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IRS.gov Website
Publication 544
taxmap/pubs/p544-015.htm#en_us_publink100072546

Chapter 3
Ordinary or Capital Gain or Loss for Business Property(p26)


taxmap/pubs/p544-015.htm#en_us_publink1000276604Introduction

When you dispose of business property, your taxable gain or loss usually is a section 1231 gain or loss. Its treatment as ordinary or capital is determined under rules for section 1231 transactions.
When you dispose of depreciable property (section 1245 property or section 1250 property) at a gain, you may have to recognize all or part of the gain as ordinary income under the depreciation recapture rules. Any remaining gain is a section 1231 gain.

taxmap/pubs/p544-015.htm#TXMP30952f74

Useful items

You may want to see:


Publication
 534 Depreciating Property Placed in Service Before 1987
 537 Installment Sales
 547 Casualties, Disasters, and Thefts
 551 Basis of Assets
 946 How To Depreciate Property
Form (and Instructions)
 4797: Sales of Business Property
See chapter 5 for information about getting publications and forms.
taxmap/pubs/p544-015.htm#en_us_publink100072547

Section 1231 Gains and Losses(p26)

rule
Section 1231 gains and losses are the taxable gains and losses from section 1231 transactions (discussed below). Their treatment as ordinary or capital depends on whether you have a net gain or a net loss from all your section 1231 transactions.
EIC
If you have a gain from a section 1231 transaction, first determine whether any of the gain is ordinary income under the depreciation recapture rules (explained later). Do not take that gain into account as section 1231 gain.
taxmap/pubs/p544-015.htm#en_us_publink100072549

Section 1231 transactions.(p26)

rule
The following transactions result in gain or loss subject to section 1231 treatment.
taxmap/pubs/p544-015.htm#en_us_publink100072550

Property for sale to customers.(p26)

rule
A sale, exchange, or involuntary conversion of property held mainly for sale to customers is not a section 1231 transaction. If you will get back all, or nearly all, of your investment in the property by selling it rather than by using it up in your business, it is property held mainly for sale to customers.
taxmap/pubs/p544-015.htm#en_us_publink100072551

Example.(p26)

You manufacture and sell steel cable, which you deliver on returnable reels that are depreciable property. Customers make deposits on the reels, which you refund if the reels are returned within a year. If they are not returned, you keep each deposit as the agreed-upon sales price. Most reels are returned within the 1-year period. You keep adequate records showing depreciation and other charges to the capitalized cost of the reels. Under these conditions, the reels are not property held for sale to customers in the ordinary course of your business. Any gain or loss resulting from their not being returned may be capital or ordinary, depending on your section 1231 transactions.
taxmap/pubs/p544-015.htm#en_us_publink100072552

Patents and copyrights.(p26)

rule
The sale of a patent, invention, model or design (whether or not patented), a secret formula or process, a copyright, a literary, musical, or artistic composition, or similar property is not a section 1231 transaction if your personal efforts created the property, or if you acquired the property in a way that entitled you to the basis of the previous owner whose personal efforts created it (for example, if you receive the property as a gift). The sale of such property results in ordinary income and generally is reported in Part II of Form 4797.
taxmap/pubs/p544-015.htm#en_us_publink100084331

Property deducted under the de minimis safe harbor for tangible property.(p27)

rule
If you deducted the costs of a property under the de minimis safe harbor for tangible property, then upon its sale or disposition, this property is not treated as property used in the trade or business under section 1231. Generally, any gain on the disposition of this property is treated as ordinary income and is reported on Part II of Form 4797.
taxmap/pubs/p544-015.htm#en_us_publink100084332
Example.(p27)
In 2018 you paid $1,000 for a machine that you used in your business. You deducted the $1,000 cost of the machine on your 2018 income tax return under the de minimis safe harbor for tangible property. In 2020 you sold the machine for $1,500. Because you deducted the cost of the machine under the de minimis safe harbor, this property is not treated as property used in the trade or business under section 1231. Upon sale of the machine, you must report the $1,500 as ordinary gain on line 10 of Form 4797.
taxmap/pubs/p544-015.htm#en_us_publink100072553

Treatment as ordinary or capital.(p27)

rule
To determine the treatment of section 1231 gains and losses, combine all your section 1231 gains and losses for the year.
taxmap/pubs/p544-015.htm#en_us_publink100072554
Nonrecaptured section 1231 losses.(p27)
Your nonrecaptured section 1231 losses are your net section 1231 losses for the previous 5 years that have not been applied against a net section 1231 gain. Therefore, if in any of your 5 preceding tax years you had section 1231 losses, a net gain for the current year from the sale of section 1231 assets is ordinary gain to the extent of your prior losses. These losses are applied against your net section 1231 gain beginning with the earliest loss in the 5-year period.
taxmap/pubs/p544-015.htm#en_us_publink100072555

Example.(p27)

In 2018, Ben has a $2,000 net section 1231 gain. To figure how much he has to report as ordinary income and long-term capital gain, he must first determine his section 1231 gains and losses from the previous 5-year period. From 2013 through 2017 he had the following section 1231 gains and losses.
Year Amount
2013-0-
2014-0-
2015($2,500)
2016-0-
2017$1,800
Ben uses this information to figure how to report his net section 1231 gain for 2018 as shown below.
1)Net section 1231 gain (2018)$2,000
2)Net section 1231 loss (2014)($2,500) 
3)Net section 1231 gain (2016)1,800 
4)Remaining net section
1231 loss from
prior 5 years
($700) 
5)Gain treated as
ordinary income
$700
6)Gain treated as long-term
capital gain
$1,300