What is the difference between 1245, 1231, and 1250 properties?

January, 24 2022 by Karen Reed, EA

Those who own business property may be interested in understanding the difference between section 1231, 1245, and 1250 properties, as this can be helpful in tax planning for the years when assets are sold. Section 1231, 1245, and 1250 of the Internal Revenue Code (IRC) provide categories for different types of business assets and define how each will be taxed when there is a disposition. All property used in a trade or business is considered section 1231 property and, for taxation purposes, either section 1245 or 1250 applies, depending on the property’s characteristics.
 

Section 1231 Property

Section 1231 applies to property that is used in a trade or business, subject to depreciation rules under IRC 167, and held for more than a year. It also applies to real property used in the trade or business held for more than a year. This category does not include inventory or property held for sale to customers—and it does not include intangible assets such as patents, inventions, copyrights, and the like.

Examples of section 1231 property that are depreciable business assets include business assets with a useful life that exceeds one year. This includes machinery and equipment, buildings, vehicles, and computers. Section 1231 property also includes land, timber, livestock, and unharvested crops—but it does not include poultry.

When section 1231 property is sold at a gain, the amount in excess of the property’s basis and depreciation receives capital gains treatment, which generally means lower tax rates, while the amount attributed to depreciation recapture is treated as ordinary income. When section 1231 property is sold at a loss, the loss is treated as an ordinary loss and may be deducted in full against ordinary income. This is more favorable than capital loss treatment, which limits capital losses to $3,000 per tax year (unless other capital gains are available to offset the losses).
 

Section 1245 Property

Section 1245 was put in place to ensure that the tax benefits of depreciation are considered when businesses sell certain tangible and intangible assets on which a depreciation or amortization deduction has been allowed. Examples of Section 1245 property include furniture, business equipment, light fixtures, and carpeting. Section 1245 property does not include buildings and structural components, which fall under Section 1250.

Section 1245 property is not truly a separate class of property from section 1231 property. Rather, section 1245 property may be defined as certain types of section 1231 property on which there exists an unrecaptured allowed or allowable depreciation or amortization deduction.

The importance of section 1245 comes into play when a business sells business property at a gain. When section 1245 property is sold at a gain, amounts previously claimed as depreciation (allowed or allowable) are recaptured at ordinary income tax rates, and the remaining gain is taxed at capital gains rates. This is because they have already received favorable tax treatment on the property through depreciation or amortization deductions.

If section 1245 property is sold at a loss, the property follows section 1231 rules, and the loss is ordinary and can offset ordinary income.
 

Section 1250 Property

Section 1250 generally applies to real property (such as commercial buildings and rental houses) and real property structural components (such as roofs and flooring) that are depreciated over longer periods of time than section 1245 property. Section 1250 outlines specific taxation rules for property that has been depreciated using an accelerated depreciation method. When section 1250 property is sold at a gain, the difference between the straight-line depreciation and the accelerated method claimed is taxed as ordinary income, while the rest of the gain is taxed at capital gains rates.

In summary, code sections 1231, 1245, and 1250 provide classification guidelines for different types of depreciable business property and how they are taxed when they are sold. Section 1231 applies to all depreciable business assets owned for more than one year, while sections 1245 and 1250 provide guidance on how different asset categories are taxed when sold at a gain or loss. Understanding these code sections can help business owners with tax planning when they are getting ready to sell business assets.