Academic journal article Journal of Accountancy

Best of Both Worlds? Timing Is Key in Disposing of Business Property

Academic journal article Journal of Accountancy

Best of Both Worlds? Timing Is Key in Disposing of Business Property

Article excerpt


* IRC [section] 1231 allows gains and losses from disposal of property used in a trade or business to be netted and a net gain to be treated as long-term capital gain and a net loss to be treated as an ordinary loss,

* Although it is generally in a taxpayer's interest to recognize gains as capital and losses as ordinary, other tax provisions limit section 1231 's advantages and must be reckoned with by CPA advisers and their clients. These include the five-year "lookback" period for section 1231 net losses that must be recaptured. Any section 1231 gain is ordinary to the extent that it does not exceed any remaining unrecaptured section 1231 losses in the previous five years.

* Depreciation recapture provisions of sections 1245 and 1250 can convert into ordinary income all or a portion of gain that would otherwise qualify as long-term capital gain under section 1231. Section 1245 applies to depreciable personal property. Section 1250 applies to depreciable real property and, for property purchased in or before 1986, the difference between accelerated and straight-line depreciation.

* Even though capital losses otherwise are limited to $3,000 per year for individuals (and to the extent of capital gains for corporations), it may behoove taxpayers to postpone a section 1231 gain beyond a tax year in which they claim a capital loss. Tax savings can also result from delaying a section 1231 gain beyond a year in which the taxpayer recognizes a section 1231 loss.



Over the past several years many companies pursued extremely aggressive growth, resulting in an accumulation of fixed assets on balance sheets. Many of these assets (especially land and buildings) have enjoyed an unprecedented appreciation in value. However, the current recession and accompanying credit crunch have caught some companies in a crisis of having to raise cash or face going out of business. For example, among the measures General Motors Corp. was considering in late 2008 to stave off bankruptcy was a plan to sell its new corporate headquarters in the landmark Renaissance Center in Detroit for approximately $500 million and to rent facilities there instead.

The credit crunch has also dramatically affected small businesses. In a survey of small and midsize businesses, the National Small Business Association found that two-thirds of the respondents had been affected by the credit crunch, with more than 30% indicating a decline in the conditions surrounding traditional bank loans. In fact, over half of the respondents leveraged their loans using credit cards, personal savings and home equity. As the economic downturn and credit crunch continue, asset leasing, combined with the disposal of selected assets, will be viewed as an increasingly viable option to improve cash flows.

Properly managing taxation of gains and losses on the disposal of such assets requires careful planning and analysis even in the best of times to maximize cash flows. Normally, it's to your clients' advantage to treat a taxable gain as long-term capital gain, to which lower rates apply, and a loss as an ordinary loss, because it can be used to offset ordinary income. That's exactly what IRC [section] 1231 allows. It covers the sale or exchange of both depreciable and real property held for more than one year that has been used in a trade or business. Also included is property involuntarily converted via destruction, theft, seizure or condemnation.

A client's failure to take advantage of these provisions can result in higher taxes and, thus, in reduced after-tax cash flows. As this article shows, however, rules governing recapture of net ordinary losses and depreciation complicate the picture. CPAs can help businesses make the most of section 1231 by timing the sale or disposal of assets to overcome these hurdles.

For many companies, the importance attached to the disposal of capital assets has increased dramatically due to the forced sell-off of noncore assets to raise cash. …

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