Julie is both a real estate developer and the owner and manager of residential r
ID: 2444760 • Letter: J
Question
Julie is both a real estate developer and the owner and manager of residential rental real estate. Julie is retiring and is going to sell both the land she is holding for future development and the rental properties she owns. Straight-line depreciation was used to depreciate the rental real estate. The rental properties will be sold at a substantial loss, and the development property will be sold at a substantial gain. What is the nature of these gains and losses?
My question relates to the character of these gains and losses. I am in need of clarification when it comes to 1221 and 1231 assets and if sec 167 depreciation nulls the classification of 1221 assets of the rental real estate property, and in turn changes their character to 1231 property. PLEASE AND THANK YOU!!
Explanation / Answer
Answer: The sale and exchange of property held for long-term (more than one year) and is used in a trade or business or held for producing rent is a section 1231 asset. Section 1231 assets can be treated as an ordinary or capital, depending on whether the tax payer has a net gain or net loss.
Julie will treat the sale of the residential properties as § 1231 assets, and will recognize an ordinary loss. Julie can deduct the full amount of the ordinary loss. The sale of the property held for development is also a §1231 asset. Julie will recognize a long-term capital gain from this sale.
The developmental property should be classified as an ordinary gain, and the rental property should be classified as an ordinary loss. The ordinary gain will be added to Julie’s ordinary income and the ordinary loss will be fully deductible.
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