Question

Tonya Jefferson (single), a sole proprietor, runs a successful lobbying business in Washington, DC. She doesn't sell many business assets, but she is planning on retiring and selling her historic townhouse, from which she runs her business, to buy a place somewhere sunny and warm. Tonya's townhouse is worth $1,000,000 and the land is worth another $1,000,000. The original basis in the townhouse was $600,000, and she has claimed $250,000 of depreciation deductions against the asset over the years. The original basis in the land was $500,000. Tonya has located a buyer that would like to finalize the transaction in December of the current year. Tonya's marginal ordinary income tax rate is 35 percent and her capital gains tax rate is 20 percent.

What is the character of the gain or loss?
O $250,000 Unrecaptured $1250 and $900,000 other $1231 gain
O $900,000 Unrecaptured $1250 and $250,000 other $1231 gain
O $1,150,000 Unrecaptured $1250
O $250,000 Unrecaptured $1250 and $900,000 long-term capital gain
O $900,000 Unrecaptured $1250 and $250,000 long-term capital gain

Answer 1

The character of Tonya Jefferson's gain is $250,000 Unrecaptured $1250 gain, representing the depreciation recapture on the townhouse, and $900,000 long-term capital gain, combining the remaining gain on the building and the gain on the land.

Step-by-step explanation:

The question is about calculating the character of the gain or loss on the sale of a townhouse used for a business, which includes determining the portion of the gain that is treated as unrecaptured Section 1250 gain (a subset of Section 1231 gains which pertains to depreciation recapture on real estate) and the remaining as either other Section 1231 gain or long-term capital gain.

Starting with the building's sale, we have a sales price of $1,000,000 and an adjusted basis of $350,000 (original basis of $600,000 minus $250,000 depreciation claimed). This results in a total gain of $650,000 on the building. However, $250,000 of this gain represents the depreciation recapture and is taxed as unrecaptured Section 1250 gain. The remaining $400,000 is the Section 1231 gain which could be treated as long-term capital gain if used in a trade or business. Land sale has no depreciation recapture and the gain of $500,000 ($1,000,000 sale price minus $500,000 basis) is treated as Section 1231 gain, which is generally taxed preferentially like long-term capital gain.

Hence, the correct character of the gain is $250,000 Unrecaptured $1250 and $900,000 long-term capital gain ($400,000 from building and $500,000 from land).