In Year 5, a taxpayer has a §1231 gain of $20,000. In Year 1, they had a §1231 loss of $8,000 that was deducted as ordinary. No other §1231 transactions occurred in Years 2-4. How is the Year 5 gain characterized?

Answer options:

$20,000 Capital Gain

$20,000 Ordinary Income

$8,000 Ordinary Income, $12,000 Capital Gain

$12,000 Ordinary Income, $8,000 Capital Gain

How to approach this question

Apply §1231(c) Lookback Rule. Current §1231 gain is ordinary to the extent of unrecaptured §1231 losses from the prior 5 years. $8,000 is ordinary; remainder ($12,000) is LTCG.

Full Answer

C.$8,000 Ordinary Income, $12,000 Capital Gain✓ Correct

IRC §1231(c). The $20,000 gain is treated as ordinary income to the extent of non-recaptured §1231 losses from the previous 5 years ($8,000). The remaining $12,000 is long-term capital gain.

Common mistakes

Forgetting the 5-year lookback rule.

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