Character of gain or loss
| Asset type | Treatment |
|---|---|
| Capital assets (investments, personal-use property) | Capital gain/loss |
| Inventory, receivables, self-created works | Ordinary |
| §1231 — depreciable property and land used in a trade or business held >1 year | Net gain → long-term capital; net loss → ordinary (the best of both worlds) |
IMPORTANT — recapture: Before §1231 treatment applies, recapture converts some gain to ordinary income.
• §1245 (personal property, e.g. equipment): recapture all depreciation taken, as ordinary income, up to the amount of gain.
• §1250 (real property): recapture applies to excess of accelerated over straight-line depreciation. For most modern real estate on straight-line, there's no §1250 recapture, but individuals face unrecaptured §1250 gain taxed at a maximum 25% rate.
EXAMPLE: Equipment cost $50,000, accumulated depreciation $30,000 (adjusted basis $20,000), sold for $55,000. Total gain = $35,000. §1245 recaptures the $30,000 of depreciation as ordinary income; the remaining $5,000 (excess over original cost) is §1231 gain.
Capital loss rules for individuals
Capital losses offset capital gains; excess losses are deductible against ordinary income up to $3,000 per year, with the remainder carried forward indefinitely (retaining short/long character). C corporations get no ordinary offset at all — capital losses only offset capital gains, carried back 3 years and forward 5.
Section 1031 like-kind exchanges
Since the TCJA, §1031 applies only to real property held for productive use in a trade or business or for investment. Personal property no longer qualifies.
- Timing: identify replacement property within 45 days; complete the exchange within 180 days (or the return due date, if earlier)
- Boot (cash or non-like-kind property received) triggers gain recognition equal to the lesser of realized gain or boot received
- Losses are never recognized in a like-kind exchange
- Basis of replacement = FMV of replacement − deferred gain (or: basis of old + gain recognized + boot paid − boot received)
EXAM TIP: Relief from a mortgage counts as boot received; assuming a mortgage counts as boot paid. Net them, but remember you can never net down to a recognized loss.