Nonrecaptured Net Section 1231 Losses from Prior Periods
“Hey, what is Statement 10 all about?”
Great question from a client this week on nonrecaptured net Section 1231 losses from prior periods. Even better that we are able to share the answer to our client’s question with our blog’s audience.
The categorization and tax treatment of the sale or exchange, or compulsory or involuntary conversion, of certain property, is covered in Internal Revenue Code Section 1231. Section 1231 applies to property used in a trade or business, or a capital asset that is held in connection with the trade or business, or a transaction that was entered into for profit, and held for over one year.
Generally, the Section 1231 capital gain/ordinary loss rule gives taxpayers the benefit of paying preferential tax rates on gains that are recognized from the sale or exchange of Section 1231 property, while also enabling taxpayers to treat losses from the sale or exchange of such property as ordinary losses. Over the years, the depreciation recapture rules of Sections 1245 and 1250 have limited some of the benefits of Section 1231 (previously covered here). Any depreciation recapture under Sections 1245 and 1250 must be considered prior to the application of the Section 1231 rules.
The nonrecaptured Section 1231 loss carryforward rule was created to prevent taxpayers from manipulating the timing of Section 1231 asset sales to secure ordinary loss treatment for losses in one year and long-term capital gain treatment for gains in a subsequent year. Taxpayers that have deducted net Section 1231 losses against ordinary income are required to recapture all or a portion of such amounts at ordinary tax rates.
For the purposes of calculating the Section 1231 recapture, a net Section 1231 loss is realized when the taxpayer’s total Section 1231 losses exceed the total Section 1231 gains for the tax year. A net Section 1231 gain is realized when the taxpayer’s total Section 1231 gains exceed total Section 1231 losses.
A net Section 1231 gain is treated as ordinary income recapture to the extent that there are unrecaptured Section 1231 losses remaining from the taxpayer’s last five years of Section 1231 netting. A nonrecaptured net Section 1231 loss occurs when the taxpayer’s aggregate net Section 1231 losses for the five most recently preceding tax years exceed the net Section 1231 losses that were recaptured and applied against any net Section 1231 gains that were recognized during the five most recent tax years.
Sources: IRS.gov, Bloomberg Tax, RIA Checkpoint
- Carey M. Heyman, CPA
- Managing Principal of Industry - Real Estate
- CliftonLarsonAllen LLP
- Century City (Los Angeles)
Carey is the Managing Principal of the Real Estate Industry at CLA. He is a trusted advisor with close to 20 years of experience providing accounting, assurance, tax, and consulting services to real estate industry owners, operators, family offices, developers and syndicators. Carey has a strong track record of helping clients build and retain capital by leveraging tax- and cost-saving strategies and employing tax credits and incentives. He also consults with high net worth individuals, large family groups, and owners of closely-held businesses on all aspects of tax planning, estate planning, and retirement planning.
Great post. It may also be worth clarifying that 1231 losses from a 199A-eligible business that ultimately get treated as ordinary deductions reduce QBI, and that 1231 gains from a 199A-eligible business that get recaptured as ordinary income increase QBI. Ordinary income recapture can sting a bit, but being able to increase your 199A deduction can help lessen the blow.