The tax mechanics involved in the sale of trade or business property
What tax consequences result from selling a piece of the property employed in your trade or business?
A variety of laws may govern the sale of commercial real estate. To make the topic more straightforward, let’s assume that the asset you want to sell is land or depreciable property used in your company. Let’s also assume that it has been in your possession for at least a year. There are different rules for property held primarily for sale to customers in the ordinary course of:
- Intellectual Property
- Low-income housing
- Property that involves farming or livestock
- Other types of property
Selling trade or business property
Your gains and losses from the sales of business property net against one another per the IRS Internal Revenue Code. The net gain or loss is eligible for the following tax treatment:
- Suppose the netting of gains and losses results in a net gain. In that case, long-term capital gain treatment results, subject to the “recapture” rules discussed below. Ordinary income treatment is typically less favorable than long-term capital gain treatment.
- If there remains a net loss after offsetting profits and losses, the loss is entirely deductible from ordinary income. In other words, none of the rules that limit the deductibility of capital losses apply.
Recapture rules apply when amounts are considered ordinary income rather than capital gain due to prior ordinary loss or deduction treatment for these amounts. These regulations place restrictions on long-term capital gain treatment for commercial property net gains.
There is a unique recapture regulation that only applies to commercial property. According to this regulation, any business property net gain is ordinary income rather than a long-term capital gain if you’ve suffered a net loss on the business property during the previous five years.
Section 1245 Property
All depreciable personal property, tangible or intangible, and specific depreciable real property are “Section 1245 Property.” Further, it is usually real property that performs particular functions. It would be best if you recouped your gain from selling Section 1245 property as ordinary income to the extent that you previously claimed depreciation deductions for the asset.
Section 1250 Property
Typically, “Section 1250 Property” refers to buildings and the structural elements of those buildings. Depreciation recapture will not apply to any long-term capital gains related to depreciation deductions if you sell Section 1250 property that was in operation after 1986. However, for most noncorporate taxpayers, the gain attributable to depreciation deductions will be taxed at no more than a 28.8% rate (25% as adjusted for the 3.8% net investment income tax). That is, as long as it doesn’t exceed business property net gain as reduced by the business property recapture rule above. The alternative is the maximum 23.8% (20% as adjusted for the 3.8% net investment income tax) that typically applies.
Different regulations can be applicable depending on the implementation of Section 1250 Property.
Tax implications for selling business assets
As you can see, the tax treatment of the sale of business assets can be complex, even with the article’s simplifying assumptions. If you have any further concerns or want to learn more about the tax implications of a particular transaction, contact our RRBB accountants and advisors.
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