So far we have asked if there is a realized gain or loss on the disposition of property.

And if so, is it recognized?

To continue the refresher in property transactions,

we are now interested in the character of a recognized gain or

loss which can be effected by recapture provisions.

We will discuss recapture later.

Character determines how a gain or loss is treated for federal tax purposes,

and is based on the type of property involved.

Gains and losses take one of two characters: ordinary or capital.

For individuals and corporations,

ordinary gains are taxed at ordinary tax rates while

ordinary losses offset ordinary income that is taxed at ordinary tax rates.

Capital character is further characterized as

long term or short term in nature depending on the holding period.

More on this in just a minute.

For individuals, long term capital gains may be taxed at preferential that

is lower rates while deductions for capital losses are often limited.

For corporations however there are no preferential tax rates for

capital gains and no deduction for capital losses in excess of capital gains.

The capital characterization is still important though because it affects the netting of

gains and losses as well as the calculation of carry forwards and carry backs.

Holding period is another key concept in

property transactions as different tax treatments

can apply depending on whether gains and losses are short or long term in nature.

Holding period is also used to categorize property.

The classifications are very straightforward.

If an asset is held for one year or less,

any gain or loss is labeled short term.

It is considered long term if an asset is held for more than one year.

Character is ultimately determined by the type of

property involved which considers holding period.

There are three primary types of property.

First, ordinary assets are those created or used in

a trade or business such as inventory and accounts receivable.

Other assets such as computer equipment are ordinary if

they have been used in a trade or business for one year or less.

Section 1231 assets are defined as

depreciable assets and land used in a trade or business for more than one year.

For example as depreciable personal property,

a photocopier used by an accounting firm is

a section 1231 asset if it has been used in the business for more than one year.

Otherwise, it is an ordinary asset.

Note that personal property does not mean personal use property.

Confusing I know, but that's how the law is written.

Finally capital assets are property other

than those used or created in a trade or business.

In other words not ordinary assets or section 1231 assets.

See section 1221 for a description of what is not a capital asset.

Notice that holding period is not a determining factor for this category.

Investment securities and personal use assets are examples of capital assets.

Lesson 3.1.3 Character

Taxation of Business Entities I: Corporations

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