Section 1231 of the Internal Revenue Code applies to and categorizes gains and losses from property used in the trade or business and from involuntary conversions.
When disposing of an asset, you have to determine whether property is a capital asset or is ordinary income property. Property generally can’t be both. However, Code Sec. 1231 is a special categorization provision that allows you to “have it” both ways:
Code Sec. 1231 gains include:
Property used in a trade or business is property that is subject to depreciation and held by the taxpayer for more than one year.
Code Sec. 1231 losses are any recognized loss from a sale, exchange, or conversion of the same categories of property.
Gains and losses from these transactions are referred to as Code Sec. 1231 gains and Code Sec. 1231 losses.
The character of the gain or loss depends on whether Code Sec. 1231 gains exceed Code Sec. 1231 losses for the tax year. If the Code Sec. 1231 gains exceed the Code Sec. 1231 losses, then all of the Code Sec. 1231 gains and losses are treated as long-term capital gains and losses. The result is a net long-term capital gain. This amount can then be netted with other capital gains and losses.
If, however, the Code Sec. 1231 losses equal or exceed the Code Sec. 1231 gains, then all of the Code Sec. 1231 gains and losses are treated as ordinary income and losses. The net result is an ordinary loss, which can offset other ordinary income.
Code Sec. 1231 does not apply to depreciation that must be recaptured as ordinary income under either Code Sec. 1245 (depreciable personal property and certain real property) or Code Sec. 1250 (depreciable real property that is not Code Sec. 1245 property).