Tangible business assets used in business operations for more than one year are classified as Section 1231 property by the Internal Revenue Service (IRS). Common types of Section 1231 property include office buildings and depreciable assets such as equipment, machinery, vehicles, and furniture. Business owners need to have a good understanding of Section 1231 property as it can impact taxes.
This Huddle Business Capital blog article features an overview of Section 1231 property. We explain how it works and how to report gains and losses from qualifying 1231 assets on your business tax return.
As mentioned earlier, Section 1231 property is defined as actual property (i.e., business structure) or depreciable assets (i.e., equipment) that a business holds over twelve months. Unharvested crops, cattle, livestock, and some natural resources (i.e., timber) are also classified under Section 1231, providing they are at least one year old. It is worth noting that Section 1231 does not apply to poultry, trademarks, copyrights, patents, or business inventory that is for customer purchase.
Eligible Section 1231 property is subject to depreciation rules under Internal Revenue Code Section 167—Depreciation (IRC 167). IRC 167 allows a reasonable depreciation deduction for wear and tear (including obsolescence) of property used in a business or property held for business income production.
When business owners sell a Section 1231 property held for more than a year at a gain, the capital gains tax rate is usually lower. In addition, the depreciation amount is treated as ordinary income. This usually results in lower tax rates.
From a tax perspective, it can also be advantageous for business owners to sell Section 1231 property at a loss. The reason is that the loss is treated as an ordinary loss, and the amount can be deducted from the business's ordinary income. In 2025, the capital loss limit is $3,000 for the tax year, so selling Section 1231 property at a loss might allow for tax relief.
Sales of business property (at a gain or a loss) need to be reported on IRS Form 4797, Sales of Business Property.1
Section 1231 transactions refer to specific categories of property sales or exchanges that the Internal Revenue Code governs in the United States. Following are some Section 1231 transactions (sales or exchanges) that can result in gains or losses.
Real Property — permanently fixed property (e.g., building, warehouse, storefront) that was held for over one year and used for business purposes.
Personal Property — moveable property (e.g., equipment, machinery, vehicles, office furniture) that was held for over one year and used for business purposes.
Leaseholds — leased or rented business property used in a trade or business and held for over one year.
Cattle — used for breeding or dairy purposes and held for two years or longer.
Unharvested Crops — vegetables and fruits held for at least one year before being sold or exchanged.
To calculate Section 1231 gains or losses, you must subtract the amount the property has depreciated from its original purchase price. Then, subtract the tax basis from the resale price, which reveals the Section 1231 gain or loss. The following is an example to illustrate this better.
A coffee shop owner wants to replace their espresso machine, which cost $10,000 five years ago. Since the purchase date, the espresso machine depreciated by $7,000, giving the machine a current tax basis of $3,000. The coffee shop owner then sells the espresso machine for $4,000. To determine the capital gain, the owner needs to subtract the $3,000 tax basis from the sale price of $4,000, which is $1,000.
The coffee shop will be taxed at the lower capital gains tax rate ($1,000) because it used the equipment for five years, four years longer than the IRS requirement.
Understanding Section 1231 transactions and their implications can play a crucial role in business tax planning. Huddle Business Capital recommends consulting a business accountant with questions about Section 1231, as every business's financial situation is unique.
1. https://www.irs.gov/forms-pubs/about-form-4797
This Huddle Business Capital blog article is purely educational and contains general information and opinions; it is not intended to provide advice or recommendations of any kind. Huddle Business Capital is not affiliated with nor endorses the Internal Revenue Service (IRS).