Tax Law- What is a capital asset?

Question

The definition of a capital asset in the Code is extremely unhelpful. Can anyone give me a layman's definition of a capital asset? What is a non-capital asset? Can you give me some examples of a non-capital asset?

I'm studying for my tax exam-- I'm just trying to get a general idea of what types of assets fit into each category. Can you give a couple specific examples for capital v. noncapital?

Answer 1

I don't know what it says in the Code, but the way I was taught, was it falls into three categories:

1) Investment use property - basically everything that falls into this category is Capital. Stocks, bonds, land, collectables...anything that is not depreciable. So, a building you own that you rent out isn't Capital property because you depreciate it. The land upon which it sits is Capital.

2) Personal use property - basically everything in this category is Capital. You don't depreciate anything you use for personal purposes. So, it would be your home, car, vacation home, jewelry, coin collection, motorcycle, bicycle.

3) Business use property - The only thing in this category that is Capital is intangible non-real property such as goodwill or a franchise...also any net section 1231 gain from a sale (1).

Anything you would enter on Schedule D is a capital asset and vice versa. Things that are NOT capital include inventory (a.k.a stock-in-trade) like unsold cars on a dealers lot, items on store shelves, etc., anything that is depreciable, consumable supplies used in a business (paper, pens, etc.), any real property used in a business (notice land is Capital if it is used for investment, but not for business).

(1) Let's talk about section 1231. Let's say you have a piece of equipment that you are depreciating...like a refrigerator. Let's say you paid $1,000 and depreciated it down to $200 before selling it, and you held it for more than one year. If you:

a) sold it for $200 to $1000, the "gain" is all recaptured depreciation (section 1245 gain) and would be reported on form 4797 Part III "long-term". It would be taxed as ordinary income.

b) sold for less than $200, the loss is ordinary loss (section 1231) and is reported on form 4797 Part I "long-term". Even though the loss is considered section 1231, it is not considered Capital.

c) sold for more than $1000, the gain up to $1000 is just like answer (a), and the gain above that is section 1231 gain taxed as Long-term Capital Gain on schedule D. This 1231 gain is the only "Capital" property allowed for a depreciable asset.

Answer 2

The way the Code defines it, a capital asset is anything other than the exceptions listed. For your test, you will need to understand what the exceptions are and whether the asset described on your test question falls into one of the exceptions.

Answer 3

Describe the asset you're interested in.

Most business-use property is non-capital, though sometimes it can get capital gain treatment. Nondepreciable property such as corporate stock or land held for investment are typical capital assets.

Answer 4

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