Which of the following is true regarding �21245 depreciation recapture

Which of the following is true regarding �21245 depreciation recapture? O Changes the character of a loss O The lesser of accumulated depreciation or gain recognized becomes ordinary Changes the amount of a gain O Only applies to ordinary assets Which of the following is true regarding i;/1245 depreciation recapture? O Changes the character of a loss O The lesser of accumulated depreciation or gain recognized becomes ordinary O Changes the amount of a gain O Only applies to ordinary assets

The Correct Answer and Explanation is:

The correct answer is: The lesser of accumulated depreciation or gain recognized becomes ordinary.

Explanation:

Section 1245 of the Internal Revenue Code (IRC) deals with the recapture of depreciation when a taxpayer disposes of certain types of depreciable property, such as equipment or machinery. The purpose of depreciation recapture under IRC Section 1245 is to prevent taxpayers from using depreciation deductions to reduce their taxable income and then selling the property at a gain, essentially “undoing” the tax benefits of depreciation.

Here’s how it works:

1. Depreciation Recapture: If a taxpayer sells depreciable property (such as equipment, machinery, or other business assets) for more than its depreciated value, the gain on the sale is subject to depreciation recapture. This means the portion of the gain that is equal to or less than the total depreciation taken on the asset is “recaptured” as ordinary income.
2. Lesser of Accumulated Depreciation or Gain Recognized: The amount of gain subject to recapture under Section 1245 is limited to the lesser of:
   • The accumulated depreciation taken on the property, or
   • The gain recognized on the sale.

If the asset is sold for more than its depreciated value but less than the original purchase price, the depreciation recapture will only apply to the amount of depreciation that has been deducted over the years, up to the amount of the gain realized on the sale.

For example:

• If an asset was purchased for $100,000 and $40,000 in depreciation was taken, and the asset is sold for $90,000, the gain on the sale is $40,000. However, only $40,000 is subject to ordinary income tax, as it is the lesser of the depreciation taken ($40,000) and the gain recognized ($40,000).
• If the asset was sold for $120,000, the gain recognized would be $20,000 (after the $40,000 depreciation), and only that $20,000 would be treated as ordinary income.

3. Character of the Gain: The recaptured depreciation is treated as ordinary income, not as capital gain. This is important because ordinary income is generally taxed at a higher rate than long-term capital gains.

Incorrect Options:

• Changes the character of a loss: Depreciation recapture affects the character of gains, not losses. Losses are generally treated as capital losses, but recapture rules do not apply to losses.
• Changes the amount of a gain: Depreciation recapture does not alter the total amount of gain realized on the sale; it only changes how that gain is taxed (as ordinary income, not capital gain).
• Only applies to ordinary assets: Section 1245 depreciation recapture applies to certain depreciable personal property and not just to ordinary assets. It applies to tangible personal property, such as machinery, equipment, and other business assets, regardless of whether the asset is considered “ordinary.”

In conclusion, the key takeaway is that depreciation recapture under Section 1245 causes the lesser of the accumulated depreciation or recognized gain to be taxed as ordinary income rather than capital gain.