Question

Define a “Section 1231 Asset”? Why would the disposition of a Section 1231 be considered the “best of both worlds” for a taxpayer?

Answer 1

A “Section 1231 Asset” refers to any depreciable asset used in a trade or business and held for over one year. It includes buildings, machinery, land, timber and other natural resources, unharvested crops, cattle, livestock and leaseholds but does not include poultry, trademarks, or inventory.

A Section 1231 can be considered the “best of both worlds” for a taxpayer it allows the taxpayer to have capital gains treatment if they realize a gain on Section 1231 property, but at the same time allows the taxpayer to treat any loss on such property as ordinary loss. Ordinary losses are 100% deductible whereas capital losses are subject to an annual deduction limitation of $3,000. If there is any excess of capital losses above $3,000 are carried forward to next year. In this way, if 1231 Asset resulted in a loss, then the taxpayer can treat it as an ordinary loss and such a loss may reduce the taxpayer’s taxable income. On the other hand, when the asset is sold for a value greater than its basis then it would be taxed at a capital gains rate which is lower than an ordinary income rate.