An unincorporated business sold two warehouses during the current year.The straight-line depreciation method was used for the first building and the accelerated method (ACRS)was used for the second building.Information about those buildings is presented below. How much gain from these sales should be reported as section 1231 gain and ordinary income due to depreciation recapture by the owner of the business?

Question

An unincorporated business sold two warehouses during the current year.The straight-line depreciation method was used for the first building and the accelerated method (ACRS)was used for the second building.Information about those buildings is presented below.  How much gain from these sales should be reported as section 1231 gain and ordinary income due to depreciation recapture by the owner of the business?

Quizplus · Accepted Answer

To calculate the gain/loss from the sale of an asset, we need to calculate the adjusted basis and the amount realized. 
Adjusted basis = Original cost - Accumulated Depreciation 
Amount realized = Sale price - Selling expenses

For the first building:
Original cost = $500,000 
Depreciation = $500,000 / 30 years = $16,667 per year 
Accumulated depreciation for the current year = $16,667 x 10 years = $166,670 
Adjusted basis = $500,000 - $166,670 = $333,330 
Sale price = $400,000 
Selling expenses = $20,000 
Amount realized = $400,000 - $20,000 = $380,000 
The gain from the sale of the first building is: 
$380,000 - $333,330 = $46,670

For the second building: 
Original cost = $800,000 
ACRS depreciation percentage = 20% 
ACRS depreciation for the current year = $800,000 x 20% = $160,000 
Accumulated depreciation for the current year = $160,000 x 7 years = $1,120,000 
Adjusted basis = $800,000 - $1,120,000 = $(320,000) 
Sale price = $600,000 
Selling expenses = $30,000 
Amount realized = $600,000 - $30,000 = $570,000 
The gain from the sale of the second building is: 
$570,000 - $(320,000) = $890,000

Since both buildings were used in the taxpayer's business, the gain should be reported as section 1231 gain. However, because the ACRS depreciation method was used for the second building, there will be ordinary income due to depreciation recapture. 
The amount of ordinary income due to depreciation recapture is the lesser of: 
1. The total amount of depreciation taken (in excess of straight-line depreciation) 
2. The gain from the sale of the asset

For the second building, the ACRS depreciation taken was $160,000 x 7 years = $1,120,000. The gain from the sale was $890,000. Therefore, the ordinary income due to depreciation recapture is $890,000.

Total gain from the sale is: 
$46,670 (first building) + $890,000 (second building) = $936,670

Therefore, the best choice is B.

An Unincorporated Business Sold Two Warehouses During the Current Year