Section 1231, 1245, and 1250: What Happens First?

Section 1231

Section 1231 generally covers qualifying depreciable property and real property used in a trade or business and held for the required period. Net gains can receive favorable long-term capital gain treatment while net losses can receive ordinary loss treatment, subject to applicable recapture rules.

Section 1245

Section 1245 commonly applies to depreciable personal property. Prior depreciation can be recaptured as ordinary income to the extent required before any remaining qualifying gain enters the Section 1231 netting process.

Section 1250

Section 1250 relates to depreciable real property and uses a different recapture framework. Do not apply the Section 1245 shortcut to every building.

Land

Land is not depreciated, so depreciation recapture does not apply to land in the same way. Qualifying business land can still participate in the Section 1231 framework.

Section 1231 lookback

Current net Section 1231 gain can be recharacterized as ordinary income to the extent required by the applicable five-year lookback rule for prior unrecaptured Section 1231 losses.

The order

1. Calculate realized and recognized gain or loss.
2. Apply applicable depreciation recapture.
3. Send remaining qualifying Section 1231 amounts into netting.
4. Consider the lookback rule.

The takeaway

1231 is the overall framework. 1245 and 1250 can recapture depreciation before the remaining gain receives 1231 treatment.

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