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Computing a Net Section 1231 Gain and Loss

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How to Compute and Report a Net Section 1231 Gain or Loss-Continued

Nonrecaptured Net Section 1231 Losses:

Nonrecaptured net Section 1231 losses are net Section 1231 losses that occurred in prior years that were never used to reduce (offset) a net Section 1231 gain in a later year.

Section 1231 requires you to reduce the current year's net Section 1231 gain by any nonrecaptured net Section 1231 losses of the previous five years.

The total amount of the nonrecaptured losses for the previous five years that equal the current year's gain are considered recaptured. This recaptured amount is reported on Form 4797, Part II as an ordinary gain.

The amount of the current year's gain that exceeds the recaptured net Section 1231 losses of the prior five years is reported as a long-term capital gain on Schedule D.

Once a nonrecaptured net Section 1231 loss is recaptured it is not taken into account in any future net Section 1231 computations.

The Purpose of the Loss Recapture Rule

The loss recapture rule is intended to prevent gain and loss manipulation from year to year.

Manipulation would be possible by allowing a taxpayer to time sales of Section 1231 property so as to take gains in one year and losses in another year.

A gain would be taxed at long-term capital gain rates
A loss would be fully deductible as an ordinary loss rather than as a capital loss, which is subject to an annual deduction limit of $3,000.

Sound like a bunch of mumbo jumbo?

An example will clear things up.

Go to the next section.

Computing a Net Section 1231 Gain and Loss-Continued: Example of Section 1231 Computation

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