Question

Depreciation and Sale of Business Property (chapter 8).

1. What are the differences between these three code sections: 1231, 1245 and 1250, and when do you apply each?
2. What is Section 179 and When may this Section 179 be used?
3. How does the depreciation recapture rules work?

Answer 1

Section 1231 property - Real or depreciable property used in an active trade or business, and is held for more that 1 year. Inventory is not section 1231 property. All gains and losses resulting from the sale of section 1231 property are netted against each other to get a net sec 1231 gain or loss. Net sec 1231 gain is treated as capital gain and net sec 1231 loss is treated as ordinary loss. This is viewed as a favorable rule to the taxpayer.

1231 look back - if you have a 1231 gain for the year, you must look back 5 years and recapture as ordinary income any sec 1231 losses you have incurred.

Sec 1245 - tangible personal property that is depreciable property. All 1245 property is 1231 property.

Section 1245 recapture - Upon disposal of 1245 property, you must recapture as ordinary income the lesser of the gain recognized or accumulated depreciation. For example you sell a machine that has a cost basis of 1000 and an adjusted basis of 400 (600 of accumulated depreciation) for 1200 which results in a gain recognized of 800. 600 is treated as ordinary income and 200 is 1231 gain. The idea is that you received deductions against ordinary income via depreciation deductions therefore you should not receive the benefit of treating that portion of the gain as capital.

Section 1250 - this relates to dispositions of real property and requires you to recapture as ordinary income the excess of accumulated depreciation over depreciation calculated using the straight line method. This only applies to pre 1986 real property since post 1986 is straight line depreciation.

Section 179 of the United States Internal Revenue Code, allows a taxpayer to elect to deduct the cost of certain types of property on their income taxes as an expense, rather than requiring the cost of the property to be capitalized and depreciated.

Depreciation recapture is the gain received from the sale of depreciable capital property that must be reported as income. Depreciation recapture is assessed when the sale price of an asset exceeds the tax basis or adjusted cost basis. The difference between these figures is thus "recaptured" by reporting it as income.