Section 1231

Question 1

Section 1231

Answer 1

Definition - Assets used in a business and held for over 12 months (long- term). Section 1231 assets include realty and depreciable property but exclude capital assets, inventory, accounts receivable, copyrights, and government publications.

 1. Section 1231 applies to the sale or exchange of “Section 1231” assets
 2. Section 1231 also applies to all involuntary conversions of business assets.

Question 2

Section 1245 Recapture (depreciable property other than buildings)

Answer 2

a. All depreciation is subject to the recapture rules, regardless of the method used, to the extent of recognized gain.
b. Section 1245 recapture is the lesser of gain recognized or all depreciation taken.
c. Section 1245 treats gain on property disposed of as ordinary income to the extent depreciation was taken. No recapture is required if the property is disposed of at a loss. The taxpayer simply treats the gain amount, up to the amount depreciated, as ordinary income instead of long-term capital gain. Gain in excess of the recaptured amount is treated as Section 1231 gain.
d. If the property is disposed of at a recognized loss, the loss is a Section 1231 loss. Thus, no depreciation is recaptured.
e. Depreciation includes cost recovery, depreciation, Section 179 immediate expensing, first-year bonus depreciation, and amortization of Section 197 intangibles.

Question 3

Section 1250 Recapture (applies to buildings: depreciable real property)

Answer 3

Applies only when an accelerated depreciation method is used and property is sold at a gain. Note that accelerated depreciation is not available for real property placed into service in 1987 or later.
Also does not apply when property is disposed of at a loss.
Section 1250 of the Internal Revenue Code treats gain in an amount equal to the excess of accelerated depreciation taken over straight-line depreciation as ordinary income. This excess is known as additional depreciation.
The lower of additional depreciation or recognized gain is ordinary income. The excess gain, if any, is Section 1231 gain.
For buildings owned by individuals, “unrecaptured Section 1250 gains” recharacterizes gains on realty as eligible for a special (25%) tax rate to the extent of accumulated straight-line depreciation.

Question 4

General exceptions to Sections 1245 and 1250

Answer 4

Gifts (recapture potential carries over to donee).
Death (recapture potential is eliminated; does not carry over to one who inherits the property).
Charitable transfers (potential recapture reduces charitable contribution deduction).
Certain tax-free exchanges (i.e., like-kind and involuntary conversion). (Recapture potential carries over to the property received in the exchange.) Realized gain is recognized to the extent of boot received (like-kind exchange) or amount not reinvested (involuntary conversion).

Question 5

Shortcuts

Answer 5

Recapture does not recharacterize losses.
Gains on the sale of land held long-term in a business are always 1231 gains since land is not depreciable.
Gains on the sale of business personalty held long-term are ordinary income, unless sold for an amount greater than the original purchase price.

Question 6

Recapture for Corporations

Answer 6

For Section 1245 property (personalty), the rules for a corporation are the same as for an individual.
For Section 1250 property (buildings) for corporations, the accumulated depreciation claimed in excess of straight-line depreciation is subject to being recaptured as ordinary income.

Question 7

Netting of all Section 1231 Gains and losses

Answer 7

The combining of Section 1231 gains and losses is accomplished as follows. First, net all casualty and theft gains and losses on business property held for more than one year.
If the losses exceed gains, treat them all as ordinary losses and gains and do not net them with other Section 1231 gains and losses.
If the gains exceed losses, the net gain is combined with other Section 1231 gains and losses.
To the extent that Section 1231 gains exceed Section 1231 losses, the net gain is treated as a long-term capital gain (subject to a lookback limit during the previous five years).
If Section 1231 losses exceed Section 1231 gains, the loss is deductible as an ordinary loss.
The lookback provision states that the net Section 1231 gains must be offset by net Section 1231 losses from the five preceding tax years that have not previously been recaptured. To the extent of these losses, the net Section 1231 gain is treated as ordinary income.