A taxpayer has a net §1231 gain of $50,000 in Year 5. In Year 1, they had a net §1231 loss of $12,000 which was deducted as ordinary. Years 2-4 had no §1231 transactions. How is the Year 5 gain taxed?

Answer options:

$50,000 Capital Gain

$50,000 Ordinary Income

$12,000 Ordinary Income; $38,000 Capital Gain

$12,000 Capital Gain; $38,000 Ordinary Income

How to approach this question

Lookback Rule: Current 1231 Gain is Ordinary to extent of unrecaptured 1231 Losses from past 5 years.

Full Answer

C.$12,000 Ordinary Income; $38,000 Capital Gain✓ Correct

IRC §1231(c). The non-recaptured net §1231 losses from the 5 preceding years ($12,000) convert current year §1231 gain into ordinary income. The remainder ($38,000) is long-term capital gain.

Common mistakes

Ignoring the 5-year lookback.

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