If you’re selling trade or business property, be aware that there are many tax rules that can potentially apply to such transactions. To simplify discussion, let’s assume that the property you want to sell is land or depreciable property used in your business. And let’s also assume it has been held by you for more than a year. (There are different rules for property held primarily for sale to customers in the ordinary course of business; intellectual property; low-income housing; property that involves farming or livestock; and other types of property.) We can help ensure you know the rules and consequences.
Under the Internal Revenue Code, your gains and losses from sales of business property are netted against each other. The net gain or loss qualifies for tax treatment as follows:
- If the netting of gains and losses results in a net gain, then long-term capital gain treatment results, subject to “recapture” rules discussed below. Long-term capital gain treatment is generally more favorable than ordinary income treatment.
- If the netting of gains and losses results in a net loss, that loss is fully deductible against ordinary income. (In other words, none of the rules that limit the deductibility of capital losses applies.)
The availability of long-term capital gain treatment for business property net gain is limited by “recapture” rules. These are rules under which amounts are treated as ordinary income rather than capital gain because of previous ordinary loss or deduction treatment for these amounts.
There’s a special recapture rule that applies only to business property. Under this rule, to the extent you’ve had a business property net loss within the previous five years, any business property net gain is treated as ordinary income instead of as long-term capital gain.
Section 1245 Property
“Section 1245 Property” consists of all depreciable personal property, whether tangible or intangible, and certain depreciable real property (usually, real property that performs specific functions). If you sell Section 1245 Property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset.
Section 1250 Property
Generally speaking, “Section 1250 Property” consists of buildings and their structural components. If you sell Section 1250 Property that was placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to depreciation recapture.
However, for most noncorporate taxpayers, the gain attributable to depreciation deductions, to the extent it doesn’t exceed business property net gain, will (as reduced by the business property recapture rule above) be taxed. That gain will be taxed at a rate of no more than 28.8% (25% as adjusted for the 3.8% net investment income tax) rather than the maximum 23.8% rate (20% as adjusted for the 3.8% net investment income tax) that generally applies to long-term capital gains of noncorporate taxpayers.
Other rules may apply to Section 1250 Property, depending on when it was placed in service.
Understanding the Consequences
As you can see, even with the simplifying assumptions in this article, the tax treatment of the sale of business assets can be complex. To further understand the tax details when selling trade or business property, contact the business tax professionals at Ramsay & Associates. We can help determine the tax consequences of specific transactions or answer any additional questions.