CPA Exam — REG (Regulation)Federal Taxation of Property TransactionsMedium
A corporation, XYZ Inc., sells a machine for $20,000. The machine was acquired several years ago for $50,000 and has accumulated depreciation of $40,000. What is the amount and character of the gain or loss on this sale?
- A$10,000 Section 1231 Gain
- B$10,000 Capital Gain
- C$10,000 Unrecaptured Section 1250 Gain
- D$10,000 Ordinary Gain
Show answer & explanationAnswer & explanation
Correct answer: D. $10,000 Ordinary Gain
The adjusted basis of the machine is $50,000 (cost) - $40,000 (accumulated depreciation) = $10,000. The gain on sale is $20,000 (selling price) - $10,000 (adjusted basis) = $10,000. Since this is personal property, the gain is recaptured as ordinary income under Section 1245 to the extent of depreciation taken. Here, the entire gain of $10,000 is less than the total depreciation taken ($40,000), so the entire gain is ordinary income.
Why the other options are wrong
- A. Section 1231 gain would only apply if the gain exceeded the depreciation recapture amount.
- B. Capital gain would apply if it were a capital asset, or if the gain exceeded Section 1231 gain after recapture.
- C. Unrecaptured Section 1250 gain applies only to real property, not personal property like a machine.
Section 1245 Recapture
A tax provision that recaptures gain on the sale of depreciable personal property (and certain real property) as ordinary income to the extent of depreciation deductions taken.
- Applies to personal property and certain real property (e.g., qualified improvement property).
- Recaptures gain as ordinary income up to the lesser of the gain realized or total depreciation taken.
- Any remaining gain after recapture may be Section 1231 gain.
- Prevents taxpayers from converting ordinary deductions (depreciation) into capital gains.
Memory trick: 1245 is for 'P'ersonal property 'P'rofit 'P'urged.