When it comes to calculating gains or losses on asset sales, a few factors come into play: the asset’s holding period, type, and whether it was employed for personal use or in service of a trade or business.

Regarding the first dimension, when a taxpayer disposes of property, the Internal Revenue Code recognizes the gain or loss under either a capital or ordinary classification. For the last two, the taxpayer determines the character of the transaction by looking at the nature of the asset disposed.

This post examines the disposition treatment (gains and losses) for Section 1231, 1245, and 1250 property used in a trade or business.

What are Capital Gains and Losses?

A capital asset is an item owned for investment or personal purposes, machinery and equipment, buildings, and other personal-use items like household furnishings. By extension, this includes other implements in which the owner also intends to receive a return component such as stocks or bonds.

Depreciable assets, inventory, and other assets used in a business are not considered capital assets for tax purposes.

If an asset’s value changes and a difference between the adjusted basis in the asset and the amount realized from the sale exists, the sale produces a capital gain or capital loss. This is the capital loss definition.

For taxpayers, rates under capital gains often result in a more favorable tax treatment than those received under ordinary gains (short-term). In the case of capital losses, the taxpayer wants ordinary loss treatment because this deducts directly against the taxpayer’s taxable income and does not have an annual cap.

Also, always be mindful of the tax benefits of paying zero tax on passive income and long-term capital gains up to certain income thresholds.

Finally, capital gains and losses divide into two dimensions based upon holding period: short-term and long-term. The former has an asset held by the owner for a period of under one year while the latter involves holding for one year or longer.

Some exceptions to this rule exist in the case of patent property or property acquired by gift or from a decedent. For these items, refer to Publication 544, Sales and Other Dispositions of Assets, or Publication 550, Investment Income and Expenses.

Further, capital gains and losses can occur in traditional investments as well as alternative investments or any instance in which you place capital at risk.

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