Fred’s Foam Foundations (FFF) is a sole proprietorship that Fred started in 2002. Before the current year, FFF had not disposed of any property it owned. During the current year, FFF has the following gains and losses:
Casualty Loss on foam truck $ 3,200
Section 1231 gains $ 9,400
Section 1231 losses $ 3,000
What is the effect of these transactions on Fred’s taxable income? Explain, and show the calculations
The Section 1231 netting results in an ordinary loss of $3,200 and a net long-term capital gain of $6,400. The $3,200 ordinary loss is deducted directly from Fred’s gross income. The $6,400 is combined with Fred’s other capital gains and losses in the capital gain and loss netting procedure.
Step 1 Netting:
Casualty loss on foam truck (Ordinary Loss) $3,200
Because the 1st netting results in a loss, the loss is ordinary. It is not carried to the second netting.
Step 2 Netting:
Section 1231 gains $ 9,400
Section 1231 losses (3,000)
Net Section 1231 gain – Long-term capital gain $6,400
Step 3 Netting:
Because Fred has never sold any property before the current year, there are no ordinary loss deductions to recapture under the lookback rule. The entire $6,400 net Section 1231 gain is a long-term capital gain.
