Section 1245 Property

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Section 1245 Property

A gain on the disposition of section 1245 property is treated as ordinary income to the extent of depreciation allowed or allowable on the property. See Gain Treated as Ordinary Income, later.

Any gain recognized that is more than the part that is ordinary income from depreciation is a section 1231 gain. See Treatment as ordinary or capital under Section 1231 Gains and Losses, earlier.

Section 1245 property defined. Section 1245 property includes any property that is or has been subject to an allowance for depreciation or amortization and that is any of the following types of property.
  1. Personal property (either tangible or intangible).

  2. Other tangible property (except buildings and their structural components) used as any of the following. See Buildings and structural components below.

    1. An integral part of manufacturing, production, or extraction, or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services.

    2. A research facility in any of the activities in (a).

    3. A facility in any of the activities in (a) for the bulk storage of fungible commodities (discussed on the next page).

  3. That part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following.

    1. Amortization of certified pollution control facilities.

    2. The section 179 expense deduction.

    3. Deduction for clean-fuel vehicles and certain refueling property.

    4. Deduction for capital costs incurred in complying with Environmental Protection Agency sulfur regulations.

    5. Deduction for certain qualified refinery property.

    6. Deduction for qualified energy efficient commercial building property.

    7. Deduction for election to expense qualified advanced mine safety equipment property.

    8. Amortization of railroad grading and tunnel bores, if in effect before the repeal by the revenue Reconciliation Act of 1990. (Repealed by Public Law 99-514, Tax Reform Act of 1986, section 242(a).)

    9. Certain expenditures for child care facilities. If in effect before the repeal by P.L. 101–158 sec. 11801 (a) (13). (Repealed by Public Law 101-58, Omnibus Budget Reconciliation Act of 1990, section 11801(a)(13) except with regards to deductions made prior to November 5, 1990.)

    10. Expenditures to remove architectural and transportation barriers to the handicapped and elderly.

    11. Deduction for qualified tertiary injectant expenses.

    12. Certain reforestation expenditures.

  4. Single purpose agricultural (livestock) or horticultural structures.

  5. Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary product of petroleum.

  6. Any railroad grading or tunnel bore.

Buildings and structural components. Section 1245 property does not include buildings and structural components. The term building includes a house, barn, warehouse, or garage. The term structural component includes walls, floors, windows, doors, central air conditioning systems, light fixtures, etc.

Do not treat a structure that is essentially machinery or equipment as a building or structural component. Also, do not treat a structure that houses property used as an integral part of an activity as a building or structural component if the structure's use is so closely related to the property's use that the structure can be expected to be replaced when the property it initially houses is replaced.

The fact that the structure is specially designed to withstand the stress and other demands of the property and cannot be used economically for other purposes indicates it is closely related to the use of the property it houses. Structures such as oil and gas storage tanks, grain storage bins, silos, fractionating towers, blast furnaces, basic oxygen furnaces, coke ovens, brick kilns, and coal tipples are not treated as buildings, but as section 1245 property.

Facility for bulk storage of fungible commodities. This term includes oil or gas storage tanks and grain storage bins. Bulk storage means the storage of a commodity in a large mass before it is used. For example, if a facility is used to store oranges that have been sorted and boxed, it is not used for bulk storage. To be fungible, a commodity must be such that one part may be used in place of another.

Stored materials that vary in composition, size, and weight are not fungible. Materials are not fungible if one part cannot be used in place of another part and the materials cannot be estimated and replaced by simple reference to weight, measure, and number. For example, the storage of different grades and forms of aluminum scrap is not storage of fungible commodities.

Gain Treated as Ordinary Income

The gain treated as ordinary income on the sale, exchange, or involuntary conversion of section 1245 property, including a sale and leaseback transaction, is the lesser of the following amounts.

  1. The depreciation and amortization allowed or allowable on the property.

  2. The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property).

A limit on this amount for gain on like-kind exchanges and involuntary conversions is explained later.

For any other disposition of section 1245 property, ordinary income is the lesser of (1) earlier or the amount by which its fair market value is more than its adjusted basis. See Gifts and Transfers at Death, later.

Use Part III of Form 4797 to figure the ordinary income part of the gain.

Depreciation taken on other property or taken by other taxpayers. Depreciation and amortization include the amounts you claimed on the section 1245 property as well as the following depreciation and amortization amounts.
  • Amounts you claimed on property you exchanged for, or converted to, your section 1245 property in a like-kind exchange or involuntary conversion.

  • Amounts a previous owner of the section 1245 property claimed if your basis is determined with reference to that person's adjusted basis (for example, the donor's depreciation deductions on property you received as a gift).

Depreciation and amortization. Depreciation and amortization that must be recaptured as ordinary income include (but are not limited to) the following items.
  1. Ordinary depreciation deductions.

  2. Any special depreciation allowance you claimed.

  3. Amortization deductions for all the following costs.

    1. Acquiring a lease.

    2. Lessee improvements.

    3. Certified pollution control facilities.

    4. Certain reforestation expenses.

    5. Section 197 intangibles.

    6. Childcare facility expenses made before 1982, if in effect before the repeal of IRC 188.

    7. Franchises, trademarks, and trade names acquired before August 11, 1993.

  4. The section 179 deduction.

  5. Deductions for all the following costs.

    1. Removing barriers to the disabled and the elderly.

    2. Tertiary injectant expenses.

    3. Depreciable clean-fuel vehicles and refueling property (minus the amount of any recaptured deduction).

    4. Environmental cleanup costs.

    5. Certain reforestation expenses.

    6. Qualified disaster expenses.

  6. Any basis reduction for the investment credit (minus any basis increase for credit recapture).

  7. Any basis reduction for the qualified electric vehicle credit (minus any basis increase for credit recapture).

Example.

You file your returns on a calendar year basis. In February 2009, you bought and placed in service for 100% use in your business a light-duty truck (5-year property) that cost $10,000. You used the half-year convention and your MACRS deductions for the truck were $2,000 in 2009 and $3,200 in 2010. You did not take the section 179 deduction. You sold the truck in May 2011 for $7,000. The MACRS deduction in 2011, the year of sale, is $960 (½ of $1,920). Figure the gain treated as ordinary income as follows.

1) Amount realized $7,000
2) Cost (February 2009) $10,000
3) Depreciation allowed or allowable (MACRS deductions: $2,000 + $3,200 + $960) 6,160
4) Adjusted basis (subtract line 3
from line 2)
$3,840
5) Gain realized (subtract line 4
from line 1)
$3,160
6) Gain treated as ordinary income
(lesser of line 3 or line 5)
$3,160

Depreciation on other tangible property. You must take into account depreciation during periods when the property was not used as an integral part of an activity or did not constitute a research or storage facility, as described earlier under Section 1245 property.

For example, if depreciation deductions taken on certain storage facilities amounted to $10,000, of which $6,000 is from the periods before their use in a prescribed business activity, you must use the entire $10,000 in determining ordinary income from depreciation.

Depreciation allowed or allowable. The greater of the depreciation allowed or allowable is generally the amount to use in figuring the part of gain to report as ordinary income. If, in prior years, you have consistently taken proper deductions under one method, the amount allowed for your prior years will not be increased even though a greater amount would have been allowed under another proper method. If you did not take any deduction at all for depreciation, your adjustments to basis for depreciation allowable are figured by using the straight line method.

This treatment applies only when figuring what part of gain is treated as ordinary income under the rules for section 1245 depreciation recapture.

Multiple asset accounts. In figuring ordinary income from depreciation, you can treat any number of units of section 1245 property in a single depreciation account as one item if the total ordinary income from depreciation figured by using this method is not less than it would be if depreciation on each unit were figured separately.

Example.

In one transaction you sold 50 machines, 25 trucks, and certain other property that is not section 1245 property. All of the depreciation was recorded in a single depreciation account. After dividing the total received among the various assets sold, you figured that each unit of section 1245 property was sold at a gain. You can figure the ordinary income from depreciation as if the 50 machines and 25 trucks were one item.

However, if 5 of the trucks had been sold at a loss, only the 50 machines and 20 of the trucks could be treated as one item in determining the ordinary income from depreciation.

Normal retirement. The normal retirement of section 1245 property in multiple asset accounts does not require recognition of gain as ordinary income from depreciation if your method of accounting for asset retirements does not require recognition of that gain.