What is Section 1231?

Section 1231 is the section of the Internal Revenue Code that governs the tax treatment of gains and losses on the sale or exchange of real or depreciable property used in a trade or business and held over one year.

Whether you sell one piece of section 1231 property or your entire business, the rules of section 1231 apply. Form 4797 is used to report the sale of business property.

Holding Period One Year or Less

If real or depreciable business property is held one year or less, section 1231 does not apply. Gain or loss is reported as ordinary gain or ordinary loss.

The Section 1231 Tax Advantage

The tax advantage that section 1231 provides is:

  • A net section 1231 gain is taxed at the lower capital gain rates.
  • A net section 1231 loss is fully deductible as an ordinary loss.
    • In contrast, a capital loss is only deductible up $3,000 in any tax year and any excess over $3,000 must be carried over to the next year.

A common question: What's the difference between section 1231 property and section 1245 property.

First, both refer to different sections of the Internal Revenue Code. Section 1245 contains the depreciation recapture rules that apply to gains from dispositions of certain depreciable property. For example, business equipment, furniture and fixtures.

Section 1231 governs the tax treatment of gains and losses of real and depreciable property used in a trade or business and held over one year. Such property would include not only personal property (Section 1245 property) but also real property such as a building (Section 1250 property).

As you can see, section 1245 property and Section 1250 property can be referred to as section 1231 property if held more than one year when sold or exchanged since they would be subject to the tax treatment of section 1231.

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