A taxpayer, Mr. Kim, sells an asset for $70,000. The asset's original cost was $100,000, and its adjusted basis at the time of sale was $60,000. What is the amount and character of the gain or loss if the asset was a business use machine held for 3 years?
- A$10,000 Section 1231 Gain
- B$10,000 Ordinary Income
- C$30,000 Section 1231 Gain
- D$30,000 Ordinary Income
Show answer & explanationAnswer & explanation
Correct answer: B. $10,000 Ordinary Income
The gain on the sale is $70,000 (selling price) - $60,000 (adjusted basis) = $10,000. Since the original cost was $100,000 and the adjusted basis is $60,000, the accumulated depreciation is $40,000 ($100,000 - $60,000). The asset is Section 1245 property. Under Section 1245, gain is recognized as ordinary income to the extent of depreciation taken. Here, the entire gain of $10,000 is less than the depreciation taken ($40,000), so the entire gain is ordinary income.
Why the other options are wrong
- A. Section 1231 gain would only arise if the realized gain exceeded the amount recaptured as ordinary income.
- C. This incorrectly calculates the gain and mischaracterizes it.
- D. This incorrectly calculates the gain or mischaracterizes it.
Section 1245 Property Gain
Gain on the disposition of Section 1245 property (depreciable personal property and certain real property) is treated as ordinary income to the extent of depreciation taken. Any remaining gain is Section 1231 gain.
- Primarily applies to personal property.
- Converts gain equal to accumulated depreciation into ordinary income.
- Prevents converting ordinary deductions (depreciation) into capital gains.
- Holding period for Section 1231 consideration is more than one year.
Memory trick: Character is 'C'ritical for tax 'C'ode.