 2020. Marcus incurred selling expenses of $15,000. For 2019, what is the amount of capital gain from this transaction to be included by Marcus in his gross income? A. $19,000 B. $23,000 C. $22,000 D. $11,000
$19,000
Answer (A) is correct.
The amount of gain under Sec. 453 is the proportion of the payments received in the year that the gross profit bears to the total contract price. The contract price is the total amount the seller will ultimately collect from the buyer. Section 453(i) requires full recognition of depreciation recapture and an addition of the amount treated as ordinary income to the basis of the property for determining gain or loss. Marcus’s gross profit is $95,000 [$250,000 sales price – ($120,000 adjusted basis + $20,000 depreciation recapture) – $15,000 selling expenses]. Since $50,000 was received in the year of the sale, the gain is $19,000.
$95,000 gross profit / $250,000 contract price * $50,000 = $19,000
Gibson purchased stock with a fair market value of $14,000 from Gibson’s adult child for $12,000. The child’s cost basis in the stock at the date of sale was $16,000. Gibson sold the same stock to an unrelated party for $18,000. What is Gibson’s recognized gain from the sale? A. $2,000 B. $4,000 C. $6,000 D. $0
$2,000
Answer (A) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Gibson’s adult child realized a $4,000 loss ($16,000 – $12,000) on the sale but may not deduct it. On the subsequent sale, Gibson realized a $6,000 gain ($18,000 sales price – $12,000 basis). However, he only recognizes a gain of $2,000 ($18,000 – $16,000) because the Sec. 267(d) disallowed loss is used to offset the subsequent gain on the sale of the property.
In February 2019, Auto Repair, Inc., sold a car with a basis of $12,000 to Mark, its 55% shareholder, for $10,000. In June 2019, Mark sold the car to an unrelated party for $15,000. What is the amount of Mark’s recognized gain? A. $0 B. $3,000 C. $5,000 D. $2,000
$3,000
Answer (B) is correct.
Under Sec. 267(a)(1), losses are not allowed on sales or exchanges of property between related parties. Related parties include an individual and a corporation in which the individual owns more than 50% of the outstanding stock. Auto Repair, Inc., realized a $2,000 loss ($12,000 basis – $10,000 sales price to Mark) but may not deduct it. On the subsequent sale, Mark realized a $5,000 gain ($15,000 sales price – $10,000 basis). However, he recognizes only a $3,000 capital gain [Sec. 267(d)]. The disallowed loss is used to offset the subsequent gain on the sale of the property ($5,000 realized gain – $2,000 disallowed loss).
In July, Tommy Tromboni sold for $10,000 a printing press used in his business that originally cost him $10,000. His adjusted basis at the time of the sale was $1,000, and Tommy paid $1,000 in selling expenses. What is the amount of the gain that would be ordinary income under Sec. 1245? A. $10,000 B. $8,000 C. $0 D. $9,000
$8,000
Answer (B) is correct.
Under Sec. 1001, the gain realized and recognized on the sale of property is the excess of the amount realized over its adjusted basis. Selling expenses also reduce the gain recognized. Thus, Tommy recognizes
Money received
$10,000
Less: Adjusted basis of printing press
(1,000)
Selling expenses
(1,000)
Realized and recognized gain
$ 8,000
Section 1245 requires the recapture of ordinary income up to the amount of depreciation taken. Thus, the full $8,000 recognized gain must be recaptured as ordinary income since $9,000 of depreciation expense was incurred ($10,000 original basis – $1,000 ending basis).Harry sold 100 acres of land that he had owned for over 30 years. His original cost was $100,000. He sold the property for $500,000 and had settlement costs of $50,000. He received a $150,000 down payment with the balance to be paid over 10 years. His gross profit percentage is? A. 80% B. 70% C. 50% D. 60%
70%
Answer (B) is correct.
The amount of gain under Sec. 453 is the proportion of the payments received in the year that the gross profit bears to the total contract price. The contract price is the total amount the seller will ultimately collect from the buyer. Harry’s gross profit is $350,000 ($500,000 sales price – $100,000 adjusted basis – $50,000 selling expenses). Therefore, the gross profit percentage is 70% ($350,000 ÷ $500,000).
With respect to the disposition of an installment obligation, which of the following is false?
A. No gain or loss is recognized on the transfer of an installment obligation between a husband and wife if incident to a divorce.
B. If an installment obligation is canceled, it is not treated as a disposition.
C. A gift of an installment obligation is considered a disposition.
D. If the obligation is sold, the gain or loss is the difference between the basis in the obligation and the amount realized.
If an installment obligation is canceled, it is not treated as a disposition.
Answer (B) is correct.
Section 453B provides that, when an installment obligation is disposed of, gain or loss is recognized to the extent of the difference between the basis of the obligation and the amount realized (or the fair market value of the obligation if disposed of other than by sale or exchange). The main purpose of Sec. 453B is to prevent the shifting of income between taxpayers. Section 453B(a) expressly requires recognition whether the obligation is sold or otherwise disposed of. Cancellation of an installment obligation is a disposition of the obligation.
Arlene sold property with an adjusted basis of $35,000 to Sandy for $50,000. Sandy paid cash of $5,000 and assumed an existing mortgage of $20,000. Sandy signed an installment note for the $25,000 balance at 8% interest. Payments on the note were to be made at the rate of $5,000 a year plus interest beginning 1 year after the date of the contract. Arlene did not elect out of the installment method. What is the amount of gain that Arlene should include in the first year after the date of the contract? A. $1,500 B. $4,500 C. $5,000 D. $2,500
$2,500
Answer (D) is correct.
The installment method is a special method of reporting gains (not losses) from sales of property for which at least one payment is received in a tax year after the year of sale. Under the installment method, gain from an installment sale is prorated and recognized over the years in which payments are received. The amount of gain from an installment sale that is taxable in a given year is calculated by multiplying the payments received in that year by the gross profit ratio for the sale. The gross profit ratio is equal to the anticipated gross profit divided by the total contract price. The gross profit is equal to the selling price of the property minus its adjusted basis. The total contract price is equal to the selling price minus that portion of qualifying indebtedness assumed by, or taken subject to, the buyer that does not exceed the seller’s basis in the property (adjusted to reflect commissions and other selling expenses). Arlene realized a $15,000 gain ($50,000 sale price – $35,000 adjusted basis) on the sale, and this amount serves as the anticipated gross profit in the gross profit ratio. The total contract price is $30,000 ($50,000 selling price – $20,000 mortgage assumed by buyer). Accordingly, the gross profit ratio is 50% ($15,000 gain on the sale ÷ $30,000 contract price), and a $2,500 gain is recognized ($5,000 payment × 50%).
Fact Pattern: Conner purchased 300 shares of Zinco stock for $30,000 in 2000. On May 23, 2019, Conner sold all the stock to his daughter Alice for $20,000, its fair market value at the time. Conner realized no other gain or loss during 2019. On July 26, 2019, Alice sold the 300 shares of Zinco for $25,000.
What was Alice’s recognized gain or loss on her sale?
A. $5,000 long-term loss.
B. $5,000 short-term loss.
C. $5,000 long-term gain.
D. $0
$0
Answer (D) is correct.
The $5,000 realized gain ($25,000 proceeds – $20,000 basis) is recognized only to the extent it exceeds the previously disallowed loss of $10,000. Since the realized gain on the sale to an unrelated third party is less than the amount of disallowed loss, no gain is recognized.
During the year, Michael sold the following assets he used in his business.
Machinery:
Sales price
$22,500
Original cost
20,000
Accumulated depreciation
7,500
Computer equipment:
Sales price
17,000
Original cost
14,000
Accumulated depreciation
8,000
Michael had a net Sec. 1231 loss in the previous year of $4,000. What is the amount and character of his gain for the current year?
A. $8,000 ordinary income; $26,000 capital gain.
B. $19,500 ordinary income; $1,500 capital gain.
C. $0 ordinary income; $21,000 capital gain.
D. $15,500 ordinary income; $1,500 capital gain.
$19,500 ordinary income; $1,500 capital gain.
Answer (B) is correct.
Section 1231 property is depreciable or real property used in a trade or business and held for more than 1 year, or an involuntarily converted nonpersonal capital asset (i.e., held in connection with a trade or business or a transaction entered into for profit) held for more than 1 year. A taxpayer who has a net Sec. 1231 gain (i.e., excess of Sec. 1231 gains over Sec. 1231 losses) for the tax year must review the five most recent preceding tax years for possible recapture of net Sec. 1231 losses for such years. If there were any net Sec. 1231 losses during such period, the taxpayer must treat the current year’s net Sec. 1231 gain as ordinary income to the extent of the amount of unrecaptured net Sec. 1231 losses for that past period [Code Sec. 1231(c)]. The losses are to be recaptured on a first-in, first-out (FIFO) basis. Michael realizes a total gain of $21,000, where $10,000 [$22,500 sales price – ($20,000 original cost – $7,500 depreciation)] comes from machinery and $11,000 [$17,000 sales price – ($14,000 orginal cost – $8,000 depreciation)] comes from computer equipment. Since the assets also qualify as Sec. 1245 property, this Sec. 1231 gain is recharacterized as ordinary income to the extent of depreciation recaptured ($7,500 machinery + $8,000 computer equipment = $15,500) and to the extent of any unaccounted for Sec. 1231 loss ($4,000). The remaining $1,500 ($21,000 gain – $15,500 depreciation recaptured – $4,000 loss) is recognized as a Sec. 1231 gain.
