Section 1231 Property

Loading the player...

What is the 'Section 1231 Property'

1231 property is real or depreciable business property held for over a year. Section 1231 property includes buildings, machinery, land, timber and other natural resources, unharvested crops, cattle, livestock and leaseholds that are at least a year old, but does not include poultry, trademarks, or inventory.

BREAKING DOWN 'Section 1231 Property'

Broadly speaking, 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 result it is taxed at a lower rate than ordinary income. When losses are recorded on section 1231 property, however, that loss is classified as an ordinary loss and is 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. This law makes it so taxpayers and business owners get the best of both worlds.

1231 Transactions

1231 transactions including the following are subject to treatment provided the following:

  • Casualties and thefts – If you have held a property for more than one year and it is adversely effected by theft casualty.
  • Condemnations – If a property was held for more than a year, and held as a capital asset in connection with 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 – As long as it was 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 sale. 

What is 1231 Property?

‘Section 1231 property’ is an umbrella term for section 1245 property and section 1250 property, both of which are subdivisions of section 1231. Section 1231 defines the tax treatment that the gains and losses of property fitting the definitions of sections 1245 and 1250.

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:

  • 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 temporarily goods 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 with the exception of 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 is less than the original cost of the 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 is 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 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.

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 property is executed in an installment method. 

Real World Example of Section 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 a amortization rate of 50% over 10 years. So let's say then that 10 years after the building had $2 million put into it, it is sold at a price of $6 million. The recorded gains on that sale would be $4 million dollars, 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.

History

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). 

RELATED TERMS
  1. Section 1250

    A section of the United States Internal Revenue Service Code ...
  2. Section 1031

    A section of the U.S. Internal Revenue Service Code that allows ...
  3. Form 4562: Depreciation and Amortization

    A tax form distributed by the Internal Revenue Service (IRS) ...
  4. Reverse Exchange

    A type of property exchange wherein the replacement property ...
  5. Property Tax

    A tax assessed on real estate by the local government. The tax ...
  6. Replacement Property

    Any property that is received as a replacement for property that ...
Related Articles
  1. Term

    What Is Section 1231 Property?

    Section 1231 property is depreciable business property that’s held for a year or longer.
  2. Options & Futures

    Use Real Estate To Put Off Tax Bills

    Find out how you can build wealth and reduce your taxes.
  3. Investing

    How Rental Property Depreciation Works

    It's a bit tricky, but a valuable tool to make your investment pay off.
  4. Taxes

    Avoid Capital Gains Tax On Your Home Sale

    If you have property to sell and want to avoid capital gains tax, a Section 1031 exchange may be the answer.
  5. Taxes

    10 Things to Know About 1031 Exchanges

    Real estate swaps grow popular, but traps are many. Beware new rules on vacation homes.
  6. Home & Auto

    What You Should Know About Real Estate Valuation

    Anyone involved in a real transaction can benefit from gaining a basic understanding of the different methods of real estate valuation.
  7. Taxes

    Getting U.S. Tax Deductions On Foreign Real Estate

    If your home or second home is not in the United States, you can still get U.S. tax deductions. How many and what kind depends on whether you also rent it.
  8. Active Trading

    Trade Properties To Keep The Taxman At Bay

    Like-kind exchanges can mean a much lower tax bill on real estate for savvy investors.
  9. Home & Auto

    The Complete Guide To Becoming A Landlord: Hiring A Property Manager

    A property manager can perform such duties as marketing your rental property, selecting tenants, maintaining the property, creating budgets and collecting rent. You may consider hiring a property ...
  10. Retirement

    State Laws Dictate Division Of Joint Property

    In breakup, divorce or death, community or common law will determine how property is divided.
RELATED FAQS
  1. What is the difference between real estate and real property?

    Understand how real estate is legally different from real property and the implications of that difference for each property ... Read Answer >>
  2. How are capitalism and private property related?

    Read about the relationship between capitalism and private property rights, and learn why voluntary trade would collapse ... Read Answer >>
  3. What is the importance of the capitalization rate in real estate investing?

    Find out why an investment property's capitalization rate is important to real estate investors and how it can be used to ... Read Answer >>
  4. An appraiser forms the following estimates for a rental property ...

    Free info on financial certification exams including study guides, exam questions, and much more! Read Answer >>
  5. Under the Income Capitalization approach to valuing real estate, which of the following ...

    The correct answer is: d) When valuing an entire property, and not just the equity portion in the property, we have to discount ... Read Answer >>
  6. How do taxes impact Net Operating Income (NOI)?

    Find out more about net operating income, how to calculate the NOI of a real estate property and how taxes affect NOI. Read Answer >>
Hot Definitions
  1. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  2. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  3. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  4. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  5. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  6. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
Trading Center