Milton Inc. recognized a $1,300 net Section 1231 loss in 2011. If Milton recognizes a $5,000 net Section 1231 gain in 2012, it must characterize $1,300 as ordinary income.

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According to the tax code, net Section 1231 losses are treated as ordinary losses while net Section 1231 gains are treated as long-term capital gains. However, any previously recognized net Section 1231 losses that were treated as ordinary losses must be recaptured as ordinary income to the extent of any current year net Section 1231 gain. Therefore, in this scenario, Milton must recapture the $1,300 loss as ordinary income in 2012, reducing the total net Section 1231 gain to $3,700 ($5,000 - $1,300).