Frequently Asked Questions
Who is eligible for the Section 1231 Capital Gain-Ordinary Loss Rule?
Applies to depreciable property and real property used in a trade or business held for more than 1 year, subject to a 5-year lookback recapture rule for prior ordinary losses.
How does the Section 1231 Capital Gain-Ordinary Loss Rule work?
Net gains from the sale of business property held over one year are treated as long-term capital gains, while net losses are treated as ordinary losses (deductible against ordinary income).
What law authorizes the Section 1231 Capital Gain-Ordinary Loss Rule?
The Section 1231 Capital Gain-Ordinary Loss Rule is authorized under IRC §1231 of the Internal Revenue Code (Title 26, United States Code).
Statutory Text — IRC §1231
Source: Internal Revenue Code, Title 26, United States Code
§ 1231. Property used in the trade or business and involuntary conversions(a) General rule(1) Gains exceed lossesIf—(A) the section 1231 gains for any taxable year, exceed
(B) the section 1231 losses for such taxable year,
such gains and losses shall be treated as long-term capital gains or long-term capital losses, as the case may be.
(2) Gains do not exceed lossesIf—(A) the section 1231 gains for any taxable year, do not exceed
(B) the section 1231 losses for such taxable year,
such gains and losses shall not be treated as gains and losses from sales or exchanges of capital assets.
(3) Section 1231 gains and lossesFor purposes of this subsection—(A) Section 1231 gainThe term “section 1231 gain” means—(i) any recognized gain on the sale or exchange of property used in the trade or business, and
(ii) any recognized gain from the compulsory or involuntary conversion (as a result of destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the threat or imminence thereof) into other property or money of—(I) property used in the trade or business, or
(II) any capital asset which is held for more than 1 year and is held in connection with a trade or business or a transaction entered into for profit.
(B) Section 1231 lossThe term “section 1231 loss” means any recognized loss from a sale or exchange or conversion described in subparagraph (A).
(4) Special rulesFor purposes of this subsection—(A) In determining under this subsection whether gains exceed losses—(i) the section 1231 gains shall be included only if and to the extent taken into account in computing gross income, and
(ii) the section 1231 losses shall be included only if and to the extent taken into account in computing taxable income, except that section 1211 shall not apply.
(B) Losses (including losses not compensated for by insurance or otherwise) on the destruction, in whole or in part, theft or seizure, or requisition or condemnation of—(i) property used in the trade or business, or
(ii) capital assets which are held for more than 1 year and are held in connection with a trade or business or a transaction entered into for profit,
shall be treated as losses from a compulsory or involuntary conversion.
(C) In the case of any involuntary conversion (subject to the provisions of this subsection but for this sentence) arising from fire, storm, shipwreck, or other casualty, or from theft, of any—(i) property used in the trade or business, or
(ii) any capital asset which is held for more than 1 year and is held in connection with a trade or business or a transaction entered into for profit,
this subsection shall not apply to such conversion (whether resulting in gain or loss) if during the taxable year the recognized losses from such conversions exceed the recognized gains from such conversions.
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