15.8 Disposition of Business Assets
Key Takeaways
Realized Gain/Loss = Amount Realized - Adjusted Basis.
Adjusted Basis = Cost + Improvements - Depreciation allowed or allowable.
Form 4797 reports business asset sales.
Character: Ordinary assets, Capital assets, or §1231 assets.
Depreciation recapture: taxed as ordinary income before capital treatment.
"Allowed or allowable" = must reduce basis even if not claimed.
Why This Matters for the Exam
Asset disposition ties depreciation to gain/loss. The exam tests the formula and "allowed or allowable."
The Disposition Formula
| Element | Calculation |
|---|---|
| Amount Realized | Cash + FMV property + Liabilities assumed |
| Adjusted Basis | Cost + Improvements - Depreciation |
| Gain/Loss | Amount Realized - Adjusted Basis |
Adjusted Basis Components
| Component | Effect on Basis |
|---|---|
| Original cost | + |
| Sales tax, freight, installation | + |
| Capital improvements | + |
| Depreciation (§179, bonus, MACRS) | - |
"Allowed or Allowable" Rule
| Rule | Effect |
|---|---|
| Forgot to claim depreciation | MUST still reduce basis |
| Cannot "save" basis | By skipping depreciation |
| Exception | Electing out of bonus (specific election) |
Character of Gain/Loss
| Asset Type | Definition | Treatment |
|---|---|---|
| Ordinary | Inventory, A/R | Ordinary rates |
| Capital | Investment, personal-use | Capital rates |
| §1231 | Depreciable business property >1 year | Best of both worlds |
Depreciation Recapture
| Rule | Effect |
|---|---|
| Gain up to depreciation taken | Ordinary income |
| §1245 (personal property) | All depreciation recaptured |
| §1250 (real property) | Excess over straight-line (25% rate) |
Form 4797 Parts
| Part | Assets Covered |
|---|---|
| Part I | §1231 property (>1 year) |
| Part II | Ordinary gains/losses |
| Part III | Depreciation recapture |
Real-World Scenario
Scenario: Forklift—cost $20,000, depreciation $12,000, sold for $10,000.
- Adjusted basis: $20,000 - $12,000 = $8,000.
- Gain: $10,000 - $8,000 = $2,000.
- Recapture: $2,000 < $12,000 depreciation → all $2,000 ordinary.
On the Exam
Question types to practice on dispositions:
- Gain/Loss Questions: "What is the realized gain?"
- Basis Questions: "What if taxpayer forgot to claim depreciation?"
- Recapture Questions: "How is the gain taxed?"
The key is to remember: Gain = Amount Realized - Adjusted Basis. Adjusted Basis = Cost + Improvements - Depreciation. "Allowed or allowable" = must reduce basis. Recapture = ordinary income.
Machine: $20,000 cost, $14,000 depreciation, sold for $15,000. Realized gain?
$5,000 loss
$9,000 gain
$15,000 gain
$34,000 gain
Taxpayer forgot to claim depreciation. Effect on adjusted basis?
No effect
Still reduced by allowable amount
Increased by missed amount
IRS corrects automatically
Which form reports business asset sales?
Schedule C
Schedule D
Form 4797
Form 4562
Sections you finish are checked off in the contents.