CandleFocus Glossary Editor
Section 1245, part of the Internal Revenue Code, is a special provision that allows the IRS to adjust the tax treatment of depreciation and amortization of tangible or intangible assets (also referred to as 1231 assets). Generally, taxpayers may claim tax deductions for depreciation and amortization of assets held for business purposes, resulting in lower taxable income. When assets are sold for a profit, under the provisions of Section 1245, the IRS recaptures the amount of allowed depreciation or amortization taken on the asset at ordinary income tax rates. The primary purpose of Section 1245 is to prevent taxpayers from receiving an excessively low tax rate on capital gains from asset sales.
Under Section 1245, gains from the sale of any depreciable or amortizable tangible or intangible asset which was acquired after March 11, 1998 and prior to December 31, 2021 are considered to be ordinary income up to the amount of the allowable depreciation or amortization deductions taken on the asset. For example, if a taxpayer purchased a depreciable tangible asset and claimed a depreciation deduction of $1,000 each year over the past 5 years, if the asset was subsequently sold for a gain of $6,000, the taxpayer’s gain would be taxed at ordinary income tax rates up to the amount of depreciation taken, or $5,000 in this example. The remaining $1,000 would be taxed at the lower long-term capital gains rate.
While Section 1245 does encourage taxpayers to recognize losses and long-term gains, certain taxpayers may benefit from structuring their business differently, or from using asset alternative strategies such as hedging or swapping, in order to take advantage of tax laws. Additionally, taxpayers should be aware that the sale of Section 1245 assets may trigger recapture of other tax deductions related to the asset, such as research and development credits or energy credits.
Overall, Section 1245 is an important part of the Internal Revenue Code, and taxpayers should be aware of this provision when disposing of 1231 assets. Knowing the rules and utilizing sound tax planning strategies can help taxpayers to optimize their capital gains and ensure that they remain in compliance with the IRS.
Under Section 1245, gains from the sale of any depreciable or amortizable tangible or intangible asset which was acquired after March 11, 1998 and prior to December 31, 2021 are considered to be ordinary income up to the amount of the allowable depreciation or amortization deductions taken on the asset. For example, if a taxpayer purchased a depreciable tangible asset and claimed a depreciation deduction of $1,000 each year over the past 5 years, if the asset was subsequently sold for a gain of $6,000, the taxpayer’s gain would be taxed at ordinary income tax rates up to the amount of depreciation taken, or $5,000 in this example. The remaining $1,000 would be taxed at the lower long-term capital gains rate.
While Section 1245 does encourage taxpayers to recognize losses and long-term gains, certain taxpayers may benefit from structuring their business differently, or from using asset alternative strategies such as hedging or swapping, in order to take advantage of tax laws. Additionally, taxpayers should be aware that the sale of Section 1245 assets may trigger recapture of other tax deductions related to the asset, such as research and development credits or energy credits.
Overall, Section 1245 is an important part of the Internal Revenue Code, and taxpayers should be aware of this provision when disposing of 1231 assets. Knowing the rules and utilizing sound tax planning strategies can help taxpayers to optimize their capital gains and ensure that they remain in compliance with the IRS.