The §1245 Silver Lining: Turning Tax "Pain" into Strategic Gain

[Bruce D. Kowal]

The §1245 Silver Lining: Turning Tax "Pain" into Strategic Gain

“’That'll be $500,000 in ordinary income.' Those words from your CPA could ruin your day - or become your secret weapon. Here's how a seeming tax disaster turned into a strategic triumph.

Picture this: You're sitting with your CPA, reviewing the sale of your residential rental property. The numbers look solid - you sold for $2.8 million what you bought for $2 million ten years ago. But then comes the bombshell...

"You're looking at $500,000 in ordinary income from those §1245 assets."

Your heart sinks. That cost segregation study that saved you so much in taxes over the years? It's coming back to bite you. Or is it?

Let's break it down with precision:

The "Pain" (At First Glance):

Your $2.8M sale splits out as:

Building (§1250): $2.3M

Personal Property (§1245): $500K

Original Basis Allocation:

Building: $1.6M (depreciated over 27.5 years)

Personal Property: $400K (fully depreciated)

Building Depreciation:

Annual: $1.6M ÷ 27.5 = $58,182

Total over 10 years: $581,820

Gain Breakdown:

Building (§1250):

Sale Price: $2,300,000

Original Basis: $1,600,000

Less Depreciation: ($581,820)

Adjusted Basis: $1,018,180

Total Gain: $1,281,820

Unrecaptured §1250: $581,820 (25% max rate)

Capital Gain: $700,000 (20% max rate)

Personal Property (§1245):

Sale Price: $500,000

Adjusted Basis: $0

Ordinary Income: $500,000

The Strategic Play:

Remember those suspended passive losses you couldn't use? The business venture that went sideways? That expiring NOL keeping you up at night?

Assume that you're sitting on:

$200,000 in suspended passive losses

$150,000 in business losses

$100,000 in expiring NOLs

The Magic Transformation:

That $500,000 of "painful" ordinary income becomes your strategic advantage:

Absorbs all $450,000 of those otherwise-stranded losses

Leaves you with just $50,000 net ordinary income

Meanwhile, your §1250 gain still gets preferential rates:

$581,820 at 25% max (unrecaptured §1250)

$700,000 at 20% max (capital gain)

The Plot Twist:

What looked like a tax nightmare actually solved multiple problems. Those suspended losses? Gone. That expiring NOL? Saved. That "terrible" ordinary income? It became your strategic advantage.

The Moral of the Story:

Sometimes in tax planning, what looks like a lemon can make premium lemonade. That cost segregation study wasn't just about accelerated depreciation - it was setting you up for strategic wins years down the road.

Next time your CPA mentions §1245 ordinary income, don't sweat it. Smile and ask, "So, what losses can we offset?"

[If there are errors in this analysis, please let me know, so I can adjust.  Or simply delete in shame.  :) ]

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