Definition: Section 1245 properties include certain types of business properties that are allowed to be depreciated or expensed. Gains from the sale of these assets may be taxed as ordinary income rather than capital gains. Personal property of a business that is movable or intangible may qualify as section 1245 property.
Types of Section 1245 Property
Some types of property are subject to the section 1245 rules by the Internal Revenue Service (IRS). Section 1245 property includes property that is subject to depreciation or expensing. Section 1245 properties are categorized into two main types: corporate personal property (either tangible or intangible) or tangible property used in certain business activities. Tangible property is depreciated, while intangible property is expensed.
Corporate personal property: Corporate personal property is property that is movable and not attached to land. Intangible personal property includes types of property that have no physical existence, such as trademarks, copyrights, and patents. Tangible business property: Tangible property used in business activities for transportation, communication, electricity, gas, water, or sewage disposal services may qualify as section 1245 property. It may also include research facilities and certain types of storage facilities.
The property listed under section 1245 does not include buildings and structural components such as windows, doors, lighting fixtures, and central air conditioning systems.
Note: Section 1245 properties may not always be easily identifiable. You may need the help of a licensed tax professional to determine if section 1245 tax rules apply to you.
How Section 1245 Property Works
When selling business assets (the term “property” is used by the Internal Revenue Service), you either have a gain or a loss, based on the difference between the adjusted basis of the asset and the amount for which it was sold. The adjusted basis of the asset is the original cost of the asset plus the value of any additions or improvements, minus any depreciation or losses due to accidents. If you sell an asset for more than the adjusted basis, you have a gain; if you sell it for less, you have a loss.
Gains and losses from the sale of business property are usually taxed at capital gains tax rates, but section 1245 properties are an exception. If you sell a section 1245 asset for a gain, the government can recapture (recover) part or all of that gain from depreciation by taxing it at ordinary income tax rates.
How Section 1245 Property is Taxed
For example, if you purchased a section 1245 asset for $1,000 and the total depreciation is $200, your property value is $800. If you sell that asset for $900, you realize a gain of $100. This $100 will be taxed at ordinary income tax rates, as it is a recapture of depreciation.
If you sell that asset for $1,100, you realize a gain of $300. From the $300 profit you made, $200 is taxed at ordinary income tax rates as it is a recapture of depreciation. The remaining $100 may be taxed either as ordinary income or capital gains. If you held the asset for more than a year, the remaining $100 will be taxed at capital gains rates.
If you incur a loss when selling section 1245 property, the loss is subject to tax as an ordinary loss, not as a capital loss.
Note: If you are a sole proprietor, your capital gains tax rate will likely range from 0% to 15%, depending on your taxable income. The ordinary income tax rate is determined on a scale ranging from 10% to 35%, depending on your taxable income.
Reporting
Profits and Losses on Section 1245 Property
You must first separate profits and losses into short-term (for assets held for one year or less) and long-term (for those held for more than one year).
Use Form 4797 Sales of Business Property to calculate the ordinary income portion of the gain on Section 1245 property. You may also need to report Section 1245 property gains and losses, along with all other types of gains and losses, on Form 8949 Sales and Other Dispositions of Capital Assets.
Then use Schedule D to calculate the total gain or loss from what was reported on Form 8949. You may also need to use Schedule D to report additional transactions not included on Form 8949.
Note: Keep all information regarding your Section 1245 property, including when and how you acquired it, the cost or other basis, and all depreciation or speculation up to the date of sale.
Frequently Asked Questions (FAQs)
What is the difference between Section 1231 property and Section 1245 property?
Section 1231 property is real or depreciable property that you have owned for more than one year and is used in a business. Gains from the sale of Section 1231 property are taxed as ordinary income up to the amount of unrecaptured Section 1231 losses from the previous year. Any remaining gains, if any, are taxed as capital gains. Section 1245 property is essentially a type of Section 1231 property where there is allowable or taken depreciation. A portion or all of the gain from this type of property will be taxed as ordinary income.
Is rental property Section 1250 or Section 1245?
Section 1250 property is real property, such as land and buildings. Section 1250 property includes rental property and low-income housing that meets depreciation requirements. Section 1245 property does not include buildings or rental property.
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Sources:
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Internal Revenue Service. “Publication 544 Sales and Other Dispositions of Assets.” Page 27.
Internal Revenue Service. “Publication 544 Sales and Other Dispositions of Assets.” Page 28.
Internal Revenue Service. “Publication 544 Sales and Other Dispositions of Assets.” Page 3.
Internal Revenue Service. “Publication 544 Sales and Other Dispositions of Assets.” Page 26.
Internal Revenue Service. “Topic No. 409 Capital Gains and Losses.”
Internal Revenue Service. “Publication 544 Sales and Other Dispositions of Assets.” Page 34.
Internal Revenue Service. “Publication 544 Sales and Other Dispositions of Assets.” Page 19.
TaxAudit. “What is the difference between 1245, 1231, and 1250 property?”
Internal Revenue Service. “Publication 544 Sales and Other Dispositions of Assets.” Pages 28-29.
Source: https://www.thebalancemoney.com/what-is-section-1245-property-6744002
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