Section 1231 assets include real estate and depreciable assets used for trade or business and held for more than a year. They are named after section 1231 of the US tax code. Capital assets are defined more broadly as property used personally or held for investment. Knowing the difference in 1231 asset vs capital asset treatment is vital to accurate tax reporting and maximization of tax benefits.
Key Takeaways
- A capital asset is property used personally or held for investment.
- A 1231 asset is depreciable property or real estate held for more than a year and used in a trade or business.
- Capital gains are taxed at favorable rates if long-term, and loss limitations apply.
- A net 1231 gain for the year is taxed at favorable capital gains rates; a net 1231 loss for the year can be used to offset ordinary (non-capital gains) income without the limitations imposed on capital losses.
Examples and Features of 1231 Assets
The following are common examples of 1231 assets:
- Office building
- Land where the company’s office building is located
- Office equipment
- Machinery used at a factory
- Vehicles used for business
Depreciable property and real estate used in a trade or business but held for a year or less are not 1231 assets. These assets held for less than a year are treated as “ordinary assets.” Similar to inventory, any gain or loss from their sale is treated as ordinary income or loss and subject to the company’s normal income tax rates. Read more about 1231 assets.
Examples and Features of Capital Assets
The tax code specifically excludes the following from being classified as capital assets:
- Inventory
- Accounts and notes receivable
- Business property classified as section 1231 property
- Certain kinds of intellectual property
The most common examples of capital assets owned by a company are stocks and bonds purchased as investments. In addition, anything owned by taxpayers and used personally—such as homes, cars, and other belongings—is classified as a capital asset.
1231 Asset vs Capital Asset Comparison
Below you’ll find a chart comparing 1231 assets and capital assets.
1231 Asset | Capital Asset |
|---|---|
Personal property (e.g., furniture, fixtures, vehicles, machinery, or equipment used in a trade or business) | Personal property (e.g., a primary residence, a vehicle, jewelry, or furniture used for nonbusiness purposes) |
Real estate used in a trade or business | Real estate held for investment purposes |
Certain kinds of livestock | Investment stocks and bonds |
1 year holding requirement to be a 1231 asset; sale results in 1231 gains or losses | Sale can result in short- or long-term capital gains or losses |
1231 Gain vs Capital Gain and Loss
Section 1231 gains and capital gains are both taxed at the same favorable capital gains tax rates, which are typically lower than the tax rates that apply to other types of income. However, net 1231 losses are treated as ordinary losses, while losses on capital assets are treated as capital.
Capital losses can be netted with capital gains, and any excess losses are generally not deductible against ordinary income. However, individuals—including partners and S-corp shareholders—can deduct capital losses of $3,000 per year against ordinary income. The $3,000 annual allowance is not available to C-corporations. Capital losses not allowed against ordinary income can be carried forward indefinitely until they are used up.
Below is a summary chart comparing 1231 gain and loss with capital gain and loss treatment.
Tax Feature | 1231 Assets | Capital Assets | Short-term Capital Assets |
|---|---|---|---|
Tax Rate on Gains | Capital gain rate | Capital gain rate | Ordinary tax rate |
Treatment of Net Losses | Can be netted in full against ordinary income | $3,000/year can be netted against ordinary income | |
Carryforward of Excess Losses | Losses can be completely deducted in year incurred | Can be carried forward indefinitely to future tax years | |
Capital Gain Treatment
The sale of capital assets results in capital gains or capital losses, which can be long- or short-term. Ordinary income rates apply when capital assets are sold after being held for a year or less. Ordinary income is taxed at higher rates than long-term capital gains.
Long-term capital gain rates apply when capital assets are sold after being held for more than a year. When losses are incurred on the sale of capital assets, they can offset capital gains. Once all of the capital gains are absorbed, any remaining losses can be deducted by the taxpayer in increments of $3,000 per year until the capital loss has been fully allocated.
Example of Capital Gain and Loss Calculation
On June 15, 2012, Joe Schmoe purchased 25 shares of ABC stock for $500 per share, for a total purchase price of $12,500. Joe sold all 25 shares on August 3, 2024, when the value of each share of ABC had plummeted to $50 per share. Joe received $1,250 in sale proceeds ($50 × 25). Joe recognized a loss of $11,250 ($12,500 − $1,250) on the disposition of ABC stock.
In a separate 2024 transaction, Joe sold 10 shares of DEF stock for $5,000. The 10 shares of DEF stock were purchased on April 21, 2018 for $1,000. The sale of Joe’s DEF stock resulted in a long-term capital gain of $4,000. These transactions generated the following reportable activity for 2024:
Reportable Activity on 2024 Tax Return: | |
|---|---|
Long-term Capital Loss: ABC stock | ($11,250) |
Long-term Capital Gain: DEF stock | $4,000 |
Net of Long-term Capital Gain and Loss | ($7,250) |
Capital Loss Allocation to Ordinary Income | ($3,000) |
Capital Loss to be Carried Forward to 2022 | ($4,250) |
2024 Tax Return: Netting of Capital Losses and Capital Gains
- $11,250 in losses minus $4,000 in gains = $7,250 capital loss remaining
- Joe used $3,000 of the $7,250 loss remaining to offset his ordinary income, like wages.
- $7,250 in excess losses; $3,000 of losses used to offset ordinary wage income = $4,250 in capital losses available to carry forward to 2025.
1231 Gain Treatment
The sale of 1231 assets results in 1231 gains or 1231 losses. 1231 gains get taxed at the same lower capital gain rates that apply to gains on the sale of capital assets. The IRS allows this favorable treatment to encourage taxpayers to engage in trade or business pursuits.
1231 losses are fully deductible against 1231 gains as well as ordinary income in the year incurred. This is a great advantage when there is a 1231 loss in a year where there is a lot of ordinary income.
Example of 1231 Gain and Loss Calculation
On June 15, 2024, Joe Schmoe sold a building at 15 Waverly Place that he had owned for more than one year for a loss of $60,000. In 2024, he also sold a second building owned for more than one year at 2150 Williams Way for a gain of $40,000. Both properties were used in Joe’s business.
Reportable Activity on 2024 Tax Return: | |
|---|---|
1231 Long-term Loss on 15 Waverly Place | ($60,000) |
1231 Long-term Gain on 2150 Williams Way | $40,000 |
Net of 1231 Gain and Loss | ($20,000) |
1231 Loss Deducted as Ordinary | ($20,000) |
2024 Tax Return: Netting of 1231 Gains and Losses
- $60,000 in losses minus $40,000 in gains = $20,000 1231 loss remaining
- Because the $20,000 loss is a 1231 loss, the entire amount can be deducted against other sources of income on the 2024 tax return
Tax Planning Pro Tips for Capital Assets vs 1231 Assets
Taxpayers can take a tactical approach to asset sales as a useful tax planning tool. Identifying the difference between capital asset and 1231 asset treatment can help you design a more tailored tax plan. Here are some commonly used strategies that can be used to help reduce your tax bill.
Planning for Capital Asset Sales
Consider selling capital assets that have decreased in value in the same year you anticipate capital gains. For instance, if Stock A has appreciated while Stock B has depreciated, selling both in the same year allows you to use the capital losses from Stock B to offset the capital gains from Stock A.
This strategy is known as tax harvesting. It’s important to note that the IRS has rules in place to make sure that the intent of the sale is transparent and legitimate. If you sell a stock to create a loss but buy it back in 30 days, the sale is considered a wash sale, and the loss is disallowed for the year. This IRS rule keeps taxpayers from creating a loss while essentially still keeping the security.
Planning for 1231 Asset Sales
In years where high ordinary income is expected, you may consider selling 1231 assets that have gone down in value to have losses available to offset that income. For example, if your company’s sales are higher than expected or you’re recognizing income from an unusually large contract, a loss on a sale of a 1231 asset could provide tax savings against that ordinary income.
It’s important to note that 1231 losses deducted against ordinary income might cause 1231 gains in the next five years to be treated as ordinary gains (instead of capital gains). This conversion from capital gain to ordinary income is called 1231 recapture. Learn more about 1231 taxation.
Frequently Asked Questions (FAQs)
Section 1231 gains—after being netted against any 1231 losses—qualify for capital gain treatment, but the assets generating the gain are not capital assets.
Section 1231 gain can be generated by different kinds of business assets, while section 1250 gain is specifically related to real estate. In other words, section 1250 gain is just one type of 1231 gain.
Yes. Sale of land results in 1231 gain or loss when it is used for trade or business purposes and held for more than one year.
Bottom Line
Capital assets include various personal and investment properties, while 1231 assets specifically refer to real estate or depreciable property used in a trade or business. Sale of 1231 assets held for over a year results in capital gain tax rates on gains and ordinary deductions for losses. Depreciable property and real estate used in a trade or business, sold for a gain but held under a year, do not qualify for favorable 1231 tax treatment. Taxpayers can use this information to develop strategic tax plans to minimize liabilities.
