The distinction between “capital” gain or loss and “ordinary” income or loss is fundamental to our current income tax system. “Capital gain”—”gain from the sale or exchange of a capital asset”—is taxed more favorably to individuals than “ordinary income,” while “capital losses” are of less tax benefit than “ordinary losses” (in part because, but for very limited exceptions, ordinary income cannot be offset with a capital loss). Real property used in a trade or business is excluded from the definition of “capital asset,” but gain from such property’s sale or exchange is nevertheless generally “treated as” capital gain.
Internal Revenue Code §1234A governs the character of gain or loss attributable to the cancellation, lapse, expiration, or other termination of a right or obligation with respect to “property which is (or on acquisition would be) a capital asset.” That provision has recently given rise to some surprising and unfavorable results.
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