Brad sold a rental house that he owned for $247,500. Brad bought the rental house five years ago for $227,500 and has claimed $48,750 of depreciation expense. What is the amount and character of Brad's gain or loss?

Question

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To find Brad's gain or loss, we need to calculate his adjusted basis in the rental house, which is his original cost of $227,500 minus his accumulated depreciation expense of $48,750, or $178,750.

Brad's selling price of $247,500 is higher than his adjusted basis of $178,750, so he has a gain. However, the character of the gain depends on whether it is considered a capital gain or an ordinary gain.

First, we need to determine whether the rental house is considered a capital asset. According to the IRS, a capital asset is generally any property that is not held for sale to customers in the ordinary course of business, such as stocks, bonds, and real estate held for investment. Since Brad owned the rental house for five years and rented it out, it is considered a capital asset.

Next, we need to determine whether any of the gain is considered ordinary income. When a taxpayer sells a capital asset that they have depreciated, part of their gain may be considered unrecaptured §1250 gain, which is taxed at a maximum rate of 25%. The remaining part of the gain is considered §1231 gain, which is taxed at capital gains rates.

To calculate the amount of unrecaptured §1250 gain, we need to find the amount of depreciation that would have been recaptured if Brad had sold the rental house for its adjusted basis of $178,750. The amount of recapture is equal to the lesser of the total depreciation claimed or the gain realized on the sale. Since Brad's gain of $68,750 is less than his total depreciation of $48,750, his unrecaptured §1250 gain is $48,750.

The remaining gain of $20,000 is considered §1231 gain, which is taxed at capital gains rates.

Therefore, Brad's gain is $48,750 unrecaptured §1250 gain and $20,000 §1231 gain. Answer choice B is the correct answer.

Brad Sold a Rental House That He Owned for $247,500