Tax 3-7 Analyze a situation to determine the tax treatment of Section 1231 property transactions.

Question 1

Section 1231 Rules

14. Which of the following statements is correct regarding the tax treatment of Section 1231 and 1245?
15. Net Section 1231 gains are treated as ordinary income.
16. Net Section 1231 gains are treated as long-term capital gains.
17. Section 1245 income is treated as capital gain income.
18. Section 1245 losses are treated as ordinary losses.

(LO 3-7)

Answer 1

2. Net Section 1231 gains are treated as long-term capital gains.

Net Section 1231 gains are treated as long-term capital gain income, unless there are unrecaptured Section 1231 losses during the look-back period.

The amount of unrecaptured Section 1231 losses during the look-back period is treated as ordinary income.

Question 2

Section 1231 Rules

22. The lookback period for Section 1231 is
    a. two years.
    b. three years.
    c. four years.
    d. five years.

(LO 3-7)

Answer 2

d. five years.

The Section 1231 lookback period is five years.

Question 3

Section 1231 Rules

29. During the current year, Raymond Gates has Section 1231 gains totaling $13,000. He also has $3,000 of Section 1231 losses. Three years ago, Raymond reported a net Section 1231 loss of $6,000. Which one of the following correctly describes the amount and treatment of the gain?
30. $10,000 is treated as ordinary income
31. $10,000 is treated as long-term capital gain
32. $6,000 is treated as ordinary income; $4,000 is treated as long-term capital gain
33. $6,000 is treated as long-term capital gain; $4,000 is treated as ordinary income

(LO 3-7)

Answer 3

3. $6,000 is treated as ordinary income; $4,000 is treated as long-term capital gain

$13,000 Section 1231 Gain
- $3,000 Section 1231 Losses
= $10,000 Net Section 1231 Gain

Lesser of
$6,000 Unrecaptured Section 1231 Losses during the 5 year lookback period
$10,000 Net Section 1231 Gain
= $6,000 Ordinary Income

$10,000 Net Section 1231 Gain
- $6,000 Ordinary Income
= $4,000 Long Term Capital Gains

Question 4

Section 1231 Rules

30. During the current year, Bill Taylor has net Section 1231 gains totaling $11,000. Four years ago, Bill reported a net Section 1231 gain of $6,000. Which one of the following correctly describes the amount and treatment of the current year’s gain?
31. $5,000 is treated as long-term capital gain; $6,000 is treated as ordinary income
32. $6,000 is treated as long-term capital gain; $4,000 is treated as ordinary income
33. $11,000 is treated as long-term capital gain

(LO 3-7)

Answer 4

3. $11,000 is treated as long-term capital gain

Step 1:
Current year:
$11,000 Section 1231 gain

4 years ago:
= $6,000 Net Section 1231 gain

Net Section 1231 gains during the look-back period have no effect on current year 1231 gains. Thus, all of the current year’s Section 1231 gain is treated as long-term capital gain.

Question 5

Section 1231 Rules

During the current year, Peter Langley has Section 1231 gains totaling $10,000. He also has $2,000 of Section 1231 losses. Two years ago, Peter reported a net Section 1231 loss of $6,000. These are the only two years in which Peter has had Section 1231 gains or losses.

Determine the amount and character of the current year’s Section 1231 gains and losses.

Answer 5

$6,000 characterized as ordinary income; $2,000 characterized as long-term capital gain

$10,000 Section 1231 Gain
- $2,000 Section 1231 Losses
= $8,000 Net Section 1231 Gain

Lesser of
$6,000 Unrecaptured Section 1231 Losses during the 5 year lookback period
$8,000 Net Section 1231 Gain
= $6,000 Ordinary Income

$8,000 Net Section 1231 Gain
- $6,000 Ordinary Income
= $2,000 Long Term Capital Gains

Question 6

Section 1231 Rules

During the current year, Mary Grogan has Section 1231 gains totaling $9,000. She also has $5,000 of Section 1231 losses. Three years ago, Mary reported a net Section 1231 loss of $6,000. These are the only two years in which Mary has had Section 1231 gains or losses.

Determine the amount and character of the current year’s Section 1231 gains and losses.

Answer 6

$4,000 characterized as ordinary income

$9,000 Section 1231 Gain
- $5,000 Section 1231 Losses
= $4,000 Net Section 1231 Gain

Lesser of
$6,000 Unrecaptured Section 1231 Losses during the 5 year lookback period
$4,000 Net Section 1231 Gain
= $4,000 Ordinary Income

$4,000 Net Section 1231 Gain
- $4,000 Ordinary Income
= $0 Long Term Capital Gains

If Mary had Section 1231 gains in the next year, the remaining $2,000 of unrecaptured Section 1231 losses would cause a recharacterization as ordinary income of the first $2,000 of gain.

Question 7

Section 1231 Rules

During the current year, Mark Feldman has Section 1231 gains totaling $12,000. He also has $4,000 of Section 1231 losses. Four years ago, Mark reported a net Section 1231 loss of $3,000. These are the only two years in which Mark has had Section 1231 gains or losses.

Determine the amount and character of the current year’s Section 1231 gains and losses.

Answer 7

$3,000 characterized as ordinary income; $5,000 characterized as long-term capital gain.

$12,000 Section 1231 Gain
- $4,000 Section 1231 Losses
= $8,000 Net Section 1231 Gain

Lesser of
$3,000 Unrecaptured Section 1231 Losses during the 5 year lookback period
$8,000 Net Section 1231 Gain
= $3,000 Ordinary Income

$8,000 Net Section 1231 Gain
- $3,000 Ordinary Income
= $5,000 Long Term Capital Gains

.

Question 8

Section 1231 Rules

Practice Test 1

71. During the current year, Vern Brodie has Section 1231 gains totaling $29,000. He also has $8,000 of Section 1231 losses. Last year, Vern reported a net Section 1231 loss of $12,000. These are the only two years in which Vern has had Section 1231 gains or losses.

What is the amount and character of the current year’s Section 1231 gains and losses?

1. $9,000 ordinary income
2. $9,000 long-term capital gain
3. $9,000 ordinary income, $12,000 long-term capital gain
4. $12,000 ordinary income, $9,000 long-term capital gain,
5. $21,000 long-term capital gain

(LO 3-7)

Answer 8

4. $12,000 ordinary income, $9,000 long-term capital gain

$29,000 Section 1231 Gain
- $8,000 Section 1231 Losses
= $21,000 Net Section 1231 Gain

Lesser of
$12,000 Unrecaptured Section 1231 Losses during the 5 year lookback period
$21,000 Net Section 1231 Gain
= $12,000 Ordinary Income

$21,000 Net Section 1231 Gain
- $12,000 Ordinary Income
= $9,000 Long Term Capital Gains

Question 9

Section 1231 Netting Process

The Section 1231 netting process can best be described by the following steps:

(3-7, pg 50 of text)

Answer 9

1. Combine the current year Section 1231 gains and losses to arrive at a net gain or a net loss.
2. If the result is a net loss, it is characterized as an ordinary loss.
3. If the result is a net gain, determine if the “lookback” rules apply.
4. If the lookback rules do not apply, the net gain is characterized as a capital gain.
5. If the lookback rules do apply, the amount of net gain characterized as ordinary income is equal to the lesser of
   (a) the unrecaptured Section 1231 losses,

or

(b) the current year’s net gain.

Question 10

Practice Test 2

Section 1231 Rules

31. During the current year, Chuck Langston has Section 1231 gains totaling $14,000. He also has $3,000 of Section 1231 losses. Four years ago, Chuck reported a net Section 1231 loss of $7,000. These are the only two years in which Chuck has had Section 1231 gains or losses.

What is the character of the current year’s Section 1231 gains and losses?

$4,000 long-term capital gain

$4,000 ordinary income, $7,000 long-term capital gain

$7,000 ordinary income, $4,000 long-term capital gain

3-7

$11,000 long-term capital gain

(LO 3–7)

Answer 10

$14,000 Section 1231 Gain
- $3,000 Section 1231 Losses
= $11,000 Net Section 1231 Gain

Lesser of
$7,000 Unrecaptured Section 1231 Losses during the 5 year lookback period
- $11,000 Net Section 1231 Gain
= $7,000 Ordinary Income

$11,000 Net Section 1231 Gain
- $7,000 Ordinary Income
= $4,000 Long Term Capital Gains