T4-M2 Dispositions of Trade or Business-Use Property

Question 1

what are capital assets vs noncapital assets?

Answer 1

• capital assets => capital gain/loss
• noncapital assets => ordinary gain/loss

1. capital assets include real and personal property held for investment or personal use:
   - personal automobile of individual taxpayer
   - furniture and fixtures in the home of the individual taxpayer
   - stocks and securities of all types (except those held by dealers)
   - personal property of a taxpayer NOT used in trade or business
   - real property NOT used in a trade or business
   - interest in partnerships
   - goodwill of a corporation
   - copyrights, literary, musical, or artistic compositions that have been purchased
   - other assets held for investment
2. Noncapital assets:
   - property includes inventory or held for sale to customers in the ordinary course of business
   - depreciation personal property and real property used in trade or business (ex: sec 1231, 1245, 1250) that may be capital or ordinary
   - accounts and notes receivable arising from sales or services in the taxpayer’s business
   - copyrights, literary, musical, or artistic compositions held by ORGINAL artist
   + exception to the rule: these types of assets receive capital gains treatment
   - treasury stock (never taxed)

Question 2

what are tax rules about section 1231?

Answer 2

1. sec 1231 is applicable when the following 3 criteria are met:
   - property is real or personal property depreciable property
   - property is used in business
   - property is held for more than 1 year (long term). If 1 year or less, gain/loss is ordinary even if used in business
2. advantages:
   - gain: 1231 gains are taxed at lower rates (0%,15%, or 20%) for individuals, NOT for C corps. for C corps, gain will be treated as LTCG and used to offset LTCL
   - loss: 1231 loss can offset ordinary income for BOTH individuals and C corps
3. 5-year look-back rules:
   - when a taxpayer has a net 1231 gain for the year, the taxpayer must first “look back” to see if there were any net 1231 losses deducted as ordinary losses during the previous 5 years
   - if so, the taxpayer must “pay back” or recapture, this ordinary treatment by treating the current year net 1231 gains as ordinary income to the extent of those prior net 1231 losses.
   - once the ordinary benefit for a prior net 1231 losses has been paid back, or recaptured, the prior net 1231 loss will no longer cause a future net section 1231 gain to be treated as ordinary
   - when doing the 5-year-look-back, you only look at any unrecaptured net 1231 losses, starting with the oldest year in the 5-year look-back period first

Question 3

what are tax rules about section 1245?

Answer 3

1. sec 1245 is applicable when the following criteria are met:
   - property is personal property depreciable property (vehicles, equipment, computers, machinery)
   - property is used in business
   - property is held for more than 1 year (long term)
   - for BOTH individuals and C corps
   - applies to gains only
   - gain is treated as ordinary gain up to AD amount
2. rules of thumb for sale of personal property depreciation recapture:
   - Loss: any net 1231 loss is treated as an ordinary loss
   - ordinary income: any gain where there is unrecaptured AD or unrecaptured 1231 losses in previous 5 years (5 year look-back rule)
   - capital gain: any gain remaining after depreciation recapture and after checking the 5 year look-back rule, will be considered a net section 1231 capital gain

Question 4

what are tax rules about section 1250?

Answer 4

1a. sec 1250 is applicable when the following criteria are met:
- property is real property depreciable property
- property is used in business
- property is held for more than 1 year (long term)
- applies to INDIVIDUALS only
- applies to gains only
- gain is treated as ordinary gain up to AD amount and 5-year look-back rule
- any sec 1250 gains remaining after 5-year look-back rule is taxed at 25% rate (max for sec 1250 gain)
- the amount of recapture (taxed at 25% rate) is LESSER of:
+ recognized gain; or
+ the accumulated straight-line depreciation

1b. sec 291 is applicable when the following criteria are met:
- property is real property depreciable property
- property is used in business
- property is held for more than 1 year (long term)
- applies to C corps only
- applies to gains only
- the amount of recapture is treated as ordinary gain: 20% of the LESSER of
+ recognized gain; or
+ the accumulated straight-line depreciation taken on the asset
- remaining gain is sec 1231 LTCG