Section 1231 Property: Definition, Examples, and Tax Treatment (2022)

What Is Section 1231 Gain?

Section 1231 property is a type of property, defined by section1231of the U.S. Internal Revenue Code. Section 1231 propertyis real or depreciable business property held for more than one year.

A section 1231 gain from the sale of a property is taxed at the lower capital gains tax rate versus the rate for ordinary income. If the sold property was held for less than one year, the 1231 gain does not apply.

Examples of section 1231 properties include buildings, machinery, land, timber, and other natural resources, unharvested crops, cattle, livestock, and leaseholds that are at least one year old. However, section 1231 property does not include poultry and certain other animals, patents, inventions, and inventory–such as goods held for sale to customers.

Key Takeaways

  • Section 1231 property is a type of property, defined by section1231of the U.S. Internal Revenue Code.
  • Section 1231 propertyis real or depreciable business property held for more than one year.
  • A section 1231 gain from the sale of a property is taxed at the lower capital gains tax rate versus the rate for ordinary income.
(Video) Section 1231 Explained in Under 10 Minutes

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Section 1231 Property

Understanding Section 1231 Gain

Broadly speaking, if gains on property fitting Section 1231's definition are more than the adjusted basis and amount of depreciation, the income iscounted as capital gains, and as a result, it is taxed at a lower rate than ordinary income.

However, when losses are recorded on section 1231 property whereby the loss is classified as an ordinary loss, it's 100% deductible against their income. Ordinarily, if income was qualified as capital gains, so would any losses, which can only be deductible up to $3,000 for the tax year, and any losses in excess of that figure would be arrived at in the following year.The section 1231 law makes it, so taxpayers and business owners get the best of both worlds.

(Video) Section 1231 Assets | Income Tax Course | Tax Cuts and Jobs Act | CPA exam Regulation | TCJA 2017

Types of Section 1231 Transactions

The following are considered 1231 transactions under IRS regulations:

  • Casualties and thefts – If you have held a property for more than one year and it is adversely affected by theft or casualty (loss or damage from an unexpected or rare event).
  • Condemnations – If a property was held for more than a year, and held as a capital asset relating to trade or business.
  • Sale or exchange of real property, personal property that is depreciable – If the property was held for more than a year and was used in trade or in a business (usually generating revenue via rent or royalties).
  • Leaseholds either sold or exchanged – If held for a year and used in trade or business.
  • Cattle and horses sold or exchanged – If held for two years and used for dairy, draft, breeding, or sporting purposes.
  • Unharvested crops sold or exchanged –If held for one year and then sold, exchanged, or converted involuntarily and then not reacquired through any means.
  • Disposal or Cutting of timber, coal, or iron ore – If treated as a sale.

Section 1231 property is related to section 1245 property and section 1250 property. Section 1231 defines the tax treatment that the gains and losses of property fitting the definitions of sections 1245 and 1250 on form 4797.

Section 1231 vs. Section 1245 Property

Section 1245 property cannot include buildings or structural components unless the structure is designed specifically to handle the stresses and demands of a specific use, and can’t be used for any other use, in which case it can be considered closely related to the property it houses. Section 1245 property is any asset that is depreciable or subject to amortization and meets any of the following descriptions in Publication 544 (2018), Sales and Other Dispositions of Assets:

  • Personal property - Generally defined as property other than real estate
  • Other tangible property - This would include machinery or facility that play a key role in production, extraction, or furnishing of services, as well as certain research facilities, or a facility for the bulk storage of fungible commodities. This does not include buildings that are included as storage for equipment but would conceivably include a facility that stored goods temporarily before they were packaged and moved.
  • Single-purpose structures built for the sole purpose of agricultural or horticultural use - This does not include a barn but would include silos or grain storage bins.
  • Facilities used to store and distribute petroleum or primary products of petroleum except for buildings and those buildings structural components.

Tax Treatment on Section 1245 Property Gains

If the sale of section 1245 property is less than the depreciation or amortization on the property, or if the gains on the disposition of the property are less than the original cost, gains are recorded as normal income and are taxed as such. If the gain on the disposition of the section 1245 property is greater than that original cost, then those gains are taxed as capital gains.

If the section 1245 property was acquired through a like-kind exchange, the amounts you claimed on the property you used in the exchange are included in the depreciation or amortization amount, as would be the amounts a previous owner of section 1245 property claimed if the adjusted basis was used as a reference to your own.

Section 1250 Property

The IRS defines section 1250 property as all real property, such as land and buildings, that are subject to allowance for depreciation, as well as a leasehold of land or section 1250 property.

(Video) Sections 1231, 1245, & 1250

Tax Treatment on Section 1250 Property Gains

Much like with section 1245 property, gains on section 1250 property qualify as ordinary income if they are less than or equal to the amount the property has depreciated, and the gains exceed the depreciation then the income is treated as capital gains.During the year of the sale, depreciation recapture is taxable as ordinary income if the sale of the property is executed in an installment method.

While section 1231 was introduced in the 1954 IRS Code, the content of the tax code referring to gains received upon deposition of depreciable and real property was introduced in 1939 in section 117(j).

Section 1231 Gains and Capital Gains

The IRS handles the taxation of a section 1231 gain as a "regular" capital gain when there is income, but not when there is a loss. Capital gains tax is a tax on the profit when you sell something that’s increased in value. It’s the gain you make that’s taxed, not the amount of money you receive.

Example ofSection 1231 Property

Let's say a building is bought at $2 million and then has another $2 million put into it in the form of refurbishment (updating A/C units, windows, and a new roof) with an amortization rate of 50% over 10 years. So, let's say then that 10 years after the building had $2 million put into it, itis sold at a price of $6 million. The recordedgains on that sale would be $4 million, not $2 because the cost of refurbishment would be capitalized on the books. That $4 million sale would be taxed as capital gains because the property was sold for more than the amount that it had depreciated.

(Video) What is Section 1231 Property or 1231 Assets

Where Does Section 1231 Gain Get Reported?

IRS Form 4797, Sales of Business Property,is used to report the section 1231 gains on a sold property.

What Is the Difference Between 1231 and 1250 Property?

Section 1231 applies to all depreciable business assets owned for more than one year, while section 1250 (and also 1245) provides guidance on how different asset categories are taxed when sold at a gain or loss. All property used in a trade or business is considered section 1231 property and, for taxation purposes, either section 1245 or 1250 applies, depending on the property’s characteristics.

What Is the Difference Between 1231 Gain and Capital Gain?

When it comes to taxation there is no difference under certain circumstances. if gains on property fitting Section 1231's definition are more than the adjusted basis and amount of depreciation, the income is counted as capital gains, and as a result, it is taxed at a lower rate than ordinary income.

(Video) Section 1231, 1245, & 1250 Gains & Losses - Income Taxes 2018 2019

The Bottom Line

Section 1231 gains are gains from depreciable property and real property used in a business and held for more than one year. Such gains are considered "tax-friendly" as they have traditionally enjoyed a favored status in the tax code. Net Section 1231 gains for the taxable year are treated as long-term capital gains, but a net Section 1231 loss is considered an ordinary loss.

FAQs

What is an example of 1231 property? ›

Examples of section 1231 properties include buildings, machinery, land, timber, and other natural resources, unharvested crops, cattle, livestock, and leaseholds that are at least one year old.

How are net section 1231 gains and losses treated for tax purposes? ›

The net section 1231 gain for any taxable year shall be treated as ordinary income to the extent such gain does not exceed the non-recaptured net section 1231 losses. the portion of such losses taken into account under paragraph (1) for such preceding taxable years.

Which of the following assets qualifies as a section 1231 asset? ›

For a quick refresher, Section 1231 assets are defined as depreciable business property that has been held for more than a year. These assets can be buildings, machinery, land, timber and other natural resources, unharvested crops, cattle, livestock and leaseholds that are at least a year old.

How is Section 1231 calculated? ›

Calculating section 1231 gains involves determining the current tax basis, which you can arrive at by subtracting the amount the property has depreciated from the cost of the original purchase. Then, subtract the tax basis from the resale price to calculate the section 1231 gain.

Which type of property is not considered Section 1231 property? ›

A sale, exchange, or involuntary conversion of property held mainly for sale to customers or used in the manufacture of products to be sold to customers, is not section 1231 property. Inventory held for use in the operations of a business, such as office and shipping supplies are not section 1231 property.

What is the difference between a capital asset and a 1231 asset? ›

Section 1231 does not reclassify property as a capital asset. Instead, it allows the taxpayer to treat net gains on 1231 property as capital gains, but to treat net losses on such property as ordinary losses.

Why is the treatment of section 1231 gains and losses for individual taxpayers more advantageous? ›

The tax advantages gained under section 1231 apply to both gains and losses. Under this special rule, the IRS taxes section 123 gains at the lower capital gains tax rate rather than the higher ordinary income tax rate. This provides a tax break when businesses sell big-ticket items like buildings or cars.

What rate is section 1231 gain taxed at? ›

However, when an individual has sold a Section 1250 asset at a gain and included it with other Section 1231 gains, is taxed at a maximum rate of 25 percent for an amount equal to the lesser of: recognized gain on the sale of the Section 1250 asset, or. the straight-line accumulated depreciation on the Section 1250 ...

Is section 1231 gain capital or ordinary? ›

Understanding Section 1231 Gains

A taxpayer's net Section 1231 gains for the taxable year are treated as long term capital gains, but a net Section 1231 loss is considered an ordinary loss.

What is subject to special rules under section 1231? ›

Special rules under IRC Section 1231 apply to the sale of real or depreciable property held for more than one year and used in a trade or business (referred to as Section 1231 property). Under these rules: Net losses from Section 1231 property are treated as ordinary losses.

When a Section 1231 asset is sold the gain can be only classified as an ordinary gain? ›

2021-10-29 When assets are sold, the tax treatment of any gain or loss depends on how the asset was used. If the asset was a capital asset, then the gain or loss is a capital gain or loss. If the asset was held for resale, then the gain or loss is classified as ordinary income.

What is the difference between 1250 and 1231 property? ›

The sale of Section 1250 property at a loss produces a Section 1231 loss and is deducted as ordinary loss which can reduce ordinary income. The Section 1250 recapture provisions only apply to gains, not losses.

Where does section 1231 gain reported? ›

Section 1231 gains are given long term capital gain treatment and subsequently reported on Schedule D.

Is 1231 property subject to depreciation recapture? ›

When section 1231 property is sold at a gain, the amount in excess of the property's basis and depreciation receives capital gains treatment, which generally means lower tax rates, while the amount attributed to depreciation recapture is treated as ordinary income.

Which of the following is considered property used in a trade or business under section 1231? ›

Definition of Section 1231 Property - Assets eligible for the preferential treatment under Section 1231 include: Depreciable or real property used in a trade or business that is held for more than one year. Timber, coal, and domestic iron ore.

What is the difference between 1231 and 1245 property? ›

It is helpful to think of Section 1231 as a "categorization provision,"-- in that it identifies a type of asset -- and Sections 1245 and 1250 as "recharacterization provisions" -- as they ultimately dictate whether gain is taxed at ordinary income rates, capital gain rates, or some other rate in between.

How are section 1231 losses treated? ›

Treatment of Sec.

If you have a net Sec. 1231 loss, it's an ordinary loss. Not only can such a loss be used to offset your ordinary income, but you're also not subject to the normal $3,000 limit per year limitation on how much of the loss can be used against ordinary income.

Which of the following statements is correct regarding the sale of section 1231 assets? ›

Which of the following statements is correct regarding the sale of Section 1231 assets? Net Section 1231 losses are fully deductible against all types of income.

What is a net section 1231 gain or loss? ›

A net Section 1231 gain is realized when the taxpayer's total Section 1231 gains exceed total Section 1231 losses. A net Section 1231 gain is treated as ordinary income recapture to the extent that there are unrecaptured Section 1231 losses remaining from the taxpayer's last five years of Section 1231 netting.

Is 1231 gain passive income? ›

For the gain from the sale of a Section 1231 asset to be excluded from the NIIT, it needs to be generated by a business that is not passive. The IRS defines passive business activities as those in which the taxpayer does not actively participate on a regular, continuous, and substantial basis.

What is a 1245 asset How is it related to a 1231 asset? ›

Section 1245 is a way for the IRS to recapture allowable or allowed depreciation or amortization the taxpayer has taken on 1231 property. This recapture occurs at the time a business sells certain tangible or intangible personal property at a gain.

How does 1231 recapture work? ›

Any gain recognized that is more than the part that is ordinary income from depreciation is a section 1231 gain. In other words, you subtract recaptured depreciation from the current year's gain and the amount that remains is a section 1231 gain.

What is the difference between 1231 and 1245 property? ›

Section 1231 applies to all depreciable business assets owned for more than one year, while sections 1245 and 1250 provide guidance on how different asset categories are taxed when sold at a gain or loss.

Is a rental home 1231 property? ›

Commercial real estate, residential investment properties, buildings and land used for business are all section 1231 properties. Equipment, automobiles and furniture may also fall under section 1231, as can unharvested crops.

What are examples of 1245 property? ›

A few examples of 1245 property are: furniture, fixtures & equipment, carpet, decorative light fixtures, electrical costs that serve telephones and data outlets.

What are examples of 1250 property? ›

The most common examples of section 1250 property are commercial buildings (MACRS 39-year real property) and residential rental property (MACRS 27.5-year residential rental property).

Is section 1231 gain ordinary or capital? ›

Understanding Section 1231 Gains

A taxpayer's net Section 1231 gains for the taxable year are treated as long term capital gains, but a net Section 1231 loss is considered an ordinary loss.

What is the tax rate on Section 1231 gain? ›

However, when an individual has sold a Section 1250 asset at a gain and included it with other Section 1231 gains, is taxed at a maximum rate of 25 percent for an amount equal to the lesser of: recognized gain on the sale of the Section 1250 asset, or. the straight-line accumulated depreciation on the Section 1250 ...

Is 1231 loss ordinary or capital? ›

1231 loss, it's an ordinary loss. Not only can such a loss be used to offset your ordinary income, but you're also not subject to the normal $3,000 limit per year limitation on how much of the loss can be used against ordinary income.

Which of the following regarding section 1231 is true? ›

Section 1231 applies to the sale or exchange of business properties but not to any involuntary conversions.

Where does section 1231 gain reported? ›

Section 1231 gains are given long term capital gain treatment and subsequently reported on Schedule D.

Is 1231 gain passive income? ›

For the gain from the sale of a Section 1231 asset to be excluded from the NIIT, it needs to be generated by a business that is not passive. The IRS defines passive business activities as those in which the taxpayer does not actively participate on a regular, continuous, and substantial basis.

What is a 1231 transaction? ›

Section 1231 is a section of the Internal Revenue Code that governs the tax treatment of real and depreciable assets used in a trade or business and held more than one year. A section 1231 transaction includes property held more than one year on the date of sale or exchange.

What is the difference between Section 1245 and 1250 property? ›

If a section 1245 asset is sold at a loss, the loss is treated as a Section 1231 loss and is deducted as an ordinary loss which can reduce ordinary income. Section 1250 property consists of real property that is not Section 1245 property (as defined above), generally buildings and their structural components.

Are Intangible Assets 1231 property? ›

Self-created intangibles, however; are not Section 1231 assets because they are neither amortizable nor depreciable and not real estate.

What are examples of property? ›

Key Takeaways. Property is any item that a person or a business has legal title over. Property can be tangible items, such as houses, cars, or appliances, or it can refer to intangible items that carry the promise of future worth, such as stock and bond certificates.

Does 1231 gain include 1250 gain? ›

The IRC allows you to offset Section 1250 gains with Section 1231 capital losses, provided both assets were held for more than a year so both your loss and your gain are long term. This means you can subtract your loss from the amount of your gain, and pay tax on the difference.

What type of property is land 4797? ›

Form 4797 is used to report gains made from the sale or exchange of business property, including property used to generate rental income, and property used for industrial, agricultural, or extractive resources.

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