Section 1231 Issues

Section 1231 is depreciable property used in a trade or business. In general, Section 1245 property is movable property and Section 1250 is real property such as land and buildings. Note that Section 1231 property is one of the best assets an investor can own since a portion of the gain can be taxed at capital gains rates and losses are taxed as ordinary losses (a heads-I-win-tails-you-lose game when dealing with the IRS).

To combat the taxpayer with a Section 1231 property, the IRS requires a 5-year look-back period for Section 1231 gains to recapture any gain as ordinary as opposed to capital when losses were utilized during that 5-year look-back period.

Lastly, any gain over the original cost is taxed as a Section 1231 gain.

As an example, assume that a machine (movable Section 1245 property) was purchased 3 years ago for $40,000, and has a net accumulated depreciation of $25,000 and a net basis of $15,000.
· If you sell for $1,000, there is a Section 1231 loss of ($14,000) deducted as an ordinary loss. Proceeds of $1,000 - $15,000 adjusted basis.
· If you sell for $38,000, there is a Section 1245 gain of $23,000 (depreciation recaptured at ordinary rates). Proceeds of $38,000 - $15,000 adjusted basis.
· If you sell for $52,500, there is a Section 1245 gain of $25,000 (depreciation recapture at ordinary rates) and a Section 1231 gain of $12,500 (at a capital-gains rate, unless a 5-year look-back of losses requires an additional Section 1245 recapture).