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1040 online 2. 1040 online   American Opportunity Credit Table of Contents Introduction Can You Claim the CreditWho Can Claim the Credit Who Cannot Claim the Credit What Expenses QualifyQualified Education Expenses No Double Benefit Allowed Expenses That Do Not Qualify Who Is an Eligible StudentException. 1040 online Who Can Claim a Dependent's Expenses Figuring the CreditEffect of the Amount of Your Income on the Amount of Your Credit Refundable Part of Credit Claiming the Credit Introduction For 2013, there are two tax credits available to help you offset the costs of higher education by reducing the amount of your income tax. 1040 online They are the American opportunity credit (this chapter) and the lifetime learning credit ( chapter 3 ). 1040 online This chapter explains: Who can claim the American opportunity credit, What expenses qualify for the credit, Who is an eligible student, Who can claim a dependent's expenses, How to figure the credit, How to claim the credit, and When the credit must be repaid. 1040 online What is the tax benefit of the American opportunity credit. 1040 online   For the tax year, you may be able to claim an American opportunity credit of up to $2,500 for qualified education expenses paid for each eligible student. 1040 online   A tax credit reduces the amount of income tax you may have to pay. 1040 online Unlike a deduction, which reduces the amount of income subject to tax, a credit directly reduces the tax itself. 1040 online Forty percent of the American opportunity credit may be refundable. 1040 online This means that if the refundable portion of your credit is more than your tax, the excess will be refunded to you. 1040 online   Your allowable American opportunity credit may be limited by the amount of your income. 1040 online Also, the nonrefundable part of the credit may be limited by the amount of your tax. 1040 online Overview of the American opportunity credit. 1040 online   See Table 2-1, Overview of the American Opportunity Credit , for the basics of this credit. 1040 online The details are discussed in this chapter. 1040 online Can you claim more than one education credit this year. 1040 online   For each student, you can elect for any year only one of the credits. 1040 online For example, if you elect to take the American opportunity credit for a child on your 2013 tax return, you cannot use that same child's qualified education expenses to figure the lifetime learning credit for 2013. 1040 online   If you pay qualified education expenses for more than one student in the same year, you can choose to take the American opportunity credit on a per-student, per-year basis. 1040 online If you pay qualified education expenses for a student (or students) for whom you do not claim the American opportunity credit, you can use the adjusted qualified education expenses of that student (or those students) in figuring your lifetime learning credit. 1040 online This means that, for example, you can claim the American opportunity credit for one student and the lifetime learning credit for another student in the same year. 1040 online Differences between the American opportunity and lifetime learning credits. 1040 online   There are several differences between these two credits. 1040 online For example, you can claim the American opportunity credit based on the same student's expenses for no more than 4 tax years, which includes any tax years you claimed the Hope Scholarship Credit for that student. 1040 online However, there is no limit on the number of years for which you can claim a lifetime learning credit based on the same student's expenses. 1040 online The differences between these credits are shown in Appendix B, Highlights of Education Tax Benefits for Tax Year 2013 near the end of this publication. 1040 online If you claim the American opportunity credit for any student, you can choose between using that student's adjusted qualified education expenses for the American opportunity credit or the lifetime learning credit. 1040 online If you have the choice, the American opportunity credit will always be greater than the lifetime learning credit. 1040 online Table 2-1. 1040 online Overview of the American Opportunity Credit Maximum credit Up to $2,500 credit per eligible student Limit on modified adjusted gross income (MAGI) $180,000 if married filing jointly; $90,000 if single, head of household, or qualifying widow(er) Refundable or nonrefundable 40% of credit may be refundable; the rest is nonrefundable Number of years of postsecondary education Available ONLY if the student had not completed the first 4 years of postsecondary education before 2013 Number of tax years credit available Available ONLY for 4 tax years per eligible student (including any year(s) Hope Scholarship Credit was claimed) Type of program required Student must be pursuing a program leading to a degree or other recognized education credential Number of courses Student must be enrolled at least half time for at least one academic period that begins during the tax year Felony drug conviction As of the end of 2013, the student had not been convicted of a felony for possessing or distributing a controlled substance Qualified expenses Tuition, required enrollment fees, and course materials that the student needs for a course of study whether or not the materials are bought at the educational institution as a condition of enrollment or attendance Payments for academic periods Payments made in 2013 for academic periods beginning in 2013 or beginning in the first 3 months of 2014 Can You Claim the Credit The following rules will help you determine if you are eligible to claim the American opportunity credit on your tax return. 1040 online Who Can Claim the Credit Generally, you can claim the American opportunity credit if all three of the following requirements are met. 1040 online You pay qualified education expenses of higher education. 1040 online You pay the education expenses for an eligible student. 1040 online The eligible student is either yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. 1040 online Student qualifications. 1040 online   Generally, you can take the American opportunity credit for a student only if all of the following four requirements are met. 1040 online As of the beginning of 2013, the student had not completed the first four years of postsecondary education (generally, the freshman through senior years of college), as determined by the eligible educational institution. 1040 online For this purpose, do not include academic credit awarded solely because of the student's performance on proficiency examinations. 1040 online Neither the American opportunity credit nor the Hope Scholarship Credit has been claimed (by you or anyone else) for this student for any four tax years before 2013. 1040 online If the American opportunity credit (and Hope Scholarship Credit) has been claimed for this student for any three or fewer tax years before 2013, this requirement is met. 1040 online For at least one academic period beginning (or treated as beginning) in 2013, the student both: Was enrolled in a program that leads to a degree, certificate, or other recognized educational credential; and Carried at least one-half the normal full-time workload for his or her course of study. 1040 online The standard for what is half of the normal full-time work load is determined by each eligible educational institution. 1040 online However, the standard may not be lower than any of those established by the U. 1040 online S. 1040 online Department of Education under the Higher Education Act of 1965. 1040 online For purposes of whether the student satisfies this third requirement for 2013, treat an academic period beginning in the first three months of 2014 as if it began in 2013 if qualified education expenses for the student were paid in 2013 for that academic period. 1040 online See Prepaid expenses, later. 1040 online As of the end of 2013, the student had not been convicted of a federal or state felony for possessing or distributing a controlled substance. 1040 online Example 1. 1040 online Sharon was eligible for the Hope Scholarship Credit for 2007 and 2008 and for the American opportunity credit for 2010 and 2012. 1040 online Her parents claimed the Hope Scholarship Credit for Sharon on their tax returns for 2007 and 2008 and claimed the American opportunity credit for Sharon on their 2010 tax return. 1040 online Sharon claimed the American opportunity credit on her 2012 tax return. 1040 online The American opportunity credit and Hope Scholarship Credit have been claimed for Sharon for four tax years before 2013. 1040 online Therefore, the American opportunity credit cannot be claimed by Sharon for 2013. 1040 online If Sharon were to file Form 8863 for 2013, she would check “Yes” for Part III, line 23, and would be eligible to claim only the lifetime learning credit. 1040 online Example 2. 1040 online Wilbert was eligible for the American opportunity credit for 2009, 2010, 2011, and 2013. 1040 online His parents claimed the American opportunity credit for Wilbert on their tax returns for 2009, 2010, and 2011. 1040 online No one claimed an American opportunity credit or Hope Scholarship Credit for Wilbert for any other tax year. 1040 online The American opportunity credit and Hope Scholarship Credit have been claimed for Wilbert for only three tax years before 2013. 1040 online Therefore, Wilbert meets the second requirement to be eligible for the American opportunity credit. 1040 online If Wilbert were to file Form 8863 for 2013, he would check “No” for Part III, line 23. 1040 online If Wilbert meets all of the other requirements, he is eligible for the American opportunity credit. 1040 online Example 3. 1040 online Glenda enrolls on a full-time basis in a degree program for the 2014 Spring semester, which begins in January 2014. 1040 online Glenda pays her tuition for the 2014 Spring semester in December 2013. 1040 online Because the tuition Glenda paid in 2013 relates to an academic period that begins in the first 3 months of 2014, her eligibility to claim an American opportunity credit in 2013 is determined as if the 2014 Spring semester began in 2013. 1040 online If the requirements above are not met for any student, you cannot take the American opportunity credit for that student. 1040 online You may be able to take the lifetime learning credit for part or all of that student's qualified education expenses instead. 1040 online Note. 1040 online Qualified education expenses paid by a dependent for whom you claim an exemption, or by a third party for that dependent, are considered paid by you. 1040 online “Qualified education expenses” are defined later under Qualified Education Expenses . 1040 online “Eligible students” are defined later under Who Is an Eligible Student . 1040 online A dependent for whom you claim an exemption is defined later under Who Can Claim a Dependent's Expenses . 1040 online You may find Figure 2-1, Can You Claim the American Opportunity Credit for 2013 , later, helpful in determining if you can claim an American opportunity credit on your tax return. 1040 online This image is too large to be displayed in the current screen. 1040 online Please click the link to view the image. 1040 online Figure 2-1 Can you claim the American opportunity credit for 2012? Who Cannot Claim the Credit You cannot claim the American opportunity credit for 2013 if any of the following apply. 1040 online Your filing status is married filing separately. 1040 online You are listed as a dependent on another person's tax return (such as your parents'). 1040 online See Who Can Claim a Dependent's Expenses , later. 1040 online Your modified adjusted gross income (MAGI) is $90,000 or more ($180,000 or more in the case of a joint return). 1040 online MAGI is explained later under Effect of the Amount of Your Income on the Amount of Your Credit . 1040 online You (or your spouse) were a nonresident alien for any part of 2013 and the nonresident alien did not elect to be treated as a resident alien for tax purposes. 1040 online More information on nonresident aliens can be found in Publication 519, U. 1040 online S. 1040 online Tax Guide for Aliens. 1040 online What Expenses Qualify The American opportunity credit is based on adjusted qualified education expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. 1040 online Generally, the credit is allowed for adjusted qualified education expenses paid in 2013 for an academic period beginning in 2013 or beginning in the first three months of 2014. 1040 online For example, if you paid $1,500 in December 2013 for qualified tuition for the spring 2014 semester beginning January 2014, you can use that $1,500 in figuring your 2013 credit. 1040 online Academic period. 1040 online   An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution. 1040 online In the case of an educational institution that uses credit hours or clock hours and does not have academic terms, each payment period can be treated as an academic period. 1040 online Paid with borrowed funds. 1040 online   You can claim an American opportunity credit for qualified education expenses paid with the proceeds of a loan. 1040 online Use the expenses to figure the American opportunity credit for the year in which the expenses are paid, not the year in which the loan is repaid. 1040 online Treat loan payments sent directly to the educational institution as paid on the date the institution credits the student's account. 1040 online Student withdraws from class(es). 1040 online   You can claim an American opportunity credit for qualified education expenses not refunded when a student withdraws. 1040 online Qualified Education Expenses For purposes of the American opportunity credit, qualified education expenses are tuition and certain related expenses required for enrollment or attendance at an eligible educational institution. 1040 online Eligible educational institution. 1040 online   An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U. 1040 online S. 1040 online Department of Education. 1040 online It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. 1040 online The educational institution should be able to tell you if it is an eligible educational institution. 1040 online   Certain educational institutions located outside the United States also participate in the U. 1040 online S. 1040 online Department of Education's Federal Student Aid (FSA) programs. 1040 online Related expenses. 1040 online   Student-activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. 1040 online   However, expenses for books, supplies, and equipment needed for a course of study are included in qualified education expenses whether or not the materials are purchased from the educational institution. 1040 online Prepaid expenses. 1040 online   Qualified education expenses paid in 2013 for an academic period that begins in the first three months of 2014 can be used in figuring an education credit for 2013 only. 1040 online See Academic period, earlier. 1040 online For example, if you pay $2,000 in December 2013, for qualified tuition for the 2014 winter quarter that begins in January 2014, you can use that $2,000 in figuring an education credit for 2013 only (if you meet all the other requirements). 1040 online    You cannot use any amount you paid in 2012 or 2014 to figure the qualified education expenses you use to figure your 2013 education credit(s). 1040 online   In the following examples, assume that each student is an eligible student at an eligible educational institution. 1040 online Example 1. 1040 online Jefferson is a sophomore in University V's degree program in dentistry. 1040 online This year, in addition to tuition, he is required to pay a fee to the university for the rental of the dental equipment he will use in this program. 1040 online Because the equipment rental is needed for his course of study, Jefferson's equipment rental fee is a qualified expense. 1040 online Example 2. 1040 online Grace and William, both first-year students at College W, are required to have certain books and other reading materials to use in their mandatory first-year classes. 1040 online The college has no policy about how students should obtain these materials, but any student who purchases them from College W's bookstore will receive a bill directly from the college. 1040 online William bought his books from a friend; Grace bought hers at College W's bookstore. 1040 online Both are qualified education expenses for the American opportunity credit. 1040 online Example 3. 1040 online When Kelly enrolled at College X for her freshman year, she had to pay a separate student activity fee in addition to her tuition. 1040 online This activity fee is required of all students, and is used solely to fund on-campus organizations and activities run by students, such as the student newspaper and the student government. 1040 online No portion of the fee covers personal expenses. 1040 online Although labeled as a student activity fee, the fee is required for Kelly's enrollment and attendance at College X and is a qualified expense. 1040 online No Double Benefit Allowed You cannot do any of the following. 1040 online Deduct higher education expenses on your income tax return (as, for example, a business expense) and also claim an American opportunity credit based on those same expenses. 1040 online Claim an American opportunity credit in the same year that you are claiming a tuition and fees deduction for the same student. 1040 online Claim an American opportunity credit for any student and use any of that student's expenses in figuring your lifetime learning credit. 1040 online Figure the tax-free portion of a distribution from a Coverdell education savings account (ESA) or qualified tuition program (QTP) using the same expenses you used to figure the American opportunity credit. 1040 online See Coordination With American Opportunity and Lifetime Learning Credits in chapter 7, Coverdell Education Savings Account, and Coordination With American Opportunity and Lifetime Learning Credits in chapter 8, Qualified Tuition Program. 1040 online Claim a credit based on qualified education expenses paid with tax-free educational assistance, such as a scholarship, grant, or assistance provided by an employer. 1040 online See Adjustments to Qualified Education Expenses, next. 1040 online Adjustments to Qualified Education Expenses For each student, reduce the qualified education expenses paid by or on behalf of that student under the following rules. 1040 online The result is the amount of adjusted qualified education expenses for each student. 1040 online Tax-free educational assistance. 1040 online   For tax-free educational assistance received in 2013, reduce the qualified educational expenses for each academic period by the amount of tax-free educational assistance allocable to that academic period. 1040 online See Academic period, earlier. 1040 online   Some tax-free educational assistance received after 2013 may be treated as a refund of qualified education expenses paid in 2013. 1040 online This tax-free educational assistance is any tax-free educational assistance received by you or anyone else after 2013 for qualified education expenses paid on behalf of a student in 2013 (or attributable to enrollment at an eligible educational institution during 2013). 1040 online   If this tax-free educational assistance is received after 2013 but before you file your 2013 income tax return, see Refunds received after 2013 but before your income tax return is filed, later. 1040 online If this tax-free educational assistance is received after 2013 and after you file your 2013 income tax return, see Refunds received after 2013 and after your income tax return is filed, later. 1040 online   Tax-free educational assistance includes: The tax-free parts of scholarships and fellowships (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Pell grants (see Pell Grants and Other Title IV Need-Based Education Grants in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions). 1040 online Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ), Veterans' educational assistance (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), and Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance. 1040 online Generally, any scholarship or fellowship is treated as tax free. 1040 online However, a scholarship or fellowship is not treated as tax free to the extent the student includes it in gross income (if the student is required to file a tax return for the year the scholarship or fellowship is received) and either of the following is true. 1040 online The scholarship or fellowship (or any part of it) must be applied (by its terms) to expenses (such as room and board) other than qualified education expenses as defined in Qualified education expenses in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions. 1040 online The scholarship or fellowship (or any part of it) may be applied (by its terms) to expenses (such as room and board) other than qualified education expenses as defined in Qualified education expenses in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions. 1040 online You may be able to increase the combined value of an education credit and certain educational assistance if the student includes some or all of the educational assistance in income in the year it is received. 1040 online For examples, see Coordination with Pell grants and other scholarships, later. 1040 online Refunds. 1040 online   A refund of qualified education expenses may reduce adjusted qualified education expenses for the tax year or require repayment (recapture) of a credit claimed in an earlier year. 1040 online Some tax-free educational assistance received after 2013 may be treated as a refund. 1040 online See Tax-free educational assistance, earlier. 1040 online Refunds received in 2013. 1040 online   For each student, figure the adjusted qualified education expenses for 2013 by adding all the qualified education expenses for 2013 and subtracting any refunds of those expenses received from the eligible educational institution during 2013. 1040 online Refunds received after 2013 but before your income tax return is filed. 1040 online   If anyone receives a refund after 2013 of qualified education expenses paid on behalf of a student in 2013 and the refund is paid before you file an income tax return for 2013, the amount of qualified education expenses for 2013 is reduced by the amount of the refund. 1040 online Refunds received after 2013 and after your income tax return is filed. 1040 online   If anyone receives a refund after 2013 of qualified education expenses paid on behalf of a student in 2013 and the refund is paid after you file an income tax return for 2013, you may need to repay some or all of the credit. 1040 online See Credit recapture, next. 1040 online Credit recapture. 1040 online    If any tax-free educational assistance for the qualified education expenses paid in 2013, or any refund of your qualified education expenses paid in 2013, is received after you file your 2013 income tax return, you must recapture (repay) any excess credit. 1040 online You do this by refiguring the amount of your adjusted qualified education expenses for 2013 by reducing the expenses by the amount of the refund or tax-free educational assistance. 1040 online You then refigure your education credit(s) for 2013 and figure the amount by which your 2013 tax liability would have increased if you claimed the refigured credit(s). 1040 online Include that amount as an additional tax for the year the refund or tax-free assistance was received. 1040 online Example. 1040 online   You paid $7,000 tuition and fees in August 2013, and your child began college in September 2013. 1040 online You filed your 2013 tax return on February 17, 2014, and claimed an American opportunity credit of $2,500. 1040 online After you filed your return, you received a refund of $4,000. 1040 online You must refigure your 2013 American opportunity credit using $3,000 of qualified education expenses instead of $7,000. 1040 online The refigured credit is $2,250. 1040 online The increase to your tax liability is also $250. 1040 online Include the difference of $250 as additional tax on your 2014 tax return. 1040 online See the instructions for your 2014 income tax return to determine where to include this tax. 1040 online If you pay qualified education expenses in 2014 for an academic period that begins in the first 3 months of 2014 and you receive tax-free educational assistance, or a refund, as described above, you may choose to reduce your qualified education expenses for 2014 instead of reducing your expenses for 2013. 1040 online Amounts that do not reduce qualified education expenses. 1040 online   Do not reduce qualified education expenses by amounts paid with funds the student receives as: Payment for services, such as wages, A loan, A gift, An inheritance, or A withdrawal from the student's personal savings. 1040 online   Do not reduce the qualified education expenses by any scholarship or fellowship reported as income on the student's tax return in the following situations. 1040 online The use of the money is restricted, by the terms of the scholarship or fellowship, to costs of attendance (such as room and board) other than qualified education expenses as defined in Qualified education expenses in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions. 1040 online The use of the money is not restricted. 1040 online Example 1. 1040 online Joan paid $3,000 for tuition and $5,000 for room and board at University X. 1040 online The university did not require her to pay any fees in addition to her tuition in order to enroll in or attend classes. 1040 online To help pay these costs, she was awarded a $2,000 scholarship and a $4,000 student loan. 1040 online The terms of the scholarship state that it can be used to pay any of Joan's college expenses. 1040 online University X applies the $2,000 scholarship against Joan's $8,000 total bill, and Joan pays the $6,000 balance of her bill from University X with a combination of her student loan and her savings. 1040 online Joan does not report any portion of the scholarship as income on her tax return. 1040 online In figuring the amount of either education credit (American opportunity or lifetime learning), Joan must reduce her qualified education expenses by the amount of the scholarship ($2,000) because she excluded the entire scholarship from her income. 1040 online The student loan is not tax-free educational assistance, so she does not need to reduce her qualified expenses by any part of the loan proceeds. 1040 online Joan is treated as having paid $1,000 in qualified education expenses ($3,000 tuition – $2,000 scholarship). 1040 online Example 2. 1040 online The facts are the same as in Example 1, except that Joan reports her entire scholarship as income on her tax return. 1040 online Because Joan reported the entire $2,000 scholarship in her income, she does not need to reduce her qualified education expenses. 1040 online Joan is treated as having paid $3,000 in qualified education expenses. 1040 online Coordination with Pell grants and other scholarships. 1040 online   In some cases, you may be able to reduce your tax liability by including scholarships in income. 1040 online If you are claiming an education credit for a claimed dependent who received a scholarship, you may be able to reduce your tax liability if the student includes the scholarship in income. 1040 online The scholarship must be one that may (by its terms) be applied to expenses (such as room and board) other than qualified education expenses. 1040 online Example 1—No scholarship. 1040 online Bill Pass, age 28 and unmarried, enrolled full-time in 2013 as a first-year student at a local college to earn a degree in law enforcement. 1040 online This was his first year of postsecondary education. 1040 online During 2013, he paid $5,600 for his qualified education expenses and $4,400 for his room and board for the fall 2013 semester. 1040 online He and the college meet all the requirements for the American opportunity credit. 1040 online Bill's AGI and his MAGI, for purposes of figuring his credit, are $30,000. 1040 online Bill takes the standard deduction of $5,950 and personal exemption of $3,800, reducing his AGI to taxable income of $20,250. 1040 online His income tax liability, before credits, is $2,599 and Bill claims no credits other than the American opportunity credit. 1040 online He figures his American opportunity credit based on qualified education expenses of $4,000, which results in a credit of $2,500 and tax after credits of $99. 1040 online Example 2—Scholarship excluded from income. 1040 online The facts are the same as in Example 1—No scholarship, except that Bill was awarded a $5,600 scholarship. 1040 online Under the terms of his scholarship, it may be used to pay any educational expenses, including room and board. 1040 online If Bill excludes the scholarship from income, he will be deemed (for purposes of computing his education credit) to have used the scholarship to pay for tuition, required fees, and course materials. 1040 online His adjusted qualified education expenses will be zero and he will not have an education credit. 1040 online Therefore, Bill's tax after credits would be $2,599. 1040 online Example 3—Scholarship partially included in income. 1040 online The facts are the same as in Example 2—Scholarship excluded from income. 1040 online If, unlike Example 2, Bill includes $4,000 of the scholarship in income, he will be deemed to have used that amount to pay for room and board. 1040 online The remaining $1,600 of the $5,600 scholarship will reduce his qualified education expenses and his adjusted qualified education expenses will be $4,000. 1040 online Bill's AGI will increase to $34,000, his taxable income will increase to $24,250, and his tax before credits will increase to $3,199. 1040 online Based on his adjusted qualified education expenses of $4,000, Bill would be able to claim an American opportunity tax credit of $2,500 and his tax after credits would be $699. 1040 online Expenses That Do Not Qualify Qualified education expenses do not include amounts paid for: Insurance, Medical expenses (including student health fees), Room and board, Transportation, or Similar personal, living, or family expenses. 1040 online This is true even if the amount must be paid to the institution as a condition of enrollment or attendance. 1040 online Sports, games, hobbies, and noncredit courses. 1040 online   Qualified education expenses generally do not include expenses that relate to any course of instruction or other education that involves sports, games or hobbies, or any noncredit course. 1040 online However, if the course of instruction or other education is part of the student's degree program, these expenses can qualify. 1040 online Comprehensive or bundled fees. 1040 online   Some eligible educational institutions combine all of their fees for an academic period into one amount. 1040 online If you do not receive or do not have access to an allocation showing how much you paid for qualified education expenses and how much you paid for personal expenses, such as those listed earlier, contact the institution. 1040 online The institution is required to make this allocation and provide you with the amount you paid (or were billed) for qualified education expenses on Form 1098-T, Tuition Statement. 1040 online See Figuring the Credit , later, for more information about Form 1098-T. 1040 online Who Is an Eligible Student To claim the American opportunity credit, the student for whom you pay qualified education expenses must be an eligible student. 1040 online This is a student who meets all of the following requirements. 1040 online The student did not have expenses that were used to figure an American opportunity credit in any 4 earlier tax years. 1040 online This includes any tax year(s) in which you claimed the Hope Scholarship Credit for the same student. 1040 online The student had not completed the first 4 years of postsecondary education (generally, the freshman, sophomore, junior, and senior years of college) before 2013. 1040 online For at least one academic period beginning in 2013, the student was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential. 1040 online The student has not been convicted of any federal or state felony for possessing or distributing a controlled substance as of the end of 2013. 1040 online These requirements are also shown in Figure 2-2, Who is an Eligible Student for the American Opportunity Credit , later. 1040 online Completion of first 4 years. 1040 online   A student has completed the first 4 years of postsecondary education if the institution at which the student is enrolled awards the student 4 years of academic credit at that institution for coursework completed by the student before 2013. 1040 online This student generally would not be an eligible student for purposes of the American opportunity credit. 1040 online Exception. 1040 online   Any academic credit awarded solely on the basis of the student's performance on proficiency examinations is disregarded in determining whether the student has completed 4 years of postsecondary education. 1040 online Enrolled at least half-time. 1040 online   A student was enrolled at least half-time if the student was taking at least half the normal full-time work load for his or her course of study. 1040 online   The standard for what is half of the normal full-time work load is determined by each eligible educational institution. 1040 online However, the standard may not be lower than any of those established by the U. 1040 online S. 1040 online Department of Education under the Higher Education Act of 1965. 1040 online Please click here for the text description of the image. 1040 online Figure 2-2 Example 1. 1040 online Mack graduated from high school in June 2012. 1040 online In September, he enrolled in an undergraduate degree program at College U, and attended full-time for both the 2012 fall and 2013 spring semesters. 1040 online For the 2013 fall semester, Mack was enrolled less than half-time. 1040 online Because Mack was enrolled in an undergraduate degree program on at least a half-time basis for at least one academic period that began during 2012 and at least one academic period that began during 2013, he is an eligible student for tax years 2012 and 2013 (including the 2013 fall semester when he enrolled at College U on less than a half-time basis). 1040 online Example 2. 1040 online After taking classes at College V on a part-time basis for a few years, Shelly became a full-time student for the 2013 spring semester. 1040 online College V classified Shelly as a second-semester senior (fourth year) for the 2013 spring semester and as a first-semester graduate student (fifth year) for the 2013 fall semester. 1040 online Because College V did not classify Shelly as having completed the first 4 years of postsecondary education as of the beginning of 2013, Shelly is an eligible student for tax year 2013. 1040 online Therefore, the qualified education expenses paid for the 2013 spring semester and the 2013 fall semester are taken into account in calculating the American opportunity credit for 2013. 1040 online Example 3. 1040 online During the 2012 fall semester, Larry was a high school student who took classes on a half-time basis at College X. 1040 online Larry was not enrolled as part of a degree program at College X because College X only admits students to a degree program if they have a high school diploma or equivalent. 1040 online Because Larry was not enrolled in a degree program at College X during 2012, Larry was not an eligible student for tax year 2012. 1040 online Example 4. 1040 online The facts are the same as in Example 3. 1040 online During the 2013 spring semester, Larry again attended College X but not as part of a degree program. 1040 online Larry graduated from high school in June 2013. 1040 online For the 2013 fall semester, Larry enrolled as a full-time student in College X as part of a degree program, and College X awarded Larry credit for his prior coursework at College X. 1040 online Because Larry was enrolled in a degree program at College X for the 2013 fall term on at least a half-time basis, Larry is an eligible student for all of tax year 2013. 1040 online Therefore, the qualified education expenses paid for classes taken at College X during both the 2013 spring semester (during which Larry was not enrolled in a degree program) and the 2013 fall semester are taken into account in computing any American opportunity credit. 1040 online Example 5. 1040 online Dee graduated from high school in June 2012. 1040 online In January 2013, Dee enrolled in a 1-year postsecondary certificate program on a full-time basis to obtain a certificate as a travel agent. 1040 online Dee completed the program in December 2013, and was awarded a certificate. 1040 online In January 2014, she enrolled in a 1-year postsecondary certificate program on a full-time basis to obtain a certificate as a computer programmer. 1040 online Dee is an eligible student for both tax years 2013 and 2014 because she meets the degree requirement, the work load requirement, and the year of study requirement for those years. 1040 online Who Can Claim a Dependent's Expenses If there are qualified education expenses for your dependent during a tax year, either you or your dependent, but not both of you, can claim an American opportunity credit for your dependent's expenses for that year. 1040 online For you to claim an American opportunity credit for your dependent's expenses, you must also claim an exemption for your dependent. 1040 online You do this by listing your dependent's name and other required information on Form 1040 (or Form 1040A), line 6c. 1040 online IF you. 1040 online . 1040 online . 1040 online THEN only. 1040 online . 1040 online . 1040 online claim an exemption on  your tax return for a  dependent who is an  eligible student you can claim the American opportunity credit based on that dependent's expenses. 1040 online The dependent cannot claim the credit. 1040 online do not claim an exemption on your tax return for a dependent who is an eligible student (even if entitled to the exemption) the dependent can claim the American opportunity credit. 1040 online You cannot claim the credit based on this dependent's expenses. 1040 online Expenses paid by dependent. 1040 online   If you claim an exemption on your tax return for an eligible student who is your dependent, treat any expenses paid (or deemed paid) by your dependent as if you had paid them. 1040 online Include these expenses when figuring the amount of your American opportunity credit. 1040 online    Qualified education expenses paid directly to an eligible educational institution for your dependent under a court-approved divorce decree are treated as paid by your dependent. 1040 online Expenses paid by you. 1040 online   If you claim an exemption for a dependent who is an eligible student, only you can include any expenses you paid when figuring the amount of the American opportunity credit. 1040 online If neither you nor anyone else claims an exemption for the dependent, only the dependent can include any expenses you paid when figuring the American opportunity credit. 1040 online Expenses paid by others. 1040 online   Someone other than you, your spouse, or your dependent (such as a relative or former spouse) may make a payment directly to an eligible educational institution to pay for an eligible student's qualified education expenses. 1040 online In this case, the student is treated as receiving the payment from the other person and, in turn, paying the institution. 1040 online If you claim an exemption on your tax return for the student, you are considered to have paid the expenses. 1040 online Example. 1040 online In 2013, Ms. 1040 online Allen makes a payment directly to an eligible educational institution for her grandson Todd's qualified education expenses. 1040 online For purposes of claiming an American opportunity credit, Todd is treated as receiving the money from his grandmother and, in turn, paying his qualified education expenses himself. 1040 online Unless an exemption for Todd is claimed on someone else's 2013 tax return, only Todd can use the payment to claim an American opportunity credit. 1040 online If anyone, such as Todd's parents, claims an exemption for Todd on his or her 2013 tax return, whoever claims the exemption may be able to use the expenses to claim an American opportunity credit. 1040 online If anyone else claims an exemption for Todd, Todd cannot claim an American opportunity credit. 1040 online Tuition reduction. 1040 online    When an eligible educational institution provides a reduction in tuition to an employee of the institution (or spouse or dependent child of an employee), the amount of the reduction may or may not be taxable. 1040 online If it is taxable, the employee is treated as receiving a payment of that amount and, in turn, paying it to the educational institution on behalf of the student. 1040 online For more information on tuition reductions, see Qualified Tuition Reduction in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions. 1040 online Figuring the Credit The amount of the American opportunity credit (per eligible student) is the sum of: 100% of the first $2,000 of qualified education expenses you paid for the eligible student, and 25% of the next $2,000 of qualified education expenses you paid for that student. 1040 online The maximum amount of American opportunity credit you can claim in 2013 is $2,500 multiplied by the number of eligible students. 1040 online You can claim the full $2,500 for each eligible student for whom you paid at least $4,000 of adjusted qualified education expenses. 1040 online However, the credit may be reduced based on your MAGI. 1040 online See Effect of the Amount of Your Income on the Amount of Your Credit , later. 1040 online Example. 1040 online Jack and Kay Ford are married and file a joint tax return. 1040 online For 2013, they claim an exemption for their dependent daughter on their tax return. 1040 online Their MAGI is $70,000. 1040 online Their daughter is in her junior (third) year of studies at the local university. 1040 online Jack and Kay paid qualified education expenses of $4,300 in 2013. 1040 online Jack and Kay, their daughter, and the local university meet all of the requirements for the American opportunity credit. 1040 online Jack and Kay can claim a $2,500 American opportunity credit in 2013. 1040 online This is 100% of the first $2,000 of qualified education expenses, plus 25% of the next $2,000. 1040 online Form 1098-T. 1040 online   To help you figure your American opportunity credit, the student should receive Form 1098-T, Tuition Statement. 1040 online Generally, an eligible educational institution (such as a college or university) must send Form 1098-T (or acceptable substitute) to each enrolled student by January 31, 2014. 1040 online An institution may choose to report either payments received (box 1), or amounts billed (box 2), for qualified education expenses. 1040 online However, the amounts in boxes 1 and 2 of Form 1098-T might be different than what you paid. 1040 online When figuring the credit, use only the amounts you paid or are deemed to have paid in 2013 for qualified education expenses. 1040 online   In addition, Form 1098-T should give other information for that institution, such as adjustments made for prior years, the amount of scholarships or grants, reimbursements or refunds, and whether the student was enrolled at least half-time or was a graduate student. 1040 online    The eligible educational institution may ask for a completed Form W-9S, Request for Student's or Borrower's Taxpayer Identification Number and Certification, or similar statement to obtain the student's name, address, and taxpayer identification number. 1040 online Effect of the Amount of Your Income on the Amount of Your Credit The amount of your American opportunity credit is phased out (gradually reduced) if your MAGI is between $80,000 and $90,000 ($160,000 and $180,000 if you file a joint return). 1040 online You cannot claim an American opportunity credit if your MAGI is $90,000 or more ($180,000 or more if you file a joint return). 1040 online Modified adjusted gross income (MAGI). 1040 online   For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return. 1040 online MAGI when using Form 1040A. 1040 online   If you file Form 1040A, your MAGI is the AGI on line 22 of that form. 1040 online MAGI when using Form 1040. 1040 online   If you file Form 1040, your MAGI is the AGI on line 38 of that form, modified by adding back any: Foreign earned income exclusion, Foreign housing exclusion, Foreign housing deduction, Exclusion of income by bona fide residents of American Samoa, and Exclusion of income by bona fide residents of Puerto Rico. 1040 online You can use Worksheet 2-1, next, to figure your MAGI. 1040 online    Worksheet 2-1. 1040 online MAGI for the American Opportunity Credit 1. 1040 online Enter your adjusted gross income  (Form 1040, line 38)   1. 1040 online   2. 1040 online Enter your foreign earned income exclusion and/or housing exclusion (Form 2555, line 45, or Form 2555-EZ, line 18)   2. 1040 online       3. 1040 online Enter your foreign housing deduction (Form 2555, line 50)   3. 1040 online       4. 1040 online Enter the amount of income from Puerto Rico you are excluding   4. 1040 online       5. 1040 online Enter the amount of income from American Samoa you are excluding (Form 4563, line 15)   5. 1040 online       6. 1040 online Add the amounts on lines 2, 3, 4, and 5   6. 1040 online   7. 1040 online Add the amounts on lines 1 and 6. 1040 online  This is your modified adjusted  gross income. 1040 online Enter here and  on Form 8863, line 3   7. 1040 online   Phaseout. 1040 online   If your MAGI is within the range of incomes where the credit must be reduced, you will figure your reduced credit using lines 2-7, of Form 8863, Part I. 1040 online The same method is shown in the following example. 1040 online Example. 1040 online You are filing a joint return and your MAGI is $165,000. 1040 online In 2013, you paid $5,000 of qualified education expenses. 1040 online You figure a tentative American opportunity credit of $2,500 (100% of the first $2,000 of qualified education expenses, plus 25% of the next $2,000 of qualified education expenses). 1040 online Because your MAGI is within the range of incomes where the credit must be reduced, you must multiply your tentative credit ($2,500) by a fraction. 1040 online The numerator of the fraction is $180,000 (the upper limit for those filing a joint return) minus your MAGI. 1040 online The denominator is $20,000, the range of incomes for the phaseout ($160,000 to $180,000). 1040 online The result is the amount of your phased out (reduced) American opportunity credit ($1,875). 1040 online      $2,500 × $180,000 − $165,000  $20,000 = $1,875   Refundable Part of Credit Forty percent of the American opportunity credit is refundable for most taxpayers. 1040 online However, if you were under age 24 at the end of 2013 and the conditions listed below apply to you, you cannot claim any part of the American opportunity credit as a refundable credit on your tax return. 1040 online Instead, your allowed credit (figured on Form 8863, Part II) will be used to reduce your tax as a nonrefundable credit only. 1040 online You do not qualify for a refund if items 1 (a, b, or c), 2, and 3 below apply to you. 1040 online You were: Under age 18 at the end of 2013, or Age 18 at the end of 2013 and your earned income (defined below) was less than one-half of your support (defined below), or Over age 18 and under age 24 at the end of 2013 and a full-time student (defined below) and your earned income (defined below) was less than one-half of your support (defined below). 1040 online At least one of your parents was alive at the end of 2013. 1040 online You are filing a return as single, head of household, qualifying widow(er), or married filing separately for 2013. 1040 online Earned income. 1040 online   Earned income includes wages, salaries, professional fees, and other payments received for personal services actually performed. 1040 online Earned income includes the part of any scholarship or fellowship that represents payment for teaching, research, or other services performed by the student that are required as a condition for receiving the scholarship or fellowship. 1040 online Earned income does not include that part of the compensation for personal services rendered to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. 1040 online   If you are a sole proprietor or a partner in a trade or business in which both personal services and capital are material income-producing factors, earned income also includes a reasonable allowance for compensation for personal services, but not more than 30% of your share of the net profits from that trade or business (after subtracting the deduction for one-half of self-employment tax). 1040 online However, if capital is not an income-producing factor and your personal services produced the business income, the 30% limit does not apply. 1040 online Support. 1040 online   Your support includes food, shelter, clothing, medical and dental care, education, and the like. 1040 online Generally, the amount of the item of support will be the amount of expenses incurred by the one furnishing such item. 1040 online If the item of support is in the form of property or lodging, measure the amount of such item of support by its fair market value. 1040 online However, a scholarship received by you is not considered support if you are a full-time student. 1040 online See Publication 501 for details. 1040 online Full-time student. 1040 online   You are a full-time student for 2013 if during any part of any 5 calendar months during the year you were enrolled as a full-time student at an eligible educational institution (defined earlier), or took a full-time, on-farm training course given by such an institution or by a state, county, or local government agency. 1040 online Claiming the Credit You claim the American opportunity credit by completing Form 8863 and submitting it with your Form 1040 or 1040A. 1040 online Enter the nonrefundable part of the credit on Form 1040, line 49, or on Form 1040A, line 31. 1040 online Enter the refundable part of the credit on Form 1040, line 66, or on Form 1040A, line 40. 1040 online A filled-in Form 8863 is shown at the end of this publication. 1040 online Note. 1040 online In Appendix A. 1040 online at the end of this publication, there is an example illustrating the use of Form 8863 when both the American opportunity credit and the lifetime learning credit are claimed on the same tax return. 1040 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Employee Tool & Equipment Plans

This resource page provides information and guidance related to Employee Tool and Equipment Plans, sometimes called Service Technician’s Tool Reimbursement Plans (Tool Plans). Tool Plans are programs that are marketed in various industries including auto dealership and repair facilities and other trades that require employees to provide their own tools. The plans typically purport to receive tax-favored treatment as “accountable plans” under Internal Revenue Code § 62(c) and the accompanying regulations.

Available Guidance and other Information

View recent Department of Justice activity

Revenue Rule 2012-25
Revenue Rule 2012-25 clarifies that an arrangement that recharacterizes taxable wages as nontaxable reimbursements or allowances does not satisfy the business connection requirement of the accountable plan rules under § 62(c) and the applicable regulations.  The ruling includes three examples of programs that do not satisfy the business connection requirement of the accountable plan rules because they impermissibly recharacterize wages.  It also includes an example in which the reimbursement arrangement satisfies the business connection requirement of the accountable plan rules because the employer’s plan only reimburses employees when a deductible business expense has been incurred in connection with performing services for the employer and the reimbursement is not in lieu of wages that the employees would otherwise receive.

ILM 201120021
A reimbursement or other expense allowance arrangement that pays an amount regardless of whether an expense is paid or incurred or reasonably expected to be paid or incurred by the employee in performing services for the employer violates the business connection requirement of an accountable plan. Specifically, such an arrangement violates the business connection’s reimbursement requirement under Treas. Reg. § 1.62-2(d)(3)(i). Accordingly, payments made under the arrangement are treated as made under a nonaccountable plan. Amounts treated as paid under a nonaccountable plan must be included in the employee’s gross income for the taxable year, are subject to withholding and payment of employment taxes, and must be reported as wages or other compensation on the employee’s Form W-2.

Employee Tool & Equipment Plans Alert
The Internal Revenue Service has established a compliance team to address significant concerns with certain Employee Tool and Equipment Plans that purport to receive tax-favored treatment as accountable plans.

IRS Letter Ruling 200930029
An employer's expense reimbursement plan satisfies the business connection, substantiation, and return of excess requirements of an accountable plan.  Payments made under the Plan in accordance with the terms of the plan will be excluded from the Technician’s income and will not be wages subject to the withholding and payment of employment taxes.

Chief Counsel Advice -   ILM 200745018
A legal memorandum that concludes that an employer's tool reimbursement plan does not satisfy the requirements of an accountable plan. 

Revenue Ruling 2005-52
This ruling holds that tool allowances paid to employees are not paid under an accountable plan because the substantiation and return of excess requirements are not met. 

 

Page Last Reviewed or Updated: 13-Feb-2014

The 1040 Online

1040 online 3. 1040 online   Ordinary or Capital Gain or Loss for Business Property Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Section 1231 Gains and LossesNonrecaptured section 1231 losses. 1040 online Depreciation RecaptureSection 1245 Property Section 1250 Property Installment Sales Gifts Transfers at Death Like-Kind Exchanges and Involuntary Conversions Multiple Properties Introduction When you dispose of business property, your taxable gain or loss is usually a section 1231 gain or loss. 1040 online Its treatment as ordinary or capital is determined under rules for section 1231 transactions. 1040 online When you dispose of depreciable property (section 1245 property or section 1250 property) at a gain, you may have to recognize all or part of the gain as ordinary income under the depreciation recapture rules. 1040 online Any remaining gain is a section 1231 gain. 1040 online Topics - This chapter discusses: Section 1231 gains and losses Depreciation recapture Useful Items - You may want to see: Publication 534 Depreciating Property Placed in Service Before 1987 537 Installment Sales 547 Casualties, Disasters and Thefts 551 Basis of Assets 946 How To Depreciate Property Form (and Instructions) 4797 Sales of Business Property See chapter 5 for information about getting publications and forms. 1040 online Section 1231 Gains and Losses Section 1231 gains and losses are the taxable gains and losses from section 1231 transactions (discussed below). 1040 online Their treatment as ordinary or capital depends on whether you have a net gain or a net loss from all your section 1231 transactions. 1040 online If you have a gain from a section 1231 transaction, first determine whether any of the gain is ordinary income under the depreciation recapture rules (explained later). 1040 online Do not take that gain into account as section 1231 gain. 1040 online Section 1231 transactions. 1040 online   The following transactions result in gain or loss subject to section 1231 treatment. 1040 online Sales or exchanges of real property or depreciable personal property. 1040 online This property must be used in a trade or business and held longer than 1 year. 1040 online Generally, property held for the production of rents or royalties is considered to be used in a trade or business. 1040 online Depreciable personal property includes amortizable section 197 intangibles (described in chapter 2 under Other Dispositions). 1040 online Sales or exchanges of leaseholds. 1040 online The leasehold must be used in a trade or business and held longer than 1 year. 1040 online Sales or exchanges of cattle and horses. 1040 online The cattle and horses must be held for draft, breeding, dairy, or sporting purposes and held for 2 years or longer. 1040 online Sales or exchanges of other livestock. 1040 online This livestock does not include poultry. 1040 online It must be held for draft, breeding, dairy, or sporting purposes and held for 1 year or longer. 1040 online Sales or exchanges of unharvested crops. 1040 online The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person and the land must be held longer than 1 year. 1040 online You cannot keep any right or option to directly or indirectly reacquire the land (other than a right customarily incident to a mortgage or other security transaction). 1040 online Growing crops sold with a lease on the land, though sold to the same person in the same transaction, are not included. 1040 online Cutting of timber or disposal of timber, coal, or iron ore. 1040 online The cutting or disposal must be treated as a sale, as described in chapter 2 under Timber and Coal and Iron Ore. 1040 online Condemnations. 1040 online The condemned property must have been held longer than 1 year. 1040 online It must be business property or a capital asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. 1040 online It cannot be property held for personal use. 1040 online Casualties and thefts. 1040 online The casualty or theft must have affected business property, property held for the production of rents and royalties, or investment property (such as notes and bonds). 1040 online You must have held the property longer than 1 year. 1040 online However, if your casualty or theft losses are more than your casualty or theft gains, neither the gains nor the losses are taken into account in the section 1231 computation. 1040 online For more information on casualties and thefts, see Publication 547. 1040 online Property for sale to customers. 1040 online   A sale, exchange, or involuntary conversion of property held mainly for sale to customers is not a section 1231 transaction. 1040 online If you will get back all, or nearly all, of your investment in the property by selling it rather than by using it up in your business, it is property held mainly for sale to customers. 1040 online Example. 1040 online You manufacture and sell steel cable, which you deliver on returnable reels that are depreciable property. 1040 online Customers make deposits on the reels, which you refund if the reels are returned within a year. 1040 online If they are not returned, you keep each deposit as the agreed-upon sales price. 1040 online Most reels are returned within the 1-year period. 1040 online You keep adequate records showing depreciation and other charges to the capitalized cost of the reels. 1040 online Under these conditions, the reels are not property held for sale to customers in the ordinary course of your business. 1040 online Any gain or loss resulting from their not being returned may be capital or ordinary, depending on your section 1231 transactions. 1040 online Copyrights. 1040 online    The sale of a copyright, a literary, musical, or artistic composition, or similar property is not a section 1231 transaction if your personal efforts created the property, or if you acquired the property in a way that entitled you to the basis of the previous owner whose personal efforts created it (for example, if you receive the property as a gift). 1040 online The sale of such property results in ordinary income and generally is reported in Part II of Form 4797. 1040 online Treatment as ordinary or capital. 1040 online   To determine the treatment of section 1231 gains and losses, combine all your section 1231 gains and losses for the year. 1040 online If you have a net section 1231 loss, it is ordinary loss. 1040 online If you have a net section 1231 gain, it is ordinary income up to the amount of your nonrecaptured section 1231 losses from previous years. 1040 online The rest, if any, is long-term capital gain. 1040 online Nonrecaptured section 1231 losses. 1040 online   Your nonrecaptured section 1231 losses are your net section 1231 losses for the previous 5 years that have not been applied against a net section 1231 gain. 1040 online Therefore, if in any of your five preceding tax years you had section 1231 losses, a net gain for the current year from the sale of section 1231 assets is ordinary gain to the extent of your prior losses. 1040 online These losses are applied against your net section 1231 gain beginning with the earliest loss in the 5-year period. 1040 online Example. 1040 online In 2013, Ben has a $2,000 net section 1231 gain. 1040 online To figure how much he has to report as ordinary income and long-term capital gain, he must first determine his section 1231 gains and losses from the previous 5-year period. 1040 online From 2008 through 2012 he had the following section 1231 gains and losses. 1040 online Year Amount 2008 -0- 2009 -0- 2010 ($2,500) 2011 -0- 2012 $1,800 Ben uses this information to figure how to report his net section 1231 gain for 2013 as shown below. 1040 online 1) Net section 1231 gain (2013) $2,000 2) Net section 1231 loss (2010) ($2,500)   3) Net section 1231 gain (2012) 1,800   4) Remaining net section 1231 loss from prior 5 years ($700)   5) Gain treated as  ordinary income $700 6) Gain treated as long-term  capital gain $1,300 Depreciation Recapture If you dispose of depreciable or amortizable property at a gain, you may have to treat all or part of the gain (even if otherwise nontaxable) as ordinary income. 1040 online To figure any gain that must be reported as ordinary income, you must keep permanent records of the facts necessary to figure the depreciation or amortization allowed or allowable on your property. 1040 online This includes the date and manner of acquisition, cost or other basis, depreciation or amortization, and all other adjustments that affect basis. 1040 online On property you acquired in a nontaxable exchange or as a gift, your records also must indicate the following information. 1040 online Whether the adjusted basis was figured using depreciation or amortization you claimed on other property. 1040 online Whether the adjusted basis was figured using depreciation or amortization another person claimed. 1040 online Corporate distributions. 1040 online   For information on property distributed by corporations, see Distributions to Shareholders in Publication 542, Corporations. 1040 online General asset accounts. 1040 online   Different rules apply to dispositions of property you depreciated using a general asset account. 1040 online For information on these rules, see Publication 946. 1040 online Section 1245 Property A gain on the disposition of section 1245 property is treated as ordinary income to the extent of depreciation allowed or allowable on the property. 1040 online See Gain Treated as Ordinary Income, later. 1040 online Any gain recognized that is more than the part that is ordinary income from depreciation is a section 1231 gain. 1040 online See Treatment as ordinary or capital under Section 1231 Gains and Losses, earlier. 1040 online Section 1245 property defined. 1040 online   Section 1245 property includes any property that is or has been subject to an allowance for depreciation or amortization and that is any of the following types of property. 1040 online Personal property (either tangible or intangible). 1040 online Other tangible property (except buildings and their structural components) used as any of the following. 1040 online See Buildings and structural components below. 1040 online An integral part of manufacturing, production, or extraction, or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services. 1040 online A research facility in any of the activities in (a). 1040 online A facility in any of the activities in (a) for the bulk storage of fungible commodities (discussed on the next page). 1040 online That part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following. 1040 online Amortization of certified pollution control facilities. 1040 online The section 179 expense deduction. 1040 online Deduction for clean-fuel vehicles and certain refueling property. 1040 online Deduction for capital costs incurred in complying with Environmental Protection Agency sulfur regulations. 1040 online Deduction for certain qualified refinery property. 1040 online Deduction for qualified energy efficient commercial building property. 1040 online Amortization of railroad grading and tunnel bores, if in effect before the repeal by the Revenue Reconciliation Act of 1990. 1040 online (Repealed by Public Law 99-514, Tax Reform Act of 1986, section 242(a). 1040 online ) Certain expenditures for child care facilities if in effect before repeal by Public Law 101-58, Omnibus Budget Reconciliation Act of 1990, section 11801(a)(13) (except with regards to deductions made prior to November 5, 1990). 1040 online Expenditures to remove architectural and transportation barriers to the handicapped and elderly. 1040 online Deduction for qualified tertiary injectant expenses. 1040 online Certain reforestation expenditures. 1040 online Deduction for election to expense qualified advanced mine safety equipment property. 1040 online Single purpose agricultural (livestock) or horticultural structures. 1040 online Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary product of petroleum. 1040 online Any railroad grading or tunnel bore. 1040 online Buildings and structural components. 1040 online   Section 1245 property does not include buildings and structural components. 1040 online The term building includes a house, barn, warehouse, or garage. 1040 online The term structural component includes walls, floors, windows, doors, central air conditioning systems, light fixtures, etc. 1040 online   Do not treat a structure that is essentially machinery or equipment as a building or structural component. 1040 online Also, do not treat a structure that houses property used as an integral part of an activity as a building or structural component if the structure's use is so closely related to the property's use that the structure can be expected to be replaced when the property it initially houses is replaced. 1040 online   The fact that the structure is specially designed to withstand the stress and other demands of the property and cannot be used economically for other purposes indicates it is closely related to the use of the property it houses. 1040 online Structures such as oil and gas storage tanks, grain storage bins, silos, fractionating towers, blast furnaces, basic oxygen furnaces, coke ovens, brick kilns, and coal tipples are not treated as buildings, but as section 1245 property. 1040 online Facility for bulk storage of fungible commodities. 1040 online   This term includes oil or gas storage tanks and grain storage bins. 1040 online Bulk storage means the storage of a commodity in a large mass before it is used. 1040 online For example, if a facility is used to store oranges that have been sorted and boxed, it is not used for bulk storage. 1040 online To be fungible, a commodity must be such that one part may be used in place of another. 1040 online   Stored materials that vary in composition, size, and weight are not fungible. 1040 online Materials are not fungible if one part cannot be used in place of another part and the materials cannot be estimated and replaced by simple reference to weight, measure, and number. 1040 online For example, the storage of different grades and forms of aluminum scrap is not storage of fungible commodities. 1040 online Gain Treated as Ordinary Income The gain treated as ordinary income on the sale, exchange, or involuntary conversion of section 1245 property, including a sale and leaseback transaction, is the lesser of the following amounts. 1040 online The depreciation and amortization allowed or allowable on the property. 1040 online The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property). 1040 online A limit on this amount for gain on like-kind exchanges and involuntary conversions is explained later. 1040 online For any other disposition of section 1245 property, ordinary income is the lesser of (1) earlier or the amount by which its fair market value is more than its adjusted basis. 1040 online See Gifts and Transfers at Death, later. 1040 online Use Part III of Form 4797 to figure the ordinary income part of the gain. 1040 online Depreciation taken on other property or taken by other taxpayers. 1040 online   Depreciation and amortization include the amounts you claimed on the section 1245 property as well as the following depreciation and amortization amounts. 1040 online Amounts you claimed on property you exchanged for, or converted to, your section 1245 property in a like-kind exchange or involuntary conversion. 1040 online Amounts a previous owner of the section 1245 property claimed if your basis is determined with reference to that person's adjusted basis (for example, the donor's depreciation deductions on property you received as a gift). 1040 online Depreciation and amortization. 1040 online   Depreciation and amortization that must be recaptured as ordinary income include (but are not limited to) the following items. 1040 online Ordinary depreciation deductions. 1040 online Any special depreciation allowance you claimed. 1040 online Amortization deductions for all the following costs. 1040 online Acquiring a lease. 1040 online Lessee improvements. 1040 online Certified pollution control facilities. 1040 online Certain reforestation expenses. 1040 online Section 197 intangibles. 1040 online Childcare facility expenses made before 1982, if in effect before the repeal of IRC 188. 1040 online Franchises, trademarks, and trade names acquired before August 11, 1993. 1040 online The section 179 deduction. 1040 online Deductions for all the following costs. 1040 online Removing barriers to the disabled and the elderly. 1040 online Tertiary injectant expenses. 1040 online Depreciable clean-fuel vehicles and refueling property (minus the amount of any recaptured deduction). 1040 online Environmental cleanup costs. 1040 online Certain reforestation expenses. 1040 online Qualified disaster expenses. 1040 online Any basis reduction for the investment credit (minus any basis increase for credit recapture). 1040 online Any basis reduction for the qualified electric vehicle credit (minus any basis increase for credit recapture). 1040 online Example. 1040 online You file your returns on a calendar year basis. 1040 online In February 2011, you bought and placed in service for 100% use in your business a light-duty truck (5-year property) that cost $10,000. 1040 online You used the half-year convention and your MACRS deductions for the truck were $2,000 in 2011 and $3,200 in 2012. 1040 online You did not take the section 179 deduction. 1040 online You sold the truck in May 2013 for $7,000. 1040 online The MACRS deduction in 2013, the year of sale, is $960 (½ of $1,920). 1040 online Figure the gain treated as ordinary income as follows. 1040 online 1) Amount realized $7,000 2) Cost (February 2011) $10,000   3) Depreciation allowed or allowable (MACRS deductions: $2,000 + $3,200 + $960) 6,160   4) Adjusted basis (subtract line 3 from line 2) $3,840 5) Gain realized (subtract line 4 from line 1) $3,160 6) Gain treated as ordinary income (lesser of line 3 or line 5) $3,160 Depreciation on other tangible property. 1040 online   You must take into account depreciation during periods when the property was not used as an integral part of an activity or did not constitute a research or storage facility, as described earlier under Section 1245 property. 1040 online   For example, if depreciation deductions taken on certain storage facilities amounted to $10,000, of which $6,000 is from the periods before their use in a prescribed business activity, you must use the entire $10,000 in determining ordinary income from depreciation. 1040 online Depreciation allowed or allowable. 1040 online   The greater of the depreciation allowed or allowable is generally the amount to use in figuring the part of gain to report as ordinary income. 1040 online However, if in prior years, you have consistently taken proper deductions under one method, the amount allowed for your prior years will not be increased even though a greater amount would have been allowed under another proper method. 1040 online If you did not take any deduction at all for depreciation, your adjustments to basis for depreciation allowable are figured by using the straight line method. 1040 online   This treatment applies only when figuring what part of gain is treated as ordinary income under the rules for section 1245 depreciation recapture. 1040 online Multiple asset accounts. 1040 online   In figuring ordinary income from depreciation, you can treat any number of units of section 1245 property in a single depreciation account as one item if the total ordinary income from depreciation figured by using this method is not less than it would be if depreciation on each unit were figured separately. 1040 online Example. 1040 online In one transaction you sold 50 machines, 25 trucks, and certain other property that is not section 1245 property. 1040 online All of the depreciation was recorded in a single depreciation account. 1040 online After dividing the total received among the various assets sold, you figured that each unit of section 1245 property was sold at a gain. 1040 online You can figure the ordinary income from depreciation as if the 50 machines and 25 trucks were one item. 1040 online However, if five of the trucks had been sold at a loss, only the 50 machines and 20 of the trucks could be treated as one item in determining the ordinary income from depreciation. 1040 online Normal retirement. 1040 online   The normal retirement of section 1245 property in multiple asset accounts does not require recognition of gain as ordinary income from depreciation if your method of accounting for asset retirements does not require recognition of that gain. 1040 online Section 1250 Property Gain on the disposition of section 1250 property is treated as ordinary income to the extent of additional depreciation allowed or allowable on the property. 1040 online To determine the additional depreciation on section 1250 property, see Additional Depreciation, below. 1040 online Section 1250 property defined. 1040 online   This includes all real property that is subject to an allowance for depreciation and that is not and never has been section 1245 property. 1040 online It includes a leasehold of land or section 1250 property subject to an allowance for depreciation. 1040 online A fee simple interest in land is not included because it is not depreciable. 1040 online   If your section 1250 property becomes section 1245 property because you change its use, you can never again treat it as section 1250 property. 1040 online Additional Depreciation If you hold section 1250 property longer than 1 year, the additional depreciation is the actual depreciation adjustments that are more than the depreciation figured using the straight line method. 1040 online For a list of items treated as depreciation adjustments, see Depreciation and amortization under Gain Treated as Ordinary Income, earlier. 1040 online For the treatment of unrecaptured section 1250 gain, see Capital Gains Tax Rate, later. 1040 online If you hold section 1250 property for 1 year or less, all the depreciation is additional depreciation. 1040 online You will not have additional depreciation if any of the following conditions apply to the property disposed of. 1040 online You figured depreciation for the property using the straight line method or any other method that does not result in depreciation that is more than the amount figured by the straight line method; you held the property longer than 1 year; and, if the property was qualified property, you made a timely election not to claim any special depreciation allowance. 1040 online In addition, if the property was in a renewal community, you must not have elected to claim a commercial revitalization deduction for property placed in service before January 1, 2010. 1040 online The property was residential low-income rental property you held for 162/3 years or longer. 1040 online For low-income rental housing on which the special 60-month depreciation for rehabilitation expenses was allowed, the 162/3 years start when the rehabilitated property is placed in service. 1040 online You chose the alternate ACRS method for the property, which was a type of 15-, 18-, or 19-year real property covered by the section 1250 rules. 1040 online The property was residential rental property or nonresidential real property placed in service after 1986 (or after July 31, 1986, if the choice to use MACRS was made); you held it longer than 1 year; and, if the property was qualified property, you made a timely election not to claim any special depreciation allowance. 1040 online These properties are depreciated using the straight line method. 1040 online In addition, if the property was in a renewal community, you must not have elected to claim a commercial revitalization deduction. 1040 online Depreciation taken by other taxpayers or on other property. 1040 online   Additional depreciation includes all depreciation adjustments to the basis of section 1250 property whether allowed to you or another person (as carryover basis property). 1040 online Example. 1040 online Larry Johnson gives his son section 1250 property on which he took $2,000 in depreciation deductions, of which $500 is additional depreciation. 1040 online Immediately after the gift, the son's adjusted basis in the property is the same as his father's and reflects the $500 additional depreciation. 1040 online On January 1 of the next year, after taking depreciation deductions of $1,000 on the property, of which $200 is additional depreciation, the son sells the property. 1040 online At the time of sale, the additional depreciation is $700 ($500 allowed the father plus $200 allowed the son). 1040 online Depreciation allowed or allowable. 1040 online   The greater of depreciation allowed or allowable (to any person who held the property if the depreciation was used in figuring its adjusted basis in your hands) generally is the amount to use in figuring the part of the gain to be reported as ordinary income. 1040 online If you can show that the deduction allowed for any tax year was less than the amount allowable, the lesser figure will be the depreciation adjustment for figuring additional depreciation. 1040 online Retired or demolished property. 1040 online   The adjustments reflected in adjusted basis generally do not include deductions for depreciation on retired or demolished parts of section 1250 property unless these deductions are reflected in the basis of replacement property that is section 1250 property. 1040 online Example. 1040 online A wing of your building is totally destroyed by fire. 1040 online The depreciation adjustments figured in the adjusted basis of the building after the wing is destroyed do not include any deductions for depreciation on the destroyed wing unless it is replaced and the adjustments for depreciation on it are reflected in the basis of the replacement property. 1040 online Figuring straight line depreciation. 1040 online   The useful life and salvage value you would have used to figure straight line depreciation are the same as those used under the depreciation method you actually used. 1040 online If you did not use a useful life under the depreciation method actually used (such as with the units-of-production method) or if you did not take salvage value into account (such as with the declining balance method), the useful life or salvage value for figuring what would have been the straight line depreciation is the useful life and salvage value you would have used under the straight line method. 1040 online   Salvage value and useful life are not used for the ACRS method of depreciation. 1040 online Figure straight line depreciation for ACRS real property by using its 15-, 18-, or 19-year recovery period as the property's useful life. 1040 online   The straight line method is applied without any basis reduction for the investment credit. 1040 online Property held by lessee. 1040 online   If a lessee makes a leasehold improvement, the lease period for figuring what would have been the straight line depreciation adjustments includes all renewal periods. 1040 online This inclusion of the renewal periods cannot extend the lease period taken into account to a period that is longer than the remaining useful life of the improvement. 1040 online The same rule applies to the cost of acquiring a lease. 1040 online   The term renewal period means any period for which the lease may be renewed, extended, or continued under an option exercisable by the lessee. 1040 online However, the inclusion of renewal periods cannot extend the lease by more than two-thirds of the period that was the basis on which the actual depreciation adjustments were allowed. 1040 online Applicable Percentage The applicable percentage used to figure the ordinary income because of additional depreciation depends on whether the real property you disposed of is nonresidential real property, residential rental property, or low-income housing. 1040 online The percentages for these types of real property are as follows. 1040 online Nonresidential real property. 1040 online   For real property that is not residential rental property, the applicable percentage for periods after 1969 is 100%. 1040 online For periods before 1970, the percentage is zero and no ordinary income because of additional depreciation before 1970 will result from its disposition. 1040 online Residential rental property. 1040 online   For residential rental property (80% or more of the gross income is from dwelling units) other than low-income housing, the applicable percentage for periods after 1975 is 100%. 1040 online The percentage for periods before 1976 is zero. 1040 online Therefore, no ordinary income because of additional depreciation before 1976 will result from a disposition of residential rental property. 1040 online Low-income housing. 1040 online    Low-income housing includes all the following types of residential rental property. 1040 online Federally assisted housing projects if the mortgage is insured under section 221(d)(3) or 236 of the National Housing Act or housing financed or assisted by direct loan or tax abatement under similar provisions of state or local laws. 1040 online Low-income rental housing for which a depreciation deduction for rehabilitation expenses was allowed. 1040 online Low-income rental housing held for occupancy by families or individuals eligible to receive subsidies under section 8 of the United States Housing Act of 1937, as amended, or under provisions of state or local laws that authorize similar subsidies for low-income families. 1040 online Housing financed or assisted by direct loan or insured under Title V of the Housing Act of 1949. 1040 online   The applicable percentage for low-income housing is 100% minus 1% for each full month the property was held over 100 full months. 1040 online If you have held low-income housing at least 16 years and 8 months, the percentage is zero and no ordinary income will result from its disposition. 1040 online Foreclosure. 1040 online   If low-income housing is disposed of because of foreclosure or similar proceedings, the monthly applicable percentage reduction is figured as if you disposed of the property on the starting date of the proceedings. 1040 online Example. 1040 online On June 1, 2001, you acquired low-income housing property. 1040 online On April 3, 2012 (130 months after the property was acquired), foreclosure proceedings were started on the property and on December 3, 2013 (150 months after the property was acquired), the property was disposed of as a result of the foreclosure proceedings. 1040 online The property qualifies for a reduced applicable percentage because it was held more than 100 full months. 1040 online The applicable percentage reduction is 30% (130 months minus 100 months) rather than 50% (150 months minus 100 months) because it does not apply after April 3, 2012, the starting date of the foreclosure proceedings. 1040 online Therefore, 70% of the additional depreciation is treated as ordinary income. 1040 online Holding period. 1040 online   The holding period used to figure the applicable percentage for low-income housing generally starts on the day after you acquired it. 1040 online For example, if you bought low-income housing on January 1, 1997, the holding period starts on January 2, 1997. 1040 online If you sold it on January 2, 2013, the holding period is exactly 192 full months. 1040 online The applicable percentage for additional depreciation is 8%, or 100% minus 1% for each full month the property was held over 100 full months. 1040 online Holding period for constructed, reconstructed, or erected property. 1040 online   The holding period used to figure the applicable percentage for low-income housing you constructed, reconstructed, or erected starts on the first day of the month it is placed in service in a trade or business, in an activity for the production of income, or in a personal activity. 1040 online Property acquired by gift or received in a tax-free transfer. 1040 online   For low-income housing you acquired by gift or in a tax-free transfer the basis of which is figured by reference to the basis in the hands of the transferor, the holding period for the applicable percentage includes the holding period of the transferor. 1040 online   If the adjusted basis of the property in your hands just after acquiring it is more than its adjusted basis to the transferor just before transferring it, the holding period of the difference is figured as if it were a separate improvement. 1040 online See Low-Income Housing With Two or More Elements, next. 1040 online Low-Income Housing With Two or More Elements If you dispose of low-income housing property that has two or more separate elements, the applicable percentage used to figure ordinary income because of additional depreciation may be different for each element. 1040 online The gain to be reported as ordinary income is the sum of the ordinary income figured for each element. 1040 online The following are the types of separate elements. 1040 online A separate improvement (defined below). 1040 online The basic section 1250 property plus improvements not qualifying as separate improvements. 1040 online The units placed in service at different times before all the section 1250 property is finished. 1040 online For example, this happens when a taxpayer builds an apartment building of 100 units and places 30 units in service (available for renting) on January 4, 2011, 50 on July 18, 2011, and the remaining 20 on January 18, 2012. 1040 online As a result, the apartment house consists of three separate elements. 1040 online The 36-month test for separate improvements. 1040 online   A separate improvement is any improvement (qualifying under The 1-year test, below) added to the capital account of the property, but only if the total of the improvements during the 36-month period ending on the last day of any tax year is more than the greatest of the following amounts. 1040 online Twenty-five percent of the adjusted basis of the property at the start of the first day of the 36-month period, or the first day of the holding period of the property, whichever is later. 1040 online Ten percent of the unadjusted basis (adjusted basis plus depreciation and amortization adjustments) of the property at the start of the period determined in (1). 1040 online $5,000. 1040 online The 1-year test. 1040 online   An addition to the capital account for any tax year (including a short tax year) is treated as an improvement only if the sum of all additions for the year is more than the greater of $2,000 or 1% of the unadjusted basis of the property. 1040 online The unadjusted basis is figured as of the start of that tax year or the holding period of the property, whichever is later. 1040 online In applying the 36-month test, improvements in any one of the 3 years are omitted entirely if the total improvements in that year do not qualify under the 1-year test. 1040 online Example. 1040 online The unadjusted basis of a calendar year taxpayer's property was $300,000 on January 1 of this year. 1040 online During the year, the taxpayer made improvements A, B, and C, which cost $1,000, $600, and $700, respectively. 1040 online The sum of the improvements, $2,300, is less than 1% of the unadjusted basis ($3,000), so the improvements do not satisfy the 1-year test and are not treated as improvements for the 36-month test. 1040 online However, if improvement C had cost $1,500, the sum of these improvements would have been $3,100. 1040 online Then, it would be necessary to apply the 36-month test to figure if the improvements must be treated as separate improvements. 1040 online Addition to the capital account. 1040 online   Any addition to the capital account made after the initial acquisition or completion of the property by you or any person who held the property during a period included in your holding period is to be considered when figuring the total amount of separate improvements. 1040 online   The addition to the capital account of depreciable real property is the gross addition not reduced by amounts attributable to replaced property. 1040 online For example, if a roof with an adjusted basis of $20,000 is replaced by a new roof costing $50,000, the improvement is the gross addition to the account, $50,000, and not the net addition of $30,000. 1040 online The $20,000 adjusted basis of the old roof is no longer reflected in the basis of the property. 1040 online The status of an addition to the capital account is not affected by whether it is treated as a separate property for determining depreciation deductions. 1040 online   Whether an expense is treated as an addition to the capital account may depend on the final disposition of the entire property. 1040 online If the expense item property and the basic property are sold in two separate transactions, the entire section 1250 property is treated as consisting of two distinct properties. 1040 online Unadjusted basis. 1040 online   In figuring the unadjusted basis as of a certain date, include the actual cost of all previous additions to the capital account plus those that did not qualify as separate improvements. 1040 online However, the cost of components retired before that date is not included in the unadjusted basis. 1040 online Holding period. 1040 online   Use the following guidelines for figuring the applicable percentage for property with two or more elements. 1040 online The holding period of a separate element placed in service before the entire section 1250 property is finished starts on the first day of the month that the separate element is placed in service. 1040 online The holding period for each separate improvement qualifying as a separate element starts on the day after the improvement is acquired or, for improvements constructed, reconstructed, or erected, the first day of the month that the improvement is placed in service. 1040 online The holding period for each improvement not qualifying as a separate element takes the holding period of the basic property. 1040 online   If an improvement by itself does not meet the 1-year test (greater of $2,000 or 1% of the unadjusted basis), but it does qualify as a separate improvement that is a separate element (when grouped with other improvements made during the tax year), determine the start of its holding period as follows. 1040 online Use the first day of a calendar month that is closest to the middle of the tax year. 1040 online If there are two first days of a month that are equally close to the middle of the year, use the earlier date. 1040 online Figuring ordinary income attributable to each separate element. 1040 online   Figure ordinary income attributable to each separate element as follows. 1040 online   Step 1. 1040 online Divide the element's additional depreciation after 1975 by the sum of all the elements' additional depreciation after 1975 to determine the percentage used in Step 2. 1040 online   Step 2. 1040 online Multiply the percentage figured in Step 1 by the lesser of the additional depreciation after 1975 for the entire property or the gain from disposition of the entire property (the difference between the fair market value or amount realized and the adjusted basis). 1040 online   Step 3. 1040 online Multiply the result in Step 2 by the applicable percentage for the element. 1040 online Example. 1040 online You sold at a gain of $25,000 low-income housing property subject to the ordinary income rules of section 1250. 1040 online The property consisted of four elements (W, X, Y, and Z). 1040 online Step 1. 1040 online The additional depreciation for each element is: W-$12,000; X-None; Y-$6,000; and Z-$6,000. 1040 online The sum of the additional depreciation for all the elements is $24,000. 1040 online Step 2. 1040 online The depreciation deducted on element X was $4,000 less than it would have been under the straight line method. 1040 online Additional depreciation on the property as a whole is $20,000 ($24,000 − $4,000). 1040 online $20,000 is lower than the $25,000 gain on the sale, so $20,000 is used in Step 2. 1040 online Step 3. 1040 online The applicable percentages to be used in Step 3 for the elements are: W-68%; X-85%; Y-92%; and Z-100%. 1040 online From these facts, the sum of the ordinary income for each element is figured as follows. 1040 online   Step 1 Step 2 Step 3 Ordinary Income W . 1040 online 50 $10,000 68% $ 6,800 X -0- -0- 85% -0- Y . 1040 online 25 5,000 92% 4,600 Z . 1040 online 25 5,000 100% 5,000 Sum of ordinary income of separate elements $16,400 Gain Treated as Ordinary Income To find what part of the gain from the disposition of section 1250 property is treated as ordinary income, follow these steps. 1040 online In a sale, exchange, or involuntary conversion of the property, figure the amount realized that is more than the adjusted basis of the property. 1040 online In any other disposition of the property, figure the fair market value that is more than the adjusted basis. 1040 online Figure the additional depreciation for the periods after 1975. 1040 online Multiply the lesser of (1) or (2) by the applicable percentage, discussed earlier under Applicable Percentage. 1040 online Stop here if this is residential rental property or if (2) is equal to or more than (1). 1040 online This is the gain treated as ordinary income because of additional depreciation. 1040 online Subtract (2) from (1). 1040 online Figure the additional depreciation for periods after 1969 but before 1976. 1040 online Add the lesser of (4) or (5) to the result in (3). 1040 online This is the gain treated as ordinary income because of additional depreciation. 1040 online A limit on the amount treated as ordinary income for gain on like-kind exchanges and involuntary conversions is explained later. 1040 online Use Form 4797, Part III, to figure the ordinary income part of the gain. 1040 online Corporations. 1040 online   Corporations, other than S corporations, must recognize an additional amount as ordinary income on the sale or other disposition of section 1250 property. 1040 online The additional amount treated as ordinary income is 20% of the excess of the amount that would have been ordinary income if the property were section 1245 property over the amount treated as ordinary income under section 1250. 1040 online Report this additional ordinary income on Form 4797, Part III, line 26 (f). 1040 online Installment Sales If you report the sale of property under the installment method, any depreciation recapture under section 1245 or 1250 is taxable as ordinary income in the year of sale. 1040 online This applies even if no payments are received in that year. 1040 online If the gain is more than the depreciation recapture income, report the rest of the gain using the rules of the installment method. 1040 online For this purpose, include the recapture income in your installment sale basis to determine your gross profit on the installment sale. 1040 online If you dispose of more than one asset in a single transaction, you must figure the gain on each asset separately so that it may be properly reported. 1040 online To do this, allocate the selling price and the payments you receive in the year of sale to each asset. 1040 online Report any depreciation recapture income in the year of sale before using the installment method for any remaining gain. 1040 online For a detailed discussion of installment sales, see Publication 537. 1040 online Gifts If you make a gift of depreciable personal property or real property, you do not have to report income on the transaction. 1040 online However, if the person who receives it (donee) sells or otherwise disposes of the property in a disposition subject to recapture, the donee must take into account the depreciation you deducted in figuring the gain to be reported as ordinary income. 1040 online For low-income housing, the donee must take into account the donor's holding period to figure the applicable percentage. 1040 online See Applicable Percentage and its discussion Holding period under Section 1250 Property, earlier. 1040 online Part gift and part sale or exchange. 1040 online   If you transfer depreciable personal property or real property for less than its fair market value in a transaction considered to be partly a gift and partly a sale or exchange and you have a gain because the amount realized is more than your adjusted basis, you must report ordinary income (up to the amount of gain) to recapture depreciation. 1040 online If the depreciation (additional depreciation, if section 1250 property) is more than the gain, the balance is carried over to the transferee to be taken into account on any later disposition of the property. 1040 online However, see Bargain sale to charity, later. 1040 online Example. 1040 online You transferred depreciable personal property to your son for $20,000. 1040 online When transferred, the property had an adjusted basis to you of $10,000 and a fair market value of $40,000. 1040 online You took depreciation of $30,000. 1040 online You are considered to have made a gift of $20,000, the difference between the $40,000 fair market value and the $20,000 sale price to your son. 1040 online You have a taxable gain on the transfer of $10,000 ($20,000 sale price minus $10,000 adjusted basis) that must be reported as ordinary income from depreciation. 1040 online You report $10,000 of your $30,000 depreciation as ordinary income on the transfer of the property, so the remaining $20,000 depreciation is carried over to your son for him to take into account on any later disposition of the property. 1040 online Gift to charitable organization. 1040 online   If you give property to a charitable organization, you figure your deduction for your charitable contribution by reducing the fair market value of the property by the ordinary income and short-term capital gain that would have resulted had you sold the property at its fair market value at the time of the contribution. 1040 online Thus, your deduction for depreciable real or personal property given to a charitable organization does not include the potential ordinary gain from depreciation. 1040 online   You also may have to reduce the fair market value of the contributed property by the long-term capital gain (including any section 1231 gain) that would have resulted had the property been sold. 1040 online For more information, see Giving Property That Has Increased in Value in Publication 526. 1040 online Bargain sale to charity. 1040 online   If you transfer section 1245 or section 1250 property to a charitable organization for less than its fair market value and a deduction for the contribution part of the transfer is allowable, your ordinary income from depreciation is figured under different rules. 1040 online First, figure the ordinary income as if you had sold the property at its fair market value. 1040 online Then, allocate that amount between the sale and the contribution parts of the transfer in the same proportion that you allocated your adjusted basis in the property to figure your gain. 1040 online See Bargain Sale under Gain or Loss From Sales and Exchanges in chapter 1. 1040 online Report as ordinary income the lesser of the ordinary income allocated to the sale or your gain from the sale. 1040 online Example. 1040 online You sold section 1245 property in a bargain sale to a charitable organization and are allowed a deduction for your contribution. 1040 online Your gain on the sale was $1,200, figured by allocating 20% of your adjusted basis in the property to the part sold. 1040 online If you had sold the property at its fair market value, your ordinary income would have been $5,000. 1040 online Your ordinary income is $1,000 ($5,000 × 20%) and your section 1231 gain is $200 ($1,200 – $1,000). 1040 online Transfers at Death When a taxpayer dies, no gain is reported on depreciable personal property or real property transferred to his or her estate or beneficiary. 1040 online For information on the tax liability of a decedent, see Publication 559, Survivors, Executors, and Administrators. 1040 online However, if the decedent disposed of the property while alive and, because of his or her method of accounting or for any other reason, the gain from the disposition is reportable by the estate or beneficiary, it must be reported in the same way the decedent would have had to report it if he or she were still alive. 1040 online Ordinary income due to depreciation must be reported on a transfer from an executor, administrator, or trustee to an heir, beneficiary, or other individual if the transfer is a sale or exchange on which gain is realized. 1040 online Example 1. 1040 online Janet Smith owned depreciable property that, upon her death, was inherited by her son. 1040 online No ordinary income from depreciation is reportable on the transfer, even though the value used for estate tax purposes is more than the adjusted basis of the property to Janet when she died. 1040 online However, if she sold the property before her death and realized a gain and if, because of her method of accounting, the proceeds from the sale are income in respect of a decedent reportable by her son, he must report ordinary income from depreciation. 1040 online Example 2. 1040 online The trustee of a trust created by a will transfers depreciable property to a beneficiary in satisfaction of a specific bequest of $10,000. 1040 online If the property had a value of $9,000 at the date used for estate tax valuation purposes, the $1,000 increase in value to the date of distribution is a gain realized by the trust. 1040 online Ordinary income from depreciation must be reported by the trust on the transfer. 1040 online Like-Kind Exchanges and Involuntary Conversions A like-kind exchange of your depreciable property or an involuntary conversion of the property into similar or related property will not result in your having to report ordinary income from depreciation unless money or property other than like-kind, similar, or related property is also received in the transaction. 1040 online For information on like-kind exchanges and involuntary conversions, see chapter 1. 1040 online Depreciable personal property. 1040 online   If you have a gain from either a like-kind exchange or an involuntary conversion of your depreciable personal property, the amount to be reported as ordinary income from depreciation is the amount figured under the rules explained earlier (see Section 1245 Property), limited to the sum of the following amounts. 1040 online The gain that must be included in income under the rules for like-kind exchanges or involuntary conversions. 1040 online The fair market value of the like-kind, similar, or related property other than depreciable personal property acquired in the transaction. 1040 online Example 1. 1040 online You bought a new machine for $4,300 cash plus your old machine for which you were allowed a $1,360 trade-in. 1040 online The old machine cost you $5,000 two years ago. 1040 online You took depreciation deductions of $3,950. 1040 online Even though you deducted depreciation of $3,950, the $310 gain ($1,360 trade-in allowance minus $1,050 adjusted basis) is not reported because it is postponed under the rules for like-kind exchanges and you received only depreciable personal property in the exchange. 1040 online Example 2. 1040 online You bought office machinery for $1,500 two years ago and deducted $780 depreciation. 1040 online This year a fire destroyed the machinery and you received $1,200 from your fire insurance, realizing a gain of $480 ($1,200 − $720 adjusted basis). 1040 online You choose to postpone reporting gain, but replacement machinery cost you only $1,000. 1040 online Your taxable gain under the rules for involuntary conversions is limited to the remaining $200 insurance payment. 1040 online All your replacement property is depreciable personal property, so your ordinary income from depreciation is limited to $200. 1040 online Example 3. 1040 online A fire destroyed office machinery you bought for $116,000. 1040 online The depreciation deductions were $91,640 and the machinery had an adjusted basis of $24,360. 1040 online You received a $117,000 insurance payment, realizing a gain of $92,640. 1040 online You immediately spent $105,000 of the insurance payment for replacement machinery and $9,000 for stock that qualifies as replacement property and you choose to postpone reporting the gain. 1040 online $114,000 of the $117,000 insurance payment was used to buy replacement property, so the gain that must be included in income under the rules for involuntary conversions is the part not spent, or $3,000. 1040 online The part of the insurance payment ($9,000) used to buy the nondepreciable property (the stock) also must be included in figuring the gain from depreciation. 1040 online The amount you must report as ordinary income on the transaction is $12,000, figured as follows. 1040 online 1) Gain realized on the transaction ($92,640) limited to depreciation ($91,640) $91,640 2) Gain includible in income (amount not spent) 3,000     Plus: fair market value of property other than depreciable personal property (the stock) 9,000 12,000 Amount reportable as ordinary income (lesser of (1) or (2)) $12,000   If, instead of buying $9,000 in stock, you bought $9,000 worth of depreciable personal property similar or related in use to the destroyed property, you would only report $3,000 as ordinary income. 1040 online Depreciable real property. 1040 online   If you have a gain from either a like-kind exchange or involuntary conversion of your depreciable real property, ordinary income from additional depreciation is figured under the rules explained earlier (see Section 1250 Property), limited to the greater of the following amounts. 1040 online The gain that must be reported under the rules for like-kind exchanges or involuntary conversions plus the fair market value of stock bought as replacement property in acquiring control of a corporation. 1040 online The gain you would have had to report as ordinary income from additional depreciation had the transaction been a cash sale minus the cost (or fair market value in an exchange) of the depreciable real property acquired. 1040 online   The ordinary income not reported for the year of the disposition is carried over to the depreciable real property acquired in the like-kind exchange or involuntary conversion as additional depreciation from the property disposed of. 1040 online Further, to figure the applicable percentage of additional depreciation to be treated as ordinary income, the holding period starts over for the new property. 1040 online Example. 1040 online The state paid you $116,000 when it condemned your depreciable real property for public use. 1040 online You bought other real property similar in use to the property condemned for $110,000 ($15,000 for depreciable real property and $95,000 for land). 1040 online You also bought stock for $5,000 to get control of a corporation owning property similar in use to the property condemned. 1040 online You choose to postpone reporting the gain. 1040 online If the transaction had been a sale for cash only, under the rules described earlier, $20,000 would have been reportable as ordinary income because of additional depreciation. 1040 online The ordinary income to be reported is $6,000, which is the greater of the following amounts. 1040 online The gain that must be reported under the rules for involuntary conversions, $1,000 ($116,000 − $115,000) plus the fair market value of stock bought as qualified replacement property, $5,000, for a total of $6,000. 1040 online The gain you would have had to report as ordinary income from additional depreciation ($20,000) had this transaction been a cash sale minus the cost of the depreciable real property bought ($15,000), or $5,000. 1040 online   The ordinary income not reported, $14,000 ($20,000 − $6,000), is carried over to the depreciable real property you bought as additional depreciation. 1040 online Basis of property acquired. 1040 online   If the ordinary income you have to report because of additional depreciation is limited, the total basis of the property you acquired is its fair market value (its cost, if bought to replace property involuntarily converted into money) minus the gain postponed. 1040 online   If you acquired more than one item of property, allocate the total basis among the properties in proportion to their fair market value (their cost, in an involuntary conversion into money). 1040 online However, if you acquired both depreciable real property and other property, allocate the total basis as follows. 1040 online Subtract the ordinary income because of additional depreciation that you do not have to report from the fair market value (or cost) of the depreciable real property acquired. 1040 online Add the fair market value (or cost) of the other property acquired to the result in (1). 1040 online Divide the result in (1) by the result in (2). 1040 online Multiply the total basis by the result in (3). 1040 online This is the basis of the depreciable real property acquired. 1040 online If you acquired more than one item of depreciable real property, allocate this basis amount among the properties in proportion to their fair market value (or cost). 1040 online Subtract the result in (4) from the total basis. 1040 online This is the basis of the other property acquired. 1040 online If you acquired more than one item of other property, allocate this basis amount among the properties in proportion to their fair market value (or cost). 1040 online Example 1. 1040 online In 1988, low-income housing property that you acquired and placed in service in 1983 was destroyed by fire and you received a $90,000 insurance payment. 1040 online The property's adjusted basis was $38,400, with additional depreciation of $14,932. 1040 online On December 1, 1988, you used the insurance payment to acquire and place in service replacement low-income housing property. 1040 online Your realized gain from the involuntary conversion was $51,600 ($90,000 − $38,400). 1040 online You chose to postpone reporting the gain under the involuntary conversion rules. 1040 online Under the rules for depreciation recapture on real property, the ordinary gain was $14,932, but you did not have to report any of it because of the limit for involuntary conversions. 1040 online The basis of the replacement low-income housing property was its $90,000 cost minus the $51,600 gain you postponed, or $38,400. 1040 online The $14,932 ordinary gain you did not report is treated as additional depreciation on the replacement property. 1040 online If you sold the property in 2013, your holding period for figuring the applicable percentage of additional depreciation to report as ordinary income will have begun December 2, 1988, the day after you acquired the property. 1040 online Example 2. 1040 online John Adams received a $90,000 fire insurance payment for depreciable real property (office building) with an adjusted basis of $30,000. 1040 online He uses the whole payment to buy property similar in use, spending $42,000 for depreciable real property and $48,000 for land. 1040 online He chooses to postpone reporting the $60,000 gain realized on the involuntary conversion. 1040 online Of this gain, $10,000 is ordinary income from additional depreciation but is not reported because of the limit for involuntary conversions of depreciable real property. 1040 online The basis of the property bought is $30,000 ($90,000 − $60,000), allocated as follows. 1040 online The $42,000 cost of depreciable real property minus $10,000 ordinary income not reported is $32,000. 1040 online The $48,000 cost of other property (land) plus the $32,000 figured in (1) is $80,000. 1040 online The $32,000 figured in (1) divided by the $80,000 figured in (2) is 0. 1040 online 4. 1040 online The basis of the depreciable real property is $12,000. 1040 online This is the $30,000 total basis multiplied by the 0. 1040 online 4 figured in (3). 1040 online The basis of the other property (land) is $18,000. 1040 online This is the $30,000 total basis minus the $12,000 figured in (4). 1040 online The ordinary income that is not reported ($10,000) is carried over as additional depreciation to the depreciable real property that was bought and may be taxed as ordinary income on a later disposition. 1040 online Multiple Properties If you dispose of depreciable property and other property in one transaction and realize a gain, you must allocate the amount realized between the two types of property in proportion to their respective fair market values to figure the part of your gain to be reported as ordinary income from depreciation. 1040 online Different rules may apply to the allocation of the amount realized on the sale of a business that includes a group of assets. 1040 online See chapter 2. 1040 online In general, if a buyer and seller have adverse interests as to the allocation of the amount realized between the depreciable property and other property, any arm's length agreement between them will establish the allocation. 1040 online In the absence of an agreement, the allocation should be made by taking into account the appropriate facts and circumstances. 1040 online These include, but are not limited to, a comparison between the depreciable property and all the other property being disposed of in the transaction. 1040 online The comparison should take into account all the following facts and circumstances. 1040 online The original cost and reproduction cost of construction, erection, or production. 1040 online The remaining economic useful life. 1040 online The state of obsolescence. 1040 online The anticipated expenditures required to maintain, renovate, or modernize the properties. 1040 online Like-kind exchanges and involuntary conversions. 1040 online   If you dispose of and acquire depreciable personal property and other property (other than depreciable real property) in a like-kind exchange or involuntary conversion, the amount realized is allocated in the following way. 1040 online The amount allocated to the depreciable personal property disposed of is treated as consisting of, first, the fair market value of the depreciable personal property acquired and, second (to the extent of any remaining balance), the fair market value of the other property acquired. 1040 online The amount allocated to the other property disposed of is treated as consisting of the fair market value of all property acquired that has not already been taken into account. 1040 online   If you dispose of and acquire depreciable real property and other property in a like-kind exchange or involuntary conversion, the amount realized is allocated in the following way. 1040 online The amount allocated to each of the three types of property (depreciable real property, depreciable personal property, or other property) disposed of is treated as consisting of, first, the fair market value of that type of property acquired and, second (to the extent of any remaining balance), any excess fair market value of the other types of property acquired. 1040 online If the excess fair market value is more than the remaining balance of the amount realized and is from both of the other two types of property, you can apply the unallocated amount in any manner you choose. 1040 online Example. 1040 online A fire destroyed your property with a total fair market value of $50,000. 1040 online It consisted of machinery worth $30,000 and nondepreciable property worth $20,000. 1040 online You received an insurance payment of $40,000 and immediately used it with $10,000 of your own funds (for a total of $50,000) to buy machinery with a fair market value of $15,000 and nondepreciable property with a fair market value of $35,000. 1040 online The adjusted basis of the destroyed machinery was $5,000 and your depreciation on it was $35,000. 1040 online You choose to postpone reporting your gain from the involuntary conversion. 1040 online You must report $9,000 as ordinary income from depreciation arising from this transaction, figured as follows. 1040 online The $40,000 insurance payment must be allocated between the machinery and the other property destroyed in proportion to the fair market value of each. 1040 online The amount allocated to the machinery is 30,000/50,000 × $40,000, or $24,000. 1040 online The amount allocated to the other property is 20,000/50,000 × $40,000, or $16,000. 1040 online Your gain on the involuntary conversion of the machinery is $24,000 minus $5,000 adjusted basis, or $19,000. 1040 online The $24,000 allocated to the machinery disposed of is treated as consisting of the $15,000 fair market value of the replacement machinery bought and $9,000 of the fair market value of other property bought in the transaction. 1040 online All $16,000 allocated to the other property disposed of is treated as consisting of the fair market value of the other property that was bought. 1040 online Your potential ordinary income from depreciation is $19,000, the gain on the machinery, because it is less than the $35,000 depreciation. 1040 online However, the amount you must report as ordinary income is limited to the $9,000 included in the amount realized for the machinery that represents the fair market value of property other than the depreciable property you bought. 1040 online Prev  Up  Next   Home   More Online Publications