If you dispose of depreciable or amortizable property at a gain, you may have to treat all or part of the gain (even if it is otherwise nontaxable) as ordinary income.
To figure any gain that must be reported as ordinary income, you must keep permanent records of the facts necessary to figure the depreciation or amortization allowed or allowable on your property. For more information, see chapter 3 of Publication 544.
A gain on the disposition of section 1245 property is treated as ordinary income to the extent of depreciation allowed or allowable.
Any recognized gain that is more than the part that is ordinary income because of depreciation is a section 1231 gain. See Treatment as ordinary or capital under Section 1231 Gains and Losses, earlier.
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.
- Personal property (either tangible or intangible).
- Other tangible property (except buildings and their structural components) used as any of the following. See Buildings and structural components below.
- An integral part of manufacturing, production, or extraction, or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services.
- A research facility in any of the activities in (a).
- A facility in any of the activities in (a) for the bulk storage of fungible commodities (discussed later).
- That part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following.
- Amortization of certified pollution control facilities.
- The section 179 expense deduction.
- Deduction for clean-fuel vehicles and certain refueling property placed in service before 2006.
- Certain expenditures for child care facilities. (Repealed by Public Law 101-58, Omnibus Budget Reconciliation Act of 1990, section 11801(a)(13) except with regards to deductions made prior to November 5, 1990.)
- Expenditures to remove architectural and transportation barriers to the handicapped and elderly.
- Certain reforestation expenditures.
- Single purpose agricultural (livestock) or horticultural structures.
- Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary product of petroleum.
See Chapter 3 of Publication 544 for more details.
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, and silos are not treated as buildings, but as section 1245 property. taxmap/pubs/p225-039.htm#en_us_publink100073627
This is a facility used mainly for the bulk storage of fungible commodities. Bulk storage means storage of a commodity in a large mass before it is used. For example, if a facility is used to store sorted and boxed oranges (the oranges are no longer in a large mass), 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.taxmap/pubs/p225-039.htm#en_us_publink100073628
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.
- The depreciation (which includes any section 179 deduction claimed) and amortization allowed or allowable on the property.
- The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property).
For any other disposition of section 1245 property, ordinary income is the lesser of (1) above or the amount by which its fair market value is more than its adjusted basis. For details, see chapter 3 of Publication 544.
Use Part III of Form 4797 to figure the ordinary income part of the gain.taxmap/pubs/p225-039.htm#en_us_publink100073629
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. For details on exchanges of property that are not taxable, see Like-Kind Exchanges in chapter 8.
- 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).
Jeff Free paid $120,000 for a tractor in 2006. On February 23, 2008, he traded it for a chopper and paid an additional $30,000. To figure his depreciation deduction for the current year, Jeff continues to use the basis of the tractor as he would have before the trade to depreciate the chopper. Jeff can also depreciate the additional $30,000 basis on the chopper.taxmap/pubs/p225-039.htm#en_us_publink100073631
Depreciation and amortization deductions that must be recaptured as ordinary income include (but are not limited to) the following items.
- Ordinary depreciation deductions.
- Section 179 deduction (see chapter 7).
- Any special depreciation allowance.
- Amortization deductions for all the following costs.
- Acquiring a lease.
- Lessee improvements.
- Pollution control facilities.
- Reforestation expenses.
- Section 197 intangibles.
- Childcare facility expenses incurred before 1982.
- Franchises, trademarks, and trade names acquired before August 11, 1993.
- Deductions for all the following costs.
- Removing barriers to the disabled and the elderly.
- Tertiary injectant expenses.
- Depreciable clean-fuel vehicles and refueling property (minus any recaptured deduction).
- Any basis reduction for the investment credit (minus any basis increase for a credit recapture).
- Any basis reduction for the qualified electric vehicle credit (minus any basis increase for a credit recapture).
You file your returns on a calendar year basis. In February 2006, you bought and placed in service for 100% use in your farming 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 $1,500 in 2006 and $2,550 in 2007. You did not claim the section 179 expense deduction for the truck. You sold it in May 2008 for $7,000. The MACRS deduction in 2008, the year of sale, is $893 (1
of $1,785). Figure the gain treated as ordinary income as follows.
|2)||Cost (February 2006)||$10,000|| |
|3)||Depreciation allowed or allowable (MACRS deductions: $1,500 + $2,550 + $893)||4,943|| |
|4)||Adjusted basis (subtract line 3|
from line 2)
|5)||Gain realized (subtract line 4|
from line 1)
|6)||Gain treated as ordinary income|
(lesser of line 3 or line 5)
You generally use the greater of the depreciation allowed or allowable when 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 the gain is treated as ordinary income under the rules for section 1245 depreciation recapture. taxmap/pubs/p225-039.htm#en_us_publink100073634
If you elect not to use the uniform capitalization rules (see chapter 6), you must treat any plant you produce as section 1245 property. If you have a gain on the property's disposition, you must recapture the preproductive expenses you would have capitalized if you had not made the election by treating the gain, up to the amount of these expenses, as ordinary income. For section 1231 transactions, show these expenses as depreciation on Form 4797, Part III, line 22. For plant sales that are reported on Schedule F (1040), Profit or Loss From Farming, this recapture rule does not change the reporting of income because the gain is already ordinary income. You can use the farm-price method or the unit-livestock-price method discussed in chapter 2 to figure these expenses. taxmap/pubs/p225-039.htm#en_us_publink100073635
Janet Maple sold her apple orchard in 2008 for $80,000. Her adjusted basis at the time of sale was $60,000. She bought the orchard in 2001, but the trees did not produce a crop until 2004. Her pre-productive expenses were $6,000. She elected not to use the uniform capitalization rules. Janet must treat $6,000 of the gain as ordinary income.taxmap/pubs/p225-039.htm#en_us_publink100073636
Section 1250 property includes all real property subject to an allowance for depreciation that is not and never has been section 1245 property. It includes a leasehold of land or section 1250 property subject to an allowance for depreciation. A fee simple interest in land is not section 1250 property because, like land, it is not depreciable.
Gain on the disposition of section 1250 property is treated as ordinary income to the extent of additional depreciation allowed or allowable. To determine the additional depreciation on section 1250 property, see Depreciation Recapture in chapter 3 of Publication 544.
You will not have additional depreciation if any of the following apply to the property disposed of.
- You figured depreciation for the property using the straight line method or any other method that does not result in depreciation that is more than the amount figured by the straight line method and you have held the property longer than 1 year.
- You chose the alternate ACRS (straight line) method for the property, which was a type of 15-, 18-, or 19-year real property covered by the section 1250 rules.
- The property was nonresidential real property placed in service after 1986 (or after July 31, 1986, if the choice to use MACRS was made) and you held it longer than 1 year. These properties are depreciated using the straight line method.
If you report the sale of property under the installment method, any depreciation recapture under section 1245 or 1250 is taxable as ordinary income in the year of sale. This applies even if no payments are received in that year. If the gain is more than the depreciation recapture income, report the rest of the gain using the rules of the installment method. For this purpose, include the recapture income in your installment sale basis to determine your gross profit on the installment sale.
If you dispose of more than one asset in a single transaction, you must separately figure the gain on each asset so that it may be properly reported. To do this, allocate the selling price and the payments you receive in the year of sale to each asset. Report any depreciation recapture income in the year of sale before using the installment method for any remaining gain.
For more information on installment sales, see chapter 10.taxmap/pubs/p225-039.htm#en_us_publink100073638
Chapter 3 of Publication 544 discusses the tax treatment of the following transfers of depreciable property.
- By gift.
- At death.
- In like-kind exchanges.
- In involuntary conversions.
Publication 544 also explains how to handle a single transaction involving multiple properties.