Question

1. For each of the below: (i) explain in general how they work, (ii) whether they apply to gains, losses or both, and (iii) the purpose of each:

1. Section 1245 Depreciation Recapture

2. Section 1231 Look Back Rule/Recapture

Answer 1

Ans i. Any asset property sold from Section 1245 property, the organisation must recapture gain as ordinary income to the extent of earlier depreciation deductions on the asset that was sold. Any gain up to the amount of the previously taken depreciation will be taxed at ordinary income rates

A loss on the sale of Section 1231 business property is treated as ordinary loss and can reduce ordinary income on the Taxpayer's return and is not subject to the capital loss limitations. However, there is a Section 1231 recapture rule that if you sell business property at a gain and you have deducted ordinary losses due to the sale of Section 1231 property in that past five years then the Section 1231 gain that you recognize will be taxed as ordinary income

Ans ii Both apply to gain as they are added back to the income for the year for tax purpose (for re-capture part).

Ans iii. Section 1245 property is (1) all depreciable personal property, whether tangible or intangible, and (2) certain depreciable real property (usually, real property that performs specific functions, for example, a storage tank, but not buildings or structural components of building) vs Section 1231 property are assets that are used in your trade or business and are held by the Taxpayer for more than one year.

The purpose lies in different assets classification and related treatment.