Federal Taxation of Property Transactions
Core concepts
Property transactions test basis, gain/loss recognition, and character. Start with basis: cost basis, adjusted basis (cost plus capital improvements minus depreciation), and substituted basis in gifts and inheritances. For gifts, carryover basis applies; for inheritances, basis steps up (or down) to fair market value at death. Gain equals amount realized (cash plus fair market value of property received minus selling costs) minus adjusted basis.
Character
Distinguish capital vs. ordinary. Section 1231 property (depreciable business property held more than one year) gets favorable treatment: net gains are capital, net losses are ordinary. Section 1245 recaptures depreciation as ordinary income on sale of personal property; Section 1250 applies to real property (generally limited recapture).
Traps
Questions test whether a loss is deductible (personal-use property losses are not), whether holding period matters, and how to allocate basis in like-kind exchanges (now limited to real property). Watch for the difference between realized and recognized gain.
Worked rule of thumb
Example: equipment purchased for $50,000, depreciated $30,000 (adjusted basis $20,000), sold for $45,000. Gain = $25,000. Section 1245 recapture = lesser of depreciation taken ($30,000) or gain ($25,000) = $25,000 ordinary; remaining $0 capital. If sold for $60,000, gain $40,000: $30,000 ordinary recapture, $10,000 Section 1231 gain.
Key points
- Adjusted basis = cost + improvements − depreciation.
- Gifts: carryover basis; inheritances: stepped-up basis.
- Section 1231 net gain is capital; net loss is ordinary.
- Section 1245 recaptures depreciation as ordinary income.
- Personal-use losses generally not deductible.