Selling Business RE Property

[rfk]

It seems I read that under "Ordinary Income Recapture" - no recapture when a an RE business property is sold at a loss? Can someone shed some light on this notion; would greatly appreciate it as always. Or can anyone just clarify this category under 1231 Gains and Losses?

Thanks.

rfk

[Gary2]

There are 1231 non-recaptured losses, which can cause future 1231 gain (over the next five years) to be treated as ordinary gain, instead of more favorable 1231 capital gains treatment.

There are 1245 gains, which causes the depreciation part to be treated as ordinary income instead of capital gains.

There is 1250 additional depreciation recapture, which causes depreciation above straight-line to be recaptured as ordinary income. This is very rare, because most 1250 property uses straight-line.

There is 1250 unrecaptured gains, which causes the gain due to straight line depreciation to be subject to the higher, 25% capital gains rate (which is not the same as treating it as ordinary income). This is much more common for 1250 property.

For all of these, selling at a loss (using adjusted basis, of course), won't trigger any immediate special recapture, but a 1231 loss must be tracked and applied against future 1231 gains for the five year period.

[Roland Slugg]

There is 1250 unrecaptured gains, which causes the gain due to straight line depreciation to be subject to the higher, 25% capital gains rate (which is not the same as treating it as ordinary income). This is much more common for 1250 property.

It is not only more common, it applies to every sale of depreciable real property sold at a gain (if held for more than one year). The exact term is "Unrecaptured section 1250 gain," and it is NOT taxed at a special "capital gains rate of 25%." Rather it is taxed the same as and along with a taxpayer's other ordinary income, but at a maximum tax rate of 25%. In other words it can be taxed at 10%, 15%, 25% or a combination of two or all three of those rates, but it can not be taxed at any of the higher rates (28%, 33%, 35%) applicable to ordinary income in general.

[Burke]

For all of these, selling at a loss (using adjusted basis, of course), won't trigger any immediate special recapture, but a 1231 loss must be tracked and applied against future 1231 gains for the five year period.

Would appreciate the cite for this. Need it for my files (and a client or two.)

[rfk]

Thanks...

for the information

rfk

[DaveinTexas]

If I post this twice I apologize

Would appreciate the cite for this. Need it for my files (and a client or two.)

But here is a good article describing the 5 year 1231 gain period, http://www.journalofaccountancy.com/...oth+worlds.htm

I hope it helps.

[Burke]

TKU verrrry much.

[Gary2]

It is not only more common, it applies to every sale of depreciable real property sold at a gain (if held for more than one year). The exact term is "Unrecaptured section 1250 gain," and it is NOT taxed at a special "capital gains rate of 25%." Rather it is taxed the same as and along with a taxpayer's other ordinary income, but at a maximum tax rate of 25%. In other words it can be taxed at 10%, 15%, 25% or a combination of two or all three of those rates, but it can not be taxed at any of the higher rates (28%, 33%, 35%) applicable to ordinary income in general.

I've never found a good, concise way of explaining this. You're right that it can be taxed at various rates, not just 25%. However, I disagree that it's taxed as ordinary income. It's still treated as capital gains, which means a) it can be offset by capital losses beyond the $3000 limit; and b) it's taxed at the capital gains tax rates with the addition of 25%, i.e., it can be taxed at 0%, 15%, or 25% - though even that's not quite true. This is detailed in the Schedule D Tax Worksheet, found in the Schedule D instructions. And the reason why I say it's not quite true, so that you're partially correct, is that the last on the worksheet compares the tax using the capital gains tax rates against the tax computed treating all income as ordinary (including ordinary capital gains, qualified dividends, etc.), and using the lesser of the two.

It is headache inducing. I'm disinclined to play with the numbers to see if there's a way for unrecaptured 1250 gain to be taxed at a marginal 10% rate, but my intuition tells me that if a person is in the 10% tax bracket, then their 1250 gain will be taxed at 0%.

[Roland Slugg]

I've never found a good, concise way of explaining this.

Well, then perhaps you should adopt the explanation in my post above, which is both correct and concise.

However, I disagree that it's taxed as ordinary income.

Sorry, but that's exactly how it is taxed, with the caveat that the tax rate applying thereto will not exceed 25%.

It's still treated as capital gains.

Yes, it is treated as capital gain, for purposes of figuring, combining and netting all capital gains and losses, but it is not taxed as capital gain. The concept of Unrecaptured §1250 gain isn't even relevant until the point where it's time to calculate the tax on a return.

It's taxed at the capital gains tax rates with the addition of 25%, i.e., it can be taxed at 0%, 15%, or 25%.

Huh????? That's a contradiction. Capital gains are never taxed at 10% or 15% rates! Capital gains, if they are taxed at all, are taxed at one rate: 20% (except for a couple of special types of property that can be taxed at up to 28%). Unrecaptured §1250 gain, on the other hand, is never taxed at the 20% capital gains rate. It is taxed right along with a taxpayer's other ordinary income at 10%, 15% and 25%, but not at the three higher ordinary income rates.

It is headache inducing.

It shouldn't be. It is, however, one of the most misunderstood concepts of the tax law.

I'm disinclined to play with the numbers to see if there's a way for unrecaptured 1250 gain to be taxed at a marginal 10% rate.

No? Then how can you have such certainty about it? I recommend that you, or anyone else wishing to gain an accurate working grasp of this important issue should do exactly that ... play with some numbers. Anyone doing so will find it to be a worthwhile, educational and eye-opening process. In fact, I would be happy to post a simple set of facts that anyone can then transfer into his own tax prep software to aid in this.

My intuition tells me that if a person is in the 10% tax bracket, then their (sic "his") [unrecaptured §]1250 gain will be taxed at 0%.

This is no place for "intuition," and your intuition about this is quite incorrect. If a taxpayer is in the 10% tax bracket, then his unrecaptured §1250 gain will be taxed at 10%.

[DaveinTexas]

A little hard on the Beav, weren't you?

Well, then perhaps you should adopt the explanation in my post above, which is both correct and concise.

Sorry, but that's exactly how it is taxed, with the caveat that the tax rate applying thereto will not exceed 25%.

Yes, it is treated as capital gain, for purposes of figuring, combining and netting all capital gains and losses, but it is not taxed as capital gain. The concept of Unrecaptured §1250 gain isn't even relevant until the point where it's time to calculate the tax on a return.

Huh????? That's a contradiction. Capital gains are never taxed at 10% or 15% rates! Capital gains, if they are taxed at all, are taxed at one rate: 20% (except for a couple of special types of property that can be taxed at up to 28%). Unrecaptured §1250 gain, on the other hand, is never taxed at the 20% capital gains rate. It is taxed right along with a taxpayer's other ordinary income at 10%, 15% and 25%, but not at the three higher ordinary income rates.

It shouldn't be. It is, however, one of the most misunderstood concepts of the tax law.

No? Then how can you have such certainty about it? I recommend that you, or anyone else wishing to gain an accurate working grasp of this important issue should do exactly that ... play with some numbers. Anyone doing so will find it to be a worthwhile, educational and eye-opening process. In fact, I would be happy to post a simple set of facts that anyone can then transfer into his own tax prep software to aid in this.

This is no place for "intuition," and your intuition about this is quite incorrect. If a taxpayer is in the 10% tax bracket, then his unrecaptured §1250 gain will be taxed at 10%.

I agree with your retorts and I understand you want to set the record straight because this is a highly misunderstood area of tax law and there is little room for error, but hey we can be cordial about our responses. In other words, can't we all just get along?

Oh, I hope I don't start a riot with that line!

[Gary2]

Huh????? That's a contradiction. Capital gains are never taxed at 10% or 15% rates! Capital gains, if they are taxed at all, are taxed at one rate: 20% (except for a couple of special types of property that can be taxed at up to 28%).

Actually, I was so taken aback by this, that I thought I was in some sort of time warp, and didn't pay much attention to the tone of the rest of the post. We haven't had a 20% capital gains tax rate since 2003. See the table on TTB page 6-8, bottom left hand column.

But having had a bit more time, I did do some more work on this. Other than the above, Roland is correct about the math concerning unrecaptured 1250 gains, but I still disagree about the terminology. I can see the point about describing them as "taxed at the same rates as ordinary income, but only up to a maximum of 25%." Nevertheless, they are legally capital gains, which not only affects netting, but also installment sales and, more importantly, state tax treatment. (As it happens, MA treats both recaptured and unrecaptured 1250 gains as capital gains.)

The confusion comes from the convoluted way in which the federal treatment came about, and hence the way it's presented. Section 1250 identifies only the recaptured 1250 gain as getting ordinary income treatment. Likewise, Pub. 544 clearly says that the recaptured gain is ordinary income: "To find what part of the gain from the disposition of section 1250 property is treated as ordinary income ...," followed by the calculation for the recaptured gain. Conversely, the unrecaptured gain is described in the Capital Gains tax Rates section. Indeed, the text of the forms, instructions, and pubs are silent, as far as I can see, with regard to the tax rates applicable to unrecaptured 1250 gains. The only way to determine it is to actually work through the work sheet in the Schedule D instructions.

So, if the text of IRC 1250 is silent as to the tax rates applied to the unrecaptured gain, then where does this unusual handling come from? I was surprised at the answer, but it's in Section 1, specifically 1(h), under Maximum Capital Gains Rate, which was written to explicitly exclude unrecaptured 1250 gains from the lower capital gains brackets. It is one of the most unnecessarily involuted sections of the code I've seen.

So where does that leave us? Yes, unrecaptured 1250 gains are taxed at the same rates as ordinary income up to 25%. But they're reported with the other capital gains on schedule D, with the total going on 1040 line 13 - so I'm very reluctant to say that they're not taxed as capital gains; they just don't get the benefit of the two lower capital gains tax rates. But which of these two ways of describing the same thing is the best depends on who you're explaining it to, and the point you're trying to make.

Anyone in a state that distinguishes capital gains care to comment on their treatment of 1250 gains? I know that there's a handful of states that require capital gains to be reported separately, and an even smaller number that taxes them differently (WI being the only one I can name off the top of my head). MA used to have different LTCG rates, progressing down 1% each year of holding period till after six years, they weren't taxed at all; that went away about 10 years ago.