Your client sells a rental building she bought for $600,000. She thinks the gain is sale price minus purchase price. She is wrong, and the error could cost her $80,000 in undertaxed depreciation recapture.
NOTE: OBBBA touchpoints. Property-transaction mechanics themselves (basis, recapture, 1031, wash sales) are unchanged by OBBBA. Two indirect effects matter: (1) 100% bonus depreciation is now permanent (OBBBA preserved the TCJA full-expensing rule), which means Section 1245 recapture amounts will continue to be substantial on disposition of personal property; (2) the SALT cap is now $40,000 with phase-down above $500,000 MAGI, which matters when a property sale spikes a client's MAGI for the year. For the full OBBBA picture, see lesson E36b: OBBBA Tax Law Changes.
Every property transaction starts with basis. The exam tests five distinct rules depending on how the taxpayer acquired the asset.
Cost basis is purchase price plus capitalized costs, commissions, transfer taxes, legal fees. You buy stock for $50,000 and pay a $200 commission. Your basis is $50,200.
Common mistakes
- Applying stepped-up basis to income in respect of a decedent. Traditional IRAs, 401(k)s, and deferred annuities do not receive a step-up. Every dollar from an inherited traditional IRA is ordinary income. Trap: $500,000 inherited IRA with a $500,000 "stepped-up basis", the correct basis is $0.
- Forgetting "allowed or allowable" depreciation. If a client never claimed depreciation on rental property, the IRS still reduces basis by the amount that should have been claimed. Trap: using the original purchase price as basis instead of subtracting allowable depreciation.
- Confusing 1245 and 1250 recapture rates. Section 1245 (personal property) recaptures at ordinary income rates up to 37%. Section 1250 (real property, straight-line) caps at 25%. Trap: applying 25% to equipment or ordinary rates to a rental building.
Bottom line
- Basis determines gain: cost, adjusted, carryover (gift), stepped-up (inheritance), or substituted (1031 exchange).
- Depreciation reduces basis even if the taxpayer never claimed it ("allowed or allowable").
- Gifted property takes carryover basis, with a double-basis rule when FMV is below the donor's basis at the gift date.
- Inherited property receives a stepped-up basis to date-of-death FMV and is automatically long-term.
Exam shortcut
DECISION: Personal property (equipment, vehicles) → §1245 ordinary recapture on all accumulated depreciation; real property with straight-line depreciation → §1250 max 25% on unrecaptured depreciation; voluntary real-for-real exchange → §1031 (45-day ID / 180-day close, qualified intermediary required); destroyed, stolen, or condemned property → §1033 (2 years, or 3 for condemned realty, similar-or-related-use standard); sale to a related party at a loss → §267 permanent disallowance; loss on substantially identical...
The full lesson (about 3,146 words, 21 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- E.41
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