How does the five-year lookback rule affect a net section 1231 gain?

The gain is ordinary income to the extent of net section 1231 losses deducted in the prior five years that have not been recaptured

It requires spreading the gain over five years

It converts losses from five years ago to capital losses

It applies only to corporations

Equipment bought for $50,000 has an adjusted basis of $20,000 after $30,000 of depreciation. It is sold for $60,000. How is the $40,000 gain characterized?

$30,000 ordinary income under section 1245 and $10,000 section 1231 gain

$30,000 section 1231 gain and $10,000 ordinary income recaptured under section 1245

An individual sells a rental building placed in service in 2015 (depreciated straight line) at a gain. How is the gain attributable to depreciation taxed?

As ordinary income under section 1245

At the regular 0%/15%/20% long-term capital gain rates with no cap

A C corporation sells depreciable real property (section 1250 property) at a gain. What special rule applies?

IRC 291 treats 20% of the straight-line depreciation (the lesser of that amount or gain) as ordinary income

All of the depreciation taken is recaptured as ordinary income under section 1245, just as it would be for equipment

The 25% rate applies to the corporation

How is depreciation recapture handled in an installment sale?

All recapture income is recognized in the year of sale, regardless of payments received

Recapture is excluded in installment sales

Recapture is spread over the installment payments in proportion to the gross profit received

Recapture is recognized only in the last year

A business sells equipment held 10 months at a gain. How is the gain characterized?

Ordinary income, because the property was not held more than one year

Long-term capital gain, because equipment used in a business is a capital asset

An individual sells depreciable equipment to a corporation he owns 100%. How is his gain characterized?

Ordinary income under IRC 1239, because the property is depreciable in the hands of a related buyer

Sections 1231, 1245 and 1250 (depreciation recapture)

When depreciable business property is sold at a gain, section 1245 turns the gain up to prior depreciation on personal property into ordinary income, section 1250 rules leave post-1986 straight-line real estate gain as unrecaptured 1250 gain (25% max for individuals), and any remaining section 1231 gain is long-term capital gain after the 5-year lookback.

Updated 2026-09-23 · 4 sources · By the EnrolledAgentKit team

Exam part

Part 2

Businesses

IRS domain

Business Tax Preparation

37 of 85 scored Qs

Tax year tested

2025

2026-27 SEE

Practice questions

10 free below

The rules the exam tests

Figures for tax year 2025, the year the 2026-27 SEE tests. Verify against the cited primary source.
Rule	What it says (2025)	Source
Section 1231 property	Business real or depreciable property held > 1 year	IRC 1231(b)
Net 1231 gain / loss	Gain = LTCG; loss = ordinary	IRC 1231(a)
5-year lookback	Net 1231 gain is ordinary to extent of unrecaptured 1231 losses in prior 5 years	IRC 1231(c)
Section 1245	Ordinary income = lesser of gain or depreciation taken	IRC 1245
Section 1250 (individuals)	Post-1986 SL real property: no ordinary recapture; unrecaptured 1250 gain taxed at 25% max	IRC 1(h)(6), 1250
Section 291 (C corps)	20% of the 1245-over-1250 excess is ordinary	IRC 291
Installment sales	All recapture recognized in year of sale	IRC 453(i)
Related party (1239)	Gain on depreciable property sold to a controlled entity = ordinary	IRC 1239
Form	Form 4797 (Part III recapture)	IRS

Worked example

Facts: Equipment cost $50,000; $30,000 depreciation taken (basis $20,000). Sold for $60,000.

Gain $40,000: section 1245 ordinary income = lesser of $40,000 or $30,000 = $30,000; the $10,000 excess over original cost is section 1231 gain. If the business had a $6,000 net 1231 loss two years ago, $6,000 of that 1231 gain would be ordinary under the lookback.

Exam traps

Assets held one year or less are not 1231 property: gain is ordinary.
Unrecaptured 1250 gain is capital gain taxed at up to 25%, not ordinary income.
Like-kind exchanges carry recapture potential into the new property.
Business casualty gains/losses net first, then feed 1231 only if a net gain.