Question

Lenny's Landing has a net Section 1231 gain in the current year of 12,000. In the previous five years, there are3,000 in unrecaptured Section 1231 losses. How will Lenny's gain be taxed in the current year?

1) Due to the unrecaptured losses, 3,000 will be characterized as unrecaptured Sec. 1250 gain taxed at 25
2) Due to the unrecaptured losses,3,000 will offset the current year's gain. The remaining 9,000 will be characterized as long-term capital gain.
3) Due to the unrecaptured losses,3,000 will be recharacterized as ordinary income. The remaining 9,000 will be long-term capital gain.
4) The12,000 gain will be combined with long-term capital gains and losses and taxed at preferential rates.

Answer 1

The $3,000 of Lenny's Landing's unrecaptured Section 1231 losses will be recharacterized as ordinary income, reducing the current year's gain. The remaining $9,000 of the gain will be taxed as long-term capital gain.

Step-by-step explanation:

If Lenny's Landing has a net Section 1231 gain of $12,000 for the current year, and there are $3,000 in unrecaptured Section 1231 losses from the previous five years, this has tax implications for the current year's gain. Under the Section 1231 tax treatment rules, the $3,000 of prior losses will first reduce the current year's gain. Thus, the $3,000 will be recharacterized as ordinary income, which essentially recaptures the loss that provided a tax benefit in the past. The remaining $9,000 will be taxed as long-term capital gain, assuming there are no other complicating factors such as additional gains or losses.