In Year 5, a business sells a machine (Section 1231 asset) for a ,000 gain. In Years 1-4, the business had net Section 1231 losses of ,000 that were deducted as ordinary losses. How is the Year 5 gain taxed?

Answer options:

,000 Long-Term Capital Gain

,000 Ordinary Income

,000 Ordinary Income; ,000 Long-Term Capital Gain

How to approach this question

Lookback Rule: Did you take 1231 ordinary losses in the last 5 years? If yes, you have to 'pay back' that benefit by treating current capital gains as ordinary income up to the amount of those past losses.

Full Answer

C.,000 Ordinary Income; ,000 Long-Term Capital Gain✓ Correct

,000 Ordinary Income; ,000 Long-Term Capital Gain

Under the Section 1231 lookback rule, net Section 1231 gains must be treated as ordinary income to the extent of unrecaptured Section 1231 losses from the preceding 5 years.

Common mistakes

Treating the entire 1231 gain as capital gain.

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