Abstract:
The sale of business or trade property can be subject to many
rules, depending on the details. Factors that affect the taxability of the sale
include the type of property, the primary use and how long the property was
held. This article gives a rundown of the rules.
Selling
trade or business property? Know the tax effects
Many rules can potentially apply to the sale
of business property, but what are the tax consequences? For simplicity, let’s
assume that the property you want to sell is depreciable property used in your
business and you’ve held it for more than a year. (Different rules apply based
on property type, such as property held for sale to customers, intellectual
property, low-income housing, and farming or livestock property.)
General rules
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:
1. If
the netting process results in a net gain, then long-term capital gain
treatment results, subject to “recapture” rules discussed below. This treatment
is generally more favorable than ordinary income treatment.
2. If
the netting of gains and losses results in a net loss, that loss is fully
deductible against ordinary income (so, none of the rules that limit the
deductibility of capital losses apply).
Recapture rules
The availability of long-term capital gain
treatment for business property net gain is limited by recapture rules. Recapture
rules specify that amounts are treated as ordinary income rather than capital
gain because of previous ordinary loss or deduction treatment for these amounts
(such as depreciation, for example).
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, not as long-term capital gain.
More tax code details
Here are some more details about two types of
property:
Section 1245 property. This is all depreciable personal property, tangible or
intangible, and certain depreciable real property (usually, real property with specific
functions). If you sell this property, you must recapture your gain as ordinary
income to the extent of your earlier depreciation deductions on the asset.
Section 1250 property. This type of property generally includes buildings and
their structural components. If you sell such 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. (Additional rules apply for Section 1250
property placed in service before 1987.)
However, for most noncorporate taxpayers, the
gain attributable to depreciation deductions up to the amount of the business
property net gain will be taxed at no higher than 28.8% (as reduced by the
business property recapture rule above). That’s 25% adjusted for the 3.8% net investment
income tax, rather than the maximum 23.8% rate (20% adjusted for the 3.8% net
investment income tax) that generally applies to long-term capital gains of
noncorporate taxpayers.
Proceed with caution
As you can see, the
tax treatment of the sale of business assets can be complex. Contact us for
help with specific transactions or additional questions.
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2022