Section 1231 Gains and Losses

Section 1231 gains and losses are the taxable gains and losses from section 1231 transactions (explained below). Their treatment as ordinary income or loss or capital gains depends on whether you have a net gain or a net loss from all of your section 1231 transactions in the tax year.

If you have a gain from a section 1231 transaction, first determine whether any of the gain is ordinary income under the depreciation (or other) recapture rules explained later. Do not take that gain into account as section 1231 gain. Only gain in excess of the recapture amount is considered section 1231 gain. See Treatment as ordinary or capital, later.

Section 1231 transactions. Section 1231 transactions are sales and exchanges of real or depreciable property used in a trade or business and held for the required holding period (based on type of asset, as discussed below). Gain or loss on the following transactions is subject to section 1231 treatment.

• Sale or exchange of cattle and horses. The cattle and horses must be held for draft, breeding, dairy, or sporting purposes and held for 24 months or longer.

• Sale or exchange of other livestock. This livestock must be held for draft, breeding, dairy, or sporting purposes and held for 12 months or longer. Other livestock includes hogs, mules, sheep, goats, donkeys, and other fur-bearing animals. Other livestock does not include poultry.

• Sale or exchange of depreciable real property or personal property. This property must be used in your business and held longer than 1 year. Generally, property held for the production of rents or royalties is considered to be used in a trade or business. This property must also be either real property or is of a kind that is subject to depreciation under section 167 of the Internal Revenue Code. Examples of depreciable personal property include farm machinery and trucks. It also includes amortizable section 197 intangibles.

• Sale or exchange of real estate. This property must be used in your business and held longer than 1 year. Examples include your farm or ranch (including barns and sheds).

• Sale or exchange of unharvested crops. The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person, and the land must have been held longer than 1 year. You cannot keep any right or option to reacquire the land directly or indirectly (other than a right customarily incident to a mortgage or other security transaction). Growing crops sold with a leasehold on the land, even if sold to the same person in a single transaction, is not considered a section 1231 transaction.

• Distributive share of partnership gains and losses. Your distributive share must be from the sale or exchange of property listed above and held by the partnership for longer than 1 year (or for the required period for certain livestock). You will receive Schedule K-1 (Form 1065) showing the appropriate classification of any gains or losses distributed to you.

• Cutting or disposal of timber. Special rules apply if you owned the timber longer than 1 year and elect to treat timber cutting as a sale or exchange, or you enter into a cutting contract, as described in chapter 8 under Timber .

• Condemnation. The condemned property (defined in chapter 11) must have been held longer than 1 year. It must be business property or a capital asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. It cannot be property held for personal use.

• Casualty or theft. The casualty or theft must have affected business property, property held for the production of rents or royalties, or investment property (such as notes and bonds). You must have held the property longer than the required holding period. However, if your casualty or theft losses are more than your casualty or theft gains, the net casualty or theft loss is fully deductible and is not combined with other section 1231 transactions in the section 1231 computation. Section 1231 does not apply to personal casualty gains and losses. See chapter 11 for information on how to treat those gains and losses.

If the property is not held for the re-