This document summarizes the key rules and concepts around the treatment of capital assets and Section 1231 assets for tax purposes. It defines capital assets and outlines the determination of capital gains and losses. Section 1231 assets are defined as depreciable business property held for over 12 months. The steps for determining Section 1231 gains and losses are presented. The document also provides summaries of depreciation recapture rules under Sections 1245 and 1250.

1. Chapter 12
Property Transactions:
Treatment of Capital and
Section 1231 Assets
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2. Chapter 12 Exhibits
1. Capital Assets—Defined
2. Determination of Capital Gains and Losses
3. Steps to Determine Taxable Income
4. Section 1231 Assets
5. Determining Section 1231 Gains and Losses
6. Recap of the Rules
7. Recap of the Rules—Applying the Loss Limitation
8. Computing Casualty and Theft Losses
9. Netting Personal-Use Casualty/Theft Gains/Losses
Chapter 12, Exhibit Contents A CCH Federal Taxation Basic Principles 2 of 24

3. Chapter 12 Exhibits
10. Personal Casualty and Theft Losses
11. Casualty and Theft Losses
12. Section 1245 Depreciation Recapture
13. Section 1250 Depreciation Recapture
Chapter 12, Exhibit Contents B CCH Federal Taxation Basic Principles 3 of 24

4. Capital Assets—Defined
Code Sec. 1221 defines capital assets by stating what they are not.
“Capital assets” generally refer to any property other than:
1. Ordinary income property (inventory, receivables, creative
works created by the taxpayer)
2. Depreciable business property (buildings and machinery)
3. Non-depreciable business property (land)
Thus, capital assets would include investment property such as stocks and
bonds, and personal use assets such as cars, principal residences,
household furnishings and jewelry. (Note: Paintings, manuscripts, and
other creative works are capital assets if created by someone other than the
taxpayer).
Chapter 12, Exhibit 1 CCH Federal Taxation Basic Principles 4 of 24

5. Determination of Capital Gains and Losses
 Long-term capital gains are taxed up to 15% (0% for
individuals in the 10% and 15% tax brackets), except for:
 Collectibles gains, which are taxed up to 28%
 Section 1202 gains, which are taxed up to 28% (sale of
small business stock held more than 5 years).
 Un-recaptured Section 1250 gains, which are taxed up to
25%.
Chapter 12, Exhibit 2a CCH Federal Taxation Basic Principles 5 of 24

6. Determination of Capital Gains and Losses
Step One
 Group gains or losses into 4 baskets and determine the net
amount in each basket.
1) Short-term gains/losses.
2) 28% long-term gains/losses.
3) 25% long-term gains (you will not have losses in this
basket).
4) 15% long-term gains/losses (including 1231 LT capital
gains)
Chapter 12, Exhibit 2b CCH Federal Taxation Basic Principles 6 of 24

7. Determination of Capital Gains and Losses
Step Two
 Long-term net losses from the 28% basket are netted
first against gains from the 25% basket and then against
gains from the 15% basket.
 Long-term net losses from the 15% basket are netted
first against gains from the 28% basket and then against
gains from the 25% basket.
 Short-term net losses are also netted against long-term
net gains (starting with the 28% basket).
 Short-term net gains reduce net losses from the 15% or
28% baskets.
Chapter 12, Exhibit 2c CCH Federal Taxation Basic Principles 7 of 24

8. Steps to Determine Taxable Income
 If the result is a net short-term capital gain, the amount is
included in ordinary income.
 If the result is net long-term capital gains, the gains are taxed
at the applicable capital gains rates (i.e., each basket’s rate).
 If the result is a loss (short-term or long-term), up to $3,000
($1,500 married filing separately) may be deducted for AGI.
The excess can be carried forward indefinitely.
Chapter 12, Exhibit 3 CCH Federal Taxation Basic Principles 8 of 24

9. Section 1231 Assets
Code Sec. 1231 Assets.
Generally, business assets held over 12 months fall under the
category “Section 1231.” These assets include depreciable
personal and real property and land used in a business.
Examples include delivery trucks, the portion of a car’s basis
allocable to business transportation, the portion of a principal
residence used for a home office, factory, office computers,
land, warehouses, office buildings, apartment buildings, and
rental houses.
Chapter 12, Exhibit 4 CCH Federal Taxation Basic Principles 9 of 24

10. Determining Section 1231 Gains and Losses
Gains entering into this calculation represent amounts remaining after
applying the recapture rules of Sections 1245 and 1250.
Step One (the first netting)
Net all business casualty & theft gains and losses.
 If the result is a net loss, the losses are ordinary losses (FOR
AGI) and gains are included in ordinary income.
 If the result is a net gain, the net gain is combined with other
section 1231 gains and losses.
Chapter 12, Exhibit 5a CCH Federal Taxation Basic Principles 10 of 24

11. Determining Section 1231 Gains and Losses
Step Two (the second netting)
Net remaining 1231 gains and losses (including net casualty & theft gains
from the first netting)
 If the result is a net loss, the losses are ordinary losses
(deducted FOR AGI) and gains are included in ordinary
income.
 If the result is a net gain, the net gain generally treated as a
long-term capital gain. (It could be treated as ordinary income
to the extent of unrecaptured Section 1231 net losses from the
past 5 years).
Chapter 12, Exhibit 5b CCH Federal Taxation Basic Principles 11 of 24

12. Recap of the Rules
1. Net each category.
2. If the long-term capital shows a gain after offsetting any net short-term
capital losses (STCLs) treat the net amount as a net long-term capital gain
(LTCG) subject to a maximum 15% or 28% tax rate, depending on which
basket survives the netting.
3. If the short-term capital shows a gain after offsetting any net LTCLs, treat
the net amount as a net STCG subject to the ordinary marginal tax rate.
4. If the Code Sec. 1231 column total shows a net loss, treat the net amount
as an ordinary loss, deductible for AGI, without the $3,000 limitation. Do
not offset it against net long-term or short-term capital gains.
5. If the Code Sec. 1231 column total shows a net gain. Treat as ordinary
income to the extent of Code Sec. 1231 net losses for the previous five
years that have not been recaptured. The remainder of the gain is treated as
long-term capital gain.
Chapter 12, Exhibit 6 CCH Federal Taxation Basic Principles 12 of 24

13. Recap of the Rules—Applying the Loss Limitation
Only $3,000 may be deducted each year for the aggregate
of “net” short-term and “net” long-term capital losses.
Short-term capital losses are used up first, then long-term
capital losses beginning with the highest “baskets.”
Unused STCLs and LTCLs are carried forward indefinitely
and retain their identity as short term or long term.
Remember, that STCLs and LTCLs on the sale of personal
use property such as a principal residence or a car used for
commuting, are NEVER deductible, and NEVER carried
forward.
Chapter 12, Exhibit 7 CCH Federal Taxation Basic Principles 13 of 24

14. Computing Casualty and Theft Losses
• “Basis” = Cost minus accumulated depreciation (if any).
• “⇓“ means “reduce” or “reduced.”
• FMV = fair market value.
Gain or Loss from Casualty:
Nature of the Personal-Use: Business-Use:
Casualty:
Reimbursements, less: Reimbursements, less:
If total destruction or theft: Lower of basis or FMV Basis
If partial destruction: Lower of Basis or ⇓FMV Lower of Basis or ⇓ FMV
Result: = “Realized” gain or loss = “Recognized” gain or loss
*Gain is recognized to the extent that insurance reimbursements exceed adjusted basis.
Chapter 12, Exhibit 8 CCH Federal Taxation Basic Principles 14 of 24

15. Netting Personal-Use Casualty/Theft
Gains/Losses
Combine casualty/theft gains and losses less $100 per
event, on personal-use property.
 If a net gain, both gains and losses are capital gains and
capital losses. Recall that the losses had been reduced by
$100 per event but are NOT reduced by the 10% AGI
floor.
 If a net loss, the net amount is treated as an ordinary
itemized deduction, having been reduced by $100 per
event AND to be further reduced by the 10% AGI floor.
Chapter 12, Exhibit 9 CCH Federal Taxation Basic Principles 15 of 24

16. Personal Casualty and Theft Losses
If a personal use gain: = “Tentative” casualty gain
If a personal use loss: Reduce by $100 per event to get:
“tentative” casualty loss.
If all personal use tentative gains The result is a net casualty gain that gets capital
and losses net to a GAIN: gains treatment.
If all tentative gains and losses Reduce by 10% AGI (applied once to all events’
net to a LOSS: combined net loss.) Any loss remaining is
deductible “from” AGI
Chapter 12, Exhibit 10 CCH Federal Taxation Basic Principles 16 of 24

17. Casualty and Theft Losses
Personal Use Business Use
Type of deduction “From” AGI “For” AGI
Type of gain Capital (Ch. 12) Sec 1231 (Ch. 12)
Chapter 12, Exhibit 11 CCH Federal Taxation Basic Principles 17 of 24

18. Section 1245 Depreciation Recapture
 Purpose – To prevent taxpayers from taking ordinary
depreciation deduction and then receiving long term capital
gain treatment through Section 1231.
 Type of Property – Section 1245 is a subcategory of Section
1231. It includes depreciable personal property.
Chapter 12, Exhibit 12a CCH Federal Taxation Basic Principles 18 of 24

19. Section 1245 Depreciation Recapture
 Ordinary income is recognized to the extent of total
depreciation taken (not to exceed recognized gain).
 Excess recognized gain is treated as Section 1231 gain.
 All losses are treated as Section 1231 losses. There is no
recapture of depreciation as ordinary income when there is a
recognized loss.
Chapter 12, Exhibit 12b CCH Federal Taxation Basic Principles 19 of 24

20. Section 1250 Depreciation Recapture
 Purpose – To prevent taxpayers from receiving the full
benefits of accelerated depreciation and long term capital gain
treatment through Section 1231.
 Type of Property – Section 1250 is a subcategory of Section
1231. It includes depreciable real property.
Chapter 12, Exhibit 13a CCH Federal Taxation Basic Principles 20 of 24

21. Section 1250 Depreciation Recapture
General Rule (applies to MACRS property)
 Unrecaptured Section 1250 gain is taxed up to 25%. Only
gain on property held over 12 months is included (i.e. only
applies to long-term gain)
 Excess recognized gain is treated as Section 1231 gain and
taxed up to 15%.
Chapter 12, Exhibit 13b CCH Federal Taxation Basic Principles 21 of 24

22. Section 1250 Depreciation Recapture
Pre-1981 Acquisitions
For nonresidential and residential real property, the following
rules apply:
 Excess depreciation is ordinary income (exception for
residential real property - excess depreciation recapture is
zero for pre-1976 time period).
 Remaining unrecaptured depreciation is in the 25% basket.
 Remaining gain is in the 15% basket.
Chapter 12, Exhibit 13c CCH Federal Taxation Basic Principles 22 of 24

23. Section 1250 Depreciation Recapture
ACRS Acquisitions
For nonresidential and residential real property, the following
rules apply:
 Excess depreciation is ordinary income. For nonresidential
real property, if accelerated depreciation was taken, total
depreciation is recaptured as ordinary income.
 Remaining unrecaptured depreciation is in the 25% basket.
 Remaining gain is in the 15% basket.
Chapter 12, Exhibit 13d CCH Federal Taxation Basic Principles 23 of 24

24. Section 1250 Depreciation Recapture
MACRS Acquisitions
For nonresidential and residential real property, the following
rules apply:
 Unrecaptured depreciation is in the 25% basket.
 Remaining gain is in the 15% basket.
Chapter 12, Exhibit 13e CCH Federal Taxation Basic Principles 24 of 24