Dispositions of Trade or Business-Use Property
An interactive guide to understanding §1231, §1245, and §1250.
The "Best of Both Worlds": Section 1231
When you sell property used in your trade or business and held for more than a year, it falls under Section 1231. This section of the tax code provides a significant advantage. The purpose of this section is to provide special tax treatment for gains and losses from the disposition of certain business-use assets. This guide will help you understand how this works.
Net §1231 Gain → Capital Gain
If your combined §1231 gains for the year exceed your losses, the net gain is treated as a long-term capital gain. This is beneficial because capital gains are often taxed at lower rates than ordinary income for individuals.
Net §1231 Loss → Ordinary Loss
If your combined §1231 losses exceed your gains, the net loss is treated as an ordinary loss. This is advantageous because ordinary losses are fully deductible against your other income, without the annual $3,000 limit that applies to capital losses for individuals.
Depreciation Recapture
While §1231 provides benefits, there's a catch called "depreciation recapture." When you sell a depreciable asset for a gain, the tax code requires you to "recapture" some or all of the depreciation deductions you previously took. This recaptured amount is treated as ordinary income, not capital gain. This rule prevents taxpayers from getting a double benefit: reducing ordinary income through depreciation deductions and then having the entire gain taxed at lower capital gain rates. The simulator in the next tab will demonstrate how this works for different property types.
Gain & Loss Simulator
Select a taxpayer and asset type, then enter the sale details to see how the gain or loss is characterized. This tool demonstrates how the rules for depreciation recapture under §1245 and §1250/§291 impact the final tax treatment.
Result Breakdown
Key Rules at a Glance
This section provides a quick summary of the main depreciation recapture rules for gains on different types of property. These rules determine how much of a gain is treated as ordinary income before the remaining portion can be treated as a §1231 gain.
§1245 Personal Property (Machinery, Equipment)
When sold at a gain, the gain is treated as ordinary income up to the amount of all accumulated depreciation. This is the most aggressive form of recapture.
Rule: Ordinary income = Lesser of (Total Gain) or (Accumulated Depreciation). Any remaining gain is a §1231 Gain.
§1250 Real Property (Buildings) - C Corporation
For C corporations, a special rule (§291) applies. Only a portion of the gain related to straight-line depreciation is recaptured as ordinary income.
Rule: Ordinary income = 20% of the Lesser of (Total Gain) or (Accumulated Straight-Line Depreciation). Any remaining gain is a §1231 Gain.
§1250 Real Property (Buildings) - Individual
For individuals, there is no direct recapture as ordinary income (assuming straight-line depreciation). Instead, the portion of the gain attributable to depreciation becomes "Unrecaptured §1250 Gain."
Tax Treatment: This portion of the gain is taxed at a maximum rate of 25%. Any remaining gain is a regular §1231 gain, taxed at the lower 0/15/20% rates.
Five-Year Look-Back Rule
If you have a net §1231 gain for the year, you must "look back" five years. If you had any net §1231 losses treated as ordinary losses in that period, you must recapture the current year's gain as ordinary income to the extent of those prior losses.
