What type of loss does Red Company initially have due to the involuntary conversion of machinery?

Involuntary conversions occur when a taxpayer's property is destroyed or taken for public use, leading to a loss. The loss is determined by the price paid for the property minus the amount received in compensation or insurance proceeds.

In this case, the correct answer reflects a casualty loss. A casualty loss is recognized when a taxpayer suffers a loss due to an unexpected event such as a natural disaster or theft. The loss amount is typically calculated based on the decrease in value of the property. If Red Company incurs a loss of $4,200 from the conversion of machinery, it qualifies as a casualty loss because it arises from a specific event that led to the involuntary conversion of the asset.

The reference to the machinery—an asset that may involve various depreciation rules—does not negate the eligibility for a casualty loss. Other losses involving § 1231 or § 1245 recapture pertain to events where property is sold, exchanged, or otherwise disposed of for benefits beyond basic compensation for destruction. Since this scenario emphasizes the loss from conversion rather than a sale or general transfer, it aligns with the definition of a casualty loss.