A taxpayer sells §1245 property (machine) on the installment method. Sale Price: $100,000. Basis: $60,000. Depreciation Recapture (Ordinary): $20,000. §1231 Gain: $20,000. Cash received in Year 1: $10,000. How is the gain reported in Year 1?

Answer options:

$4,000 gain (mixed character).

$20,000 ordinary income immediately; $2,000 §1231 gain.

$22,000 ordinary income.

$10,000 ordinary income.

How to approach this question

Installment Sale Trap: Depreciation Recapture is NOT eligible for installment deferral. It is taxed 100% in the year of sale. Only the §1231/Capital gain portion is deferred.

Full Answer

B.$20,000 ordinary income immediately; $2,000 §1231 gain.✓ Correct

IRC §453(i). Any depreciation recapture income must be recognized in the year of disposition, regardless of payments received. The recapture amount is added to the basis for calculating the gross profit ratio for the remaining gain.

Common mistakes

Applying the gross profit percentage to the total gain including recapture.

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