What Is Form 1239 and Who Needs to File It?
Understand when a sale of depreciable property to a related person requires the gain to be treated as ordinary income, not capital gain, on your tax return.
When selling certain types of property, the resulting gain is often taxed at preferential capital gains rates. However, the Internal Revenue Service (IRS) has specific rules when these sales occur between related parties. IRS Form 1239, “Gain From Sale or Exchange of Certain Depreciable Property Between Certain Related Persons,” is used to report these transactions. Its function is to enforce a tax code provision: any gain from selling depreciable property to a related person is treated as ordinary income, not capital gain. This prevents related parties from generating tax benefits by selling assets to create new depreciation cycles while paying lower capital gains taxes.
Defining a Related Person
The definition of a “related person” under Internal Revenue Code Section 1239 is precise and extends beyond immediate family. The rules target relationships involving control, where one party can influence the other. The most common scenarios involve a person and their controlled entities, such as a corporation or partnership where the individual directly or indirectly owns more than 50% of the stock value or capital and profits interest.
Other specified relationships include:
- A taxpayer and any trust in which they or their spouse is a beneficiary.
- An executor of an estate and a beneficiary of that same estate, unless the sale is to satisfy a specific monetary bequest.
- Two corporations that are members of the same controlled group.
A concept in determining these relationships is constructive ownership, or attribution. Under these rules, an individual is considered to own stock or partnership interests that are actually owned by their family members, including a spouse, children, grandchildren, and parents. These attribution rules are applied to determine if the “more than 50%” control threshold is met, meaning a person might be considered a related party even if they do not personally own a majority stake.
Completing Form 1239
The form is divided into two main parts. Part I requires the name and identifying number, such as a Social Security Number (SSN) or Employer Identification Number (EIN), of the related person or entity that purchased the property.
Part II is where the details of the property sale are entered. It includes columns for a description of each property sold, the date of the sale, and the recognized gain. The gain reported here is the amount that will be recharacterized from capital gain to ordinary income.
Filing the Completed Form
Form 1239 is not a standalone tax form and must be attached to the filer’s main income tax return for the year in which the sale occurred. For individuals, this would be Form 1040. For business entities, it would be attached to returns like Form 1120 for corporations or Form 1065 for partnerships.
The total gain calculated in Part II of Form 1239 is then reported as ordinary income on other tax forms. Specifically, the gain is entered on Part II of Form 4797, “Sales of Business Property.” From there, it flows to the taxpayer’s main return as ordinary income.