Table of Contents
- What Is Section 1245?
- Understanding Section 1245
- What Is a Section 1245 Property?
- Section 1245 Recapture Feature
- Important Note on Section 1231 Property
- Section 1245 Background
- Tax Picture of a Sale of Section 1245 Property
- Fast Fact on Tax Rates
- Example of a Sale of Section 1245 Property
- What Is Section 1231?
- What Are Capital Gains Tax Rates?
- What Is the Difference Between Section 1245 Property and Section 1231 Property?
- The Bottom Line
What Is Section 1245?
Let me explain Section 1245 directly: it's a part of the Internal Revenue Code that sets the tax rate for gains when you sell or transfer depreciable and amortizable property. This applies to specific real or tangible business property you've held for more than 12 months.
You need to know that Section 1245 specifies which properties qualify and when ordinary income tax rates apply to their sale instead of capital gains rates.
Key Takeaways
- Section 1245 lets the IRS recapture depreciation or amortization you've taken on Section 1231 property.
- This recapture happens when you sell certain tangible or intangible personal property at a gain.
- Section 1231 lets you apply higher ordinary rates to losses and lower capital gains rates to gains on property held over a year.
- If you've depreciated property and sell it for profit, Section 1245 taxes that depreciation at ordinary income rates.
Understanding Section 1245
Here's how it works: Section 1245 recaptures the depreciation or amortization you've allowed or could have allowed on tangible and intangible personal property when you sell it at a gain. It taxes that gain at ordinary income rates up to the amount of your allowable or allowed depreciation or amortization.
What Is a Section 1245 Property?
The IRS defines Section 1245 property as items that must be or have been subject to depreciation or amortization allowances. These can be personal property, either tangible or intangible, or other tangible property (not including buildings or their structural parts) used in specific ways.
Specifically, this includes property that's an integral part of manufacturing, production, extraction, or providing services like transportation, communications, electricity, gas, water, or sewage disposal. It also covers research facilities in those activities or facilities for bulk storage of fungible commodities.
Section 1245 Recapture Feature
Section 1245 acts as a tool to recapture at ordinary income rates the depreciation or amortization you've taken or could have taken on Section 1231 property. 'Allowable or allowed' means we take the greater amount— what you actually deducted or what you could have but didn't.
Important Note on Section 1231 Property
Remember, a Section 1231 property is real or depreciable business property you've held for more than one year.
Section 1245 Background
Conceptually, lower tax rates on gains mean you pay less tax, and higher rates on losses give you a bigger offset against income, reducing your tax bill. That's why tax strategies aim for capital gains rates on profits and ordinary rates on losses.
Congress created IRC Section 1231 to benefit businesses by letting them use lower capital gains rates on gains and higher ordinary rates on losses from property sales. But since many businesses already benefited from depreciation or amortization deductions, Congress added Section 1245 to recapture those at ordinary rates on profitable sales.
The language in Section 1245 suggests it covers a distinct class of property, but really, Section 1245 property is just Section 1231 property that's been depreciated or amortized. It stays Section 1245 only until the depreciation is fully recaptured, then it reverts to Section 1231.
Tax Picture of a Sale of Section 1245 Property
If you sell Section 1245 property at a loss, it becomes Section 1231 property for tax purposes, and the loss is ordinary, subject to netting and look-back rules. If sold at a gain, it remains Section 1245, with gain up to depreciation taxed at ordinary rates.
After recapturing depreciation or amortization, it converts to Section 1231, and any leftover gain gets capital gains treatment.
Fast Fact on Tax Rates
Capital gains tax rates are lower than ordinary income tax rates.
Example of a Sale of Section 1245 Property
Consider this example: suppose your business owns a $100 widget and you've taken $75 in depreciation. The adjusted basis is $100 minus $75, so $25. You sell it for $150.
The gain is $150 minus $25, or $125. Of that, $75 (the depreciation) is Section 1245 gain taxed at ordinary rates. The remaining $50 is Section 1231 gain at capital gains rates.
If you sell the widget for $20, that's a $5 loss ($20 minus $25). With no gain, Section 1245 doesn't apply, and the $5 is an ordinary Section 1231 loss.
What Is Section 1231?
Section 1231 is another IRC part that defines tax treatment for certain real or depreciable business properties. It allows sales of these, held over a year, to be taxed at capital gains rates instead of higher ordinary income rates.
What Are Capital Gains Tax Rates?
Capital gains tax applies to profits from selling investments or properties held more than a year. For 2024 (filed in 2025), rates are 0%, 15%, or 20% based on your income.
What Is the Difference Between Section 1245 Property and Section 1231 Property?
Both sections deal with similar business properties. The key difference is that Section 1245 properties have been depreciated or amortized. Once you've recaptured the tax on that depreciation, the property becomes Section 1231.
The Bottom Line
In summary, Section 1245 recaptures taxes on depreciated or amortized Section 1231 property. It targets real or depreciable business property held over a year. When you sell tangible or intangible personal property after taking depreciation and make a profit, gains are taxed at ordinary rates up to the depreciation amount. After that, it shifts to Section 1231 with capital gains rates on the rest.
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