Publication 544: Sales and Other Dispositions of Assets
Understand the tax implications of selling or exchanging property. Learn the essential steps for calculating, classifying, and reporting gains and losses.
IRS Publication 544, “Sales and Other Dispositions of Assets,” guides taxpayers in reporting the sale, exchange, or other disposition of property. It explains the tax implications for various transactions, from calculating gain or loss to understanding its character. This guide clarifies the tax obligations for dispositions including sales, exchanges, condemnations, and abandonments.
Determining Gain or Loss
To determine the tax consequences of a property disposition, you must first calculate the gain or loss. The formula is the amount you realize from the sale minus your adjusted basis in the property.
The amount realized is the total value received for the property, including cash, the fair market value (FMV) of other property or services, and any of your debts the buyer assumes. For example, if you sell a vehicle for $10,000 cash and the buyer also pays off your $5,000 car loan, your amount realized is $15,000.
A property’s adjusted basis begins with its original cost, which is then modified over time. The basis is increased by capital improvements, like adding a new room to a house. It is decreased by certain deductions, such as depreciation or claimed casualty losses.
For example, a rental property purchased for $200,000 that had $30,000 in improvements and $50,000 in depreciation deductions has an adjusted basis of $180,000 ($200,000 + $30,000 – $50,000). This figure is used to determine the gain or loss.
Character of Gain or Loss
After calculating the gain or loss, you must determine its character as either capital or ordinary. This distinction dictates how it is taxed. Capital gains are often taxed at lower rates, while the rules for deducting capital losses are more restrictive than for ordinary losses.
The IRS defines a capital asset by what it is not, excluding items like inventory and depreciable business property. For most individuals, common capital assets include stocks, bonds, and personal-use property like a home.
The holding period—the length of time you owned the asset—also affects your tax liability. A holding period of one year or less results in a short-term gain or loss, taxed at ordinary income rates. Holding an asset for more than one year results in a long-term gain or loss, which benefits from lower tax rates.
The 2024 tax rate on most net long-term capital gains is 0%, 15%, or 20%, depending on taxable income. For single filers with taxable income up to $47,025, the rate is 0%. Losses from the sale of personal-use property, like a car or home, are not tax-deductible.
Dispositions of Business Property
Property used in a trade or business has unique tax rules that blend ordinary and capital gain concepts. Section 1231 of the tax code provides special treatment for these properties when sold or exchanged.
Section 1231 Property
This section applies to depreciable and real property used in a business and held for more than one year. If the net result of all these transactions in a year is a gain, it is treated as a long-term capital gain. If the net result is a loss, it is treated as a fully deductible ordinary loss.
Depreciation Recapture
When selling business property at a gain, you may have to recapture prior depreciation deductions. This rule recharacterizes a portion of a potential capital gain as ordinary income. Because depreciation deductions offset ordinary income, the gain resulting from them is also taxed as ordinary income.
Section 1245 Recapture
Section 1245 applies to depreciable personal property like equipment and machinery. Any gain on a sale is treated as ordinary income up to the amount of depreciation previously claimed. For example, if a machine with an adjusted basis of $30,000 (due to $20,000 in depreciation) is sold for $45,000, the entire $15,000 gain is ordinary income because it’s less than the depreciation taken.
Section 1250 Recapture
Section 1250 applies to depreciable real property, like commercial buildings. A concept called “unrecaptured Section 1250 gain” applies to the portion of the gain from straight-line depreciation. This part of the gain is taxed at a maximum rate of 25%, with any remaining gain treated as a Section 1231 gain.
Nonrecognition Transactions
The tax code allows you to defer a gain or loss on certain dispositions, called nonrecognition transactions. These transactions involve reinvesting proceeds into new, similar property. The tax on the gain is postponed, not eliminated, and the basis of the old property is carried over to the new property.
Like-Kind Exchanges
A like-kind exchange under Section 1031 allows you to defer gain or loss when exchanging business or investment real property for other real property of a “like kind.” Current law limits these exchanges to real property only, so you can exchange an apartment building for land but not business equipment. These exchanges have strict rules, including deadlines for identifying and acquiring the replacement property.
Involuntary Conversions
An involuntary conversion under Section 1033 applies when property is destroyed, stolen, or condemned, and you receive insurance proceeds or an award. You can defer a gain from the conversion by reinvesting it in qualified replacement property. The replacement property must be similar or related in service or use and acquired within two years from the end of the tax year the gain was realized.
Other Types of Dispositions
Installment Sales
An installment sale is a disposition where at least one payment is received after the tax year of the sale. Under Section 453, this allows you to report the gain over time as you receive payments. A portion of each payment is reported as gain, calculated using a gross profit percentage. Sales of inventory and sales resulting in a loss are not eligible for this method.
Bad Debts
If you cannot collect money owed to you, you may be able to deduct it as a bad debt. The tax treatment depends on whether it is a business or nonbusiness debt. A business bad debt arises from your trade or business and can be deducted as an ordinary loss, fully offsetting ordinary income.
You can even deduct a partially worthless business bad debt. In contrast, a nonbusiness bad debt, such as a personal loan to a friend, is only deductible when it becomes completely worthless. These debts are treated as short-term capital losses, which are subject to a $3,000 per year deduction limit against ordinary income after offsetting capital gains.