# Understanding Section 1231 Property: Definition, Examples, and Tax Benefits

## What Is a Section 1231 Gain?

Section 1231 of the U.S. Internal Revenue Code provides an advantageous tax treatment for gains on the sale of real or depreciable business property held for more than a year. These gains are typically taxed at the favorable capital gains tax rate rather than as ordinary income. Section 1231 encompasses a wide range of properties, including buildings, machinery, land, timber, and leaseholds over a year old, but notably excludes certain categories, like poultry and patents.

Understanding the specifics of Section 1231 can help maximize tax benefits, allowing taxpayers to capitalize on gains and fully deduct ordinary losses, thereby simplifying the intricacies of business asset management.

### Key Takeaways

*   Section 1231 property consists of real or depreciable business properties held for over a year, and gains from these are taxed at the capital gains tax rate, which is lower than ordinary income tax rates.
*   Section 1231 offers potential tax advantages by allowing gains to be taxed as capital gains while losses are treated as ordinary losses, which are fully deductible against income.
*   Common examples include buildings, machinery, land, timber, livestock, and leaseholds held for more than a year; however, it excludes items such as poultry, certain livestock, and inventory.
*   For Sections 1245 and 1250, gains up to the amount of depreciation taken are taxed as ordinary income, while excess gains are considered capital gains.

![Section 1231 Property: The tax on a gain from the sale of a depreciable business property that has been held for over a year.](https://www.investopedia.com/thmb/2hgkujjoPze4BZa18VXMidVm1y0=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/section-1231.asp_final-14b349fbf4434a1cb9c804e32a833593.png)

*— Investopedia / Ellen Lindner*

## How Section 1231 Gain Affects Your Taxes

If gains on Section 1231 property exceed the adjusted basis and [depreciation](https://www.investopedia.com/terms/d/depreciation.asp), they are taxed as capital gains at a lower rate than ordinary income.

Losses on Section 1231 property are fully deductible if they are classified as ordinary losses.

Ordinarily, if income were 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 carried over to the following year. The Section 1231 law allows taxpayers and business owners to benefit from the best of both worlds.

The IRS handles the taxation of a Section 1231 gain as a "regular" capital gain when there is income, but not when there is a loss. [Capital gains tax](https://www.investopedia.com/taxes/capital-gains-tax-101/) is a tax on the profit when you sell something that's increased in value. It's the gain you make that's taxed, not the amount of money you receive.

## Common Section 1231 Transactions to Know About

Here are some 1231 transactions according to IRS regulations:

*   **Casualties and thefts** – If you have held a property for more than one year and it is adversely affected by theft or casualty (loss or damage from an unexpected or rare event).
*   **Condemnations** – If a property was held for more than a year and held as a capital asset relating to trade or business.
*   **Sale or exchange of real property or personal property that is depreciable** – If the property was held for more than a year and was used in a trade or in a business (usually generating revenue via rent or royalties). 
*   **Leaseholds either sold or exchanged** – If 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 a sale.

Section 1231 property is related to [Section 1245 property](https://www.investopedia.com/terms/s/section1245.asp) and [Section 1250 property](https://www.investopedia.com/terms/s/section1250.asp). Section 1231 defines the tax treatment of the gains and losses of property fitting the definitions of Sections 1245 and 1250 on Form 4797.

## Comparing Section 1231 and 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 includes any depreciable or amortized assets that meet criteria in Publication 544, Sales and Other Dispositions of Assets:

*   Personal property - Generally defined as property other than real estate
*   Other tangible property - This would include machinery or a facility that plays a key role in the production, extraction, or furnishing of services, as well as certain research facilities, or a facility for the bulk storage of [fungible](https://www.investopedia.com/terms/f/fungibility.asp) commodities. This does not include buildings that are included as storage for equipment, but would conceivably include a facility that stored goods temporarily 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, except for buildings and those buildings' structural components.

### How Section 1245 Property Gains Are Taxed

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 are less than the original cost, 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 the 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 are 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 a reference to your own.

## Differentiating Section 1231 and Section 1250 Property

The IRS defines Section 1250 property as [all real property, such as land and buildings](https://www.investopedia.com/ask/answers/12/capital-gains-taxes-home-sales.asp), that are subject to the allowance for depreciation, as well as a leasehold of land or Section 1250 property.  

### Understanding Taxation of Section 1250 Property Gains

Gains from Section 1250 property are treated as ordinary income if they match or are less than depreciation. If they exceed depreciation, they are capital gains. Depreciation recapture is ordinary income if the property is sold using installments.

> **Fast Fact**
>
> While Section 1231 was introduced in the 1954 IRS Code, the content of the tax code referring to gains received upon disposition of depreciable and real property was introduced in 1939 in Section 117(j).

## Example of Section 1231 Property

Let's say a building is bought for $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 an amortization rate of 50% over 10 years.

In 10 years, if the renovated building sells for $6 million, the recorded gains on that sale would be $4 million instead of $2 million, because the cost of refurbishment would be capitalized on the books. That $4 million sale would be taxed as [capital gains](https://www.investopedia.com/terms/c/capitalgain.asp) because the property was sold for more than its depreciated value.

## Where Does Section 1231 Gain Get Reported?

IRS [Form 4797](https://www.investopedia.com/terms/f/form-4797.asp), Sales of Business Property, is used to report the Section 1231 gains on a sold property.  

## What Is the Difference Between 1231 and 1250 Property?

Section 1231 applies to all depreciable business assets owned for more than one year, while Section 1250 (and also 1245) provides guidance on how different asset categories are taxed when sold at a gain or loss. 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.

## What Is the Difference Between 1231 Gain and Capital Gain?

When it comes to taxation, there is no difference under certain circumstances. 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 a result, it is taxed at a lower rate than ordinary income.

## The Bottom Line

Section 1231 gains are gains from depreciable property and real property used in a business and held for more than one year. Such gains are considered "tax-friendly" as they have traditionally enjoyed a favored status in the tax code. Net Section 1231 gains for the taxable year are treated as long-term capital gains, but a net Section 1231 loss is considered an ordinary loss.

> **Article Sources**
>
> 1.  Internal Revenue Service. "[Publication 544, Sales and Other Dispositions of Assets](https://www.irs.gov/pub/irs-pdf/p544.pdf)." Page 39.
>     
> 2.  Internal Revenue Service. "[Publication 544, Sales and Other Dispositions of Assets](https://www.irs.gov/pub/irs-pdf/p544.pdf)." Pages 40, 54-55.
>     
> 3.  Internal Revenue Service. "[Instructions for Form 4797, Sales of Business Property](https://www.irs.gov/pub/irs-pdf/i4797.pdf)."
>     
> 4.  Internal Revenue Service. "[Publication 544, Sales and Other Dispositions of Assets](https://www.irs.gov/pub/irs-pdf/p544.pdf)." Page 41.
>     
> 5.  Internal Revenue Service. "[Publication 544, Sales and Other Dispositions of Assets](https://www.irs.gov/pub/irs-pdf/p544.pdf)." Pages 41-42.
>     
> 6.  Internal Revenue Service. "[Publication 544, Sales and Other Dispositions of Assets](https://www.irs.gov/pub/irs-pdf/p544.pdf)." Page 43.
>     
> 7.  Internal Revenue Service. "[Publication 544, Sales and Other Dispositions of Assets](https://www.irs.gov/pub/irs-pdf/p544.pdf)." Page 43, 46.
>     
> 8.  Duke Law. "[Federal Income Tax: Involuntary Conversions as Section 337 Sales or Exchanges](https://scholarship.law.duke.edu/cgi/viewcontent.cgi?article=1746&context=dlj)."
>     
> 9.  Internal Revenue Service. "[Publication 544, Sales and Other Dispositions of Assets](https://www.irs.gov/pub/irs-pdf/p544.pdf)." Pages 39, 41, 43.