What is Section 1245 property? The article below has been drafted by a tax attorney at The McGuire Law Firm to provide information on section 1245 property.
Section 1245 property is property that is or has been subject to an allowance for depreciation or amortization. Gain on section 1245 property is treated as ordinary income up to the amount of depreciation allowed or allowable on the property, which will be discussed below. Furthermore, gain recognized beyond the portion taxable as ordinary income from depreciation is considered Section 1231 gain. The following are types of Section 1245 property:
– Tangible and intangible personal property
– Other tangible property (except buildings and the buildings structural components), used for: manufacturing, production, extraction or for furnishing transportation, gas, water, and other services; certain research facilities and facilities for bulk storage.
As stated above, section 1245 property does not include buildings and structure component. The term building includes a house, barn, warehouse, or garage, and the term structural component includes walls, floors, windows, central A/C systems, light fixtures etc etc. It is important to not treat a structure that is essentially machinery or equipment as a building or structural component to a building. Furthermore, a structure that houses property used as a vital or integral part of an activity should not be treated as building or structural component if the structure is so closely related to the property’s use that the structure would likely be replaced if the property were replaced.
When the section 1245 property is sold, exchanged of involuntarily converted, the gain that is treated as ordinary income is the lesser of: the depreciation and amortization allowed or allowable on the property or the gain realized on the disposition of the property (the amount realized less the adjusted basis of the property. The depreciation and amortization will include amounts claimed on property exchanged for or converted to your section 1245 property in an exchange such as a 1031 like kind exchange and amounts a previous owner of the section 1245 property claimed if the basis in the property is determined by referencing that person’s adjusted basis, just as for property you may have received as a gift.
Examples of some of the depreciation and amortization that must be recaptured as ordinary income are: ordinary income deductions, special depreciation claimed, amortization for items such as lease improvements, costs of acquiring a lease, Section 197 intangibles, and Section 179 elections.
As an example, say you purchased a truck for use in your business for $20,000. You took $10,000 of depreciation and then sold the truck for $12,500. Your adjusted basis in the truck would have been $10,000 (the $20,000 purchase price less the $10,000 in depreciation) and your amount realized would be the $12,500. Thus, you would have $2,500 in gain that would be taxed as ordinary income.
If you have questions related to the taxation of certain assets or transactions, you can speak with a Denver tax attorney at The McGuire Law Firm. Schedule a free consultation with a tax attorney and business attorney at The McGuire Law Firm.