Section 1231 assets vs. section 1245 assets

CPA Exam Forum The Forum REG Review Section 1231 assets vs. section 1245 assets

This topic contains 7 replies, has 7 voices, and was last updated by  LoopholeLewy 5 years, 10 months ago.

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  • #158293

    PTAldridge
    Participant

    I understand the tax treatment of section 1231 assets and section 1245 assets, but I am confused as to how to determine when an asset shall be classified as a section 1231 asset, and when an asset shall be classified as a section 1245 asset.

    Please advise.

    #255360

    Sandra
    Participant

    PTAIdrige,

    From what I read on pages 502 and 503 of the Wiley CPA Exam Review Regulation book, it states that Section 1231 assets would be those assets that are used in the operation of a trade or business but it excludes inventory and copyrights. Section 1245 assets are those assets that are “depreciable tangible and intangible personal property” such as desks, equipment, storage tanks, etc.

    I have a hard time with this too. I hope this helps.

    #255361

    Oceanman
    Participant

    Section 1245 asssets are really just a subdivision of 1231 assets. According to CCH Federal Taxation, 1231 assets include depreciable property and land used in trade or business (and held LT). As sdmontoya says, this excludes inventory and patents. Sec 1245 asstes are personal asstes (that is, not real assets) subject to depreciation. This typically includes equipment and machinery. Thus Section 1231 assets have a more broad definition and 1245 asstes are 1231 asstes but receive different depreciation treatment. Hope this helps, I am a little rusty with Tax but I remember that once I realized that 1245 is 1231 it made things a lot more clear.

    #255362

    CAcpahopeful2010
    Participant

    and Sec 1250 applies to Real Estate, right?

    #255363

    PTAldridge
    Participant

    Section 1250 only applies to real property placed in service before 1986. For real property acquired after 1986, you must apply MACRS which is straight line for real property and therefore does not require a depreciation recapture.

    #255364

    Anonymous

    §1250 applies to all 27.5 and 39 year property. It comes into play when real property is sold. Given how REC is hurting right now, you wouldn’t see as much of it compared to prior to 2008. However, 1250 applies to all real estate, regardless of whether it was acquired before or after the last reform act and adoption of MACRS recovery lives and methods.

    Depreciation is recaptured on ALL depreciable property. You received an ordinary deduction for it, and you will recapture that amount taken as ordinary income. Additionally, 25% of the gain from APPRECIATION is recaptured at ordinary income, §1250 gain, and the remainder is §1231 gain, generally LTCG (or loss in this economy.)

    >>Section 1250 only applies to real property placed in service before 1986. For real property acquired after 1986, you must apply MACRS which is straight line for real property and therefore does not require a depreciation recapture.

    Wrong.

    #255365

    Office Space
    Participant

    Actually 1250 does apply to commercial and residential real estate, but 1250 is known as the 25% tax. I believe that of any depreciation that you have taken on the property, 25% of it is recaptured at a 25% rate. The remainder is 1231 gain subject to LTCGain rates (whatever they end up doing with them.)

    Depreciation recapture of ordinary income is on 1245 property, which is basically any non-real estate property. Generally this will be anything in the 3-7 year class lives. 15 year to 39 year are generally permanately affixed to the land and are subject to 1250. That recapture is ordinary income to the extent of depreciation taken. If I buy a machine for 5k, depreciate it fully, and sell it for 7k, it would result in depreciation recapture of 5k and 1231 gain of 2k. If I bought the same building for 5k, depreciated it fully, and sold it for 7k, I would have a 25% gain on 1250 and 5750 in 1231 gain.

    The way you can really tell is if that if you tried to move the asset, would it cause considerable damage to the land or structure affixed to the land. If you’re still confused let me know by posting.

    #255366

    LoopholeLewy
    Participant

    LOTS OF CONFUSION ON THIS SUBJECT!

    Hope this helps you guys:

    Section 1245 property is depreciable personal property (i.e., machinery, equipment, furniture, fixtures and section 197 intangibles ). Section 1245 only applies if a GAIN is realized on the disposal of depreciable personal property. Under Section 1245 rules, depreciation allowed or allowable through the date of disposal must be recaptured as ordinary income to the extent the depreciation is equal to or less than the gain.

    The portion of the gain on the disposal of section 1245 property that EXCEEDS recaptured depreciation is a Section 1231 gain PROVIDED the property was held MORE THAN ONE YEAR on the date of disposal. Recaptured depreciation is NOT taken into account as Section 1231 gain.

    If depreciable personal property is held only one year or less on the date of disposal, the entire gain or loss is ordinary gain or ordinary loss and the property is not referred to as section 1231 property since section 1231 tax treatment would not apply.

    Certain property, such as inventory held for sale to customers or inventory consumed in the business (i.e, office supplies), are never eligible for section 1231 tax treatment.

    Section 1250 property is depreciable real property. For NONRESIDENTIAL property placed in service PRIOR to 1987, the amount of depreciation taken that is equal to or less than the gain is recaptured as ordinary income. The portion of the gain that EXCEEDS recaptured depreciation is a section 1231 gain. In other words, PRE-1987 nonresidential property gets the same treatment for depreciation recapture as Section 1245 property.

    For PRE-1987 RESIDENTIAL property, ADDITIONAL (EXCESS) depreciation must be recaptured as ordinary income. Additional depreciation is the EXCESS of accelerated depreciation over straight-line depreciation. If straight-line depreciation was used for residential property, then there is no depreciation recapture requirement since there would be no ADDITIONAL (EXCESS) depreciation.

    For depreciable real property placed in service AFTER 1986 there is NO depreciation recapture requirement because only straight-line MACRS depreciation is permitted. A gain on POST-1986 depreciable real property is subject to section 1231 netting rules. If a net section 1231 gain results, the gain attributable to depreciation is subject to tax of up to 25% on the Unrecaptured Section 1250 gain (the gain attributable to depreciation which was not required to be recaptured as ordinary income). This tax will be lower than 25% if the taxpayer’s tax bracket is less than 25%.

    Section 1245 property is also Section 1231 property PROVIDED the property was held MORE THAN ONE YEAR on the date of disposal. Section 1231 deals with the TAX TREATMENT of gains and losses of the disposal of Section 1245 property, Section 1250 property, amortizable Section 197 intangibles, and land PROVIDED the holding period of MORE THAN ONE YEAR is met for each of these types of property.

    Section 1245 and Section 1250 deal with depreciation recapture rules; Section 1231 does NOT.

    If Section 1245 propety and Section 1250 property is held one year or less, this property is not referred to as Section 1231 property because Section 1231 tax treatment would not apply.

    Section 1245 property is personal property that has been or is subject to an allowance for depreciation. Section 1250 property is real property subject to an allowance for depreciation.

    The term PERSONAL property is a legal one. It means the property is MOVEABLE as opposed to real property, such as land and anything affixed to the land such as a building and trees.

    LoopholeLewy

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