AICPA Representative Tasks (verbatim). 1. Application: Identify the character of the gain and loss recognized by a taxpayer on the disposal of an asset given a specific scenario. 2. Application: Calculate the Section 1231 capital gain and Section 1231 ordinary loss recognized for tax purposes on the disposition of an asset used in a trade or business. 3. Application: Calculate the Section 1245 and Section 1250 depreciation recapture recognized for tax purposes on the disposition of an asset used in a trade or business. 4.
When disposing of business or investment property, character determination follows a strict hierarchy. Recapture provisions convert what would otherwise be capital gain into ordinary income before any Section 1231 netting occurs.
KEY: The character waterfall runs: (1) Section 1245/1250 recapture → (2) Unrecaptured Section 1250 gain → (3) Section 1231 netting → (4) Capital gain/loss treatment. Apply each layer sequentially.
Section 1231 property includes depreciable property and real property used in a trade or business and held more than one year. The netting process produces asymmetric results that favor taxpayers.
Common mistakes
- Applying Section 1245 recapture to real property. Section 1245 applies to personal property; Section 1250 applies to real property. Trap: "recapture all depreciation on the building as ordinary income." Correct: Section 1250 recaptures only excess depreciation; unrecaptured Section 1250 gain applies to straight-line depreciation.
- Forgetting the Section 1231 lookback rule. Net Section 1231 gains are recharacterized as ordinary income to the extent of unrecaptured net Section 1231 losses from the prior five years. Trap: "net Section 1231 gain is always capital gain." Correct: check the five-year loss history first.
- Recognizing depreciation recapture on installment basis. Depreciation recapture under Sections 1245 and 1250 is recognized in full in the year of sale regardless of payment timing. Trap: "spread recapture gain using the gross profit ratio." Correct: recapture is accelerated; only Section 1231 gain defers.
Bottom line
- Section 1231 gains net against Section 1231 losses: net gain becomes long-term capital gain, net loss becomes ordinary loss (asymmetric best of both worlds)
- Recapture applies to each asset individually before Section 1231 netting (recapture first, net second)
- Section 1245 recaptures ALL depreciation on personal property as ordinary income, capped at the realized gain (a loss produces no recapture)
- Section 1250 recaptures only EXCESS depreciation over straight-line as ordinary income, making it largely obsolete for post-1986 real property
Exam shortcut
Recapture ceiling = gain realized. Recapture can never exceed the gain on the transaction. If gain is $25,000 and depreciation is $60,000, recapture is $25,000. Quick mental check: "recapture stops at gain." 1245 = personal, 1250 = real. Equipment, vehicles, furniture → Section 1245 (full recapture). Buildings, land improvements → Section 1250 (excess only) plus unrecaptured 1250 (25% layer).
The full lesson (about 4,715 words, 31 min read) adds 10 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- IV.B1
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