A taxpayer sold a machine used in their business for $50,000. The machine was purchased for $40,000, and $15,000 of depreciation had been taken (Adjusted Basis = $25,000). How is the gain recognized?

Answer options:

$15,000 Ordinary Income; $10,000 Section 1231 Gain

$25,000 Ordinary Income

$25,000 Section 1231 Gain

$10,000 Ordinary Income; $15,000 Section 1231 Gain

How to approach this question

1. Calculate Total Gain ($50k - $25k = $25k). 2. Section 1245 Recapture: Lesser of Gain ($25k) or Depreciation Taken ($15k) is Ordinary Income ($15k). 3. Remainder ($10k) is Section 1231 Gain (Capital).

Full Answer

A.$15,000 Ordinary Income; $10,000 Section 1231 Gain✓ Correct

Under IRC §1245, gain on the sale of personal property is recaptured as ordinary income to the extent of accumulated depreciation. Total gain = $25,000. Depreciation taken = $15,000. Therefore, $15,000 is ordinary income. The remaining $10,000 (which represents appreciation above original cost) is Section 1231 gain.

Common mistakes

Treating the entire gain as Section 1231 (Capital) gain.

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