A corporation may be subject to ordinary income and tax rates in an asset sale, or if in a contemplated taxable stock sale (treated as an asset sale) where a Section 336(e) or a Section 338(h)(10) election is made, shareholders (SH) are taxed on asset sales resulting in recapture for Section 1245 property.

For example, if a corporation in such a sale sold equipment for $300,000 that it held for two years, the equipment’s cost was $270,000, and accumulated depreciation was $60,000, and adjusted basis was $210,000, realized gain would be $90,000, $60,000 of that would be recaptured as ordinary income, and only $30,000 would be at favorable long term capital gains (LTCG) tax rates (Section 1231 property).
The issue is how a corporation must treat the realized gain on the sale of its assets, what kind of property is each asset under the law, and what is the character of the gain on sale of each asset. Section 1245 property is defined in Section 1245(a)(1)(3)(A) and Section 1245(a)(1)(3)(B) as any property subject to depreciation under Section 167, and is either personal property or other tangible property used “as an integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services…”.

Section 167 allows depreciation deductions to be taken on property subject to wear and tear, if used in trade or business or used in production of income. Section 1245(a)(1) provides that if Section 1245 is sold, the amount by which the sales price exceeds the adjusted basis shall be treated as ordinary income. This means that all depreciation taken against the original basis shall be recovered as ordinary income.

If a corporation has Section 1245 property, much of which has been fully depreciated, then the equipment is Section 1245 property as defined by the IRC. The assets sold would be allocated part of the aggregate deemed asset disposition price (ADADP), thus the gains subject to recapture rules will be all previously taken depreciation represents to the difference between the ADADP and the adjusted basis (a very low basis, thus large potential gain). Under Section 1245 and Reg. Sec. 1-1245-1, the treatment of this gain shall be the recapture of all depreciation taken, with only the balance of gain taxed at the applicable and favorable capital gains tax rates.

Worldview Consulting & Accounting, Inc. is an Oregon registered CPA accounting firm. William Burwell, CPA, CFF, MBA, CPIM, is a business consultant and financial forensic accounting services professional with over twenty years of high technology industry experience. Licensed in Oregon and Massachusetts.

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