There are many rules that can potentially apply to the sale of business property. Thus, to simplify discussion, we will assume that the property about which you are inquiring (the “Business Property”) is land or depreciable property used in your business and held by you for more than a year. We will further assume that none of the property is (1) inventory, (2) property held primarily for sale to customers in the ordinary course of your business, (3) copyrights, literary, musical or artistic property, letters, memoranda or similar property, (4) U.S. government publications, (5) low-income housing, or (6) the subject of a sale-leaseback or long-term lease. We will assume too that your business doesn’t involve farming or livestock, natural resources (timber, oil, mineral ore, etc.) or collectibles. Additionally, the discussion won’t take into account any gains or losses derived from exchanges of property or from theft, casualty, seizure or condemnation (or the threat or imminence of condemnation).

General rules. Under Section 1231 of the Internal Revenue Code (the “Code”), your gains and losses from sales of Business Property are netted against each other. The net gain or loss qualifies for a “best of both worlds” tax treatment as follows:

 (1) If the netting of gains and losses results in a net gain (“Business Property Net Gain”), then, subject to “recapture” rules discussed below, long-term capital gain treatment results. For taxpayers that aren’t corporations and for corporations that, under subchapter S of the Code, elect to not be subject to the corporate tax (“noncorporate taxpayers”), long-term capital gain treatment is generally more favorable than ordinary income treatment.

 (2) If the netting of gains and losses results in a net loss (“Business Property Net Loss”), that loss is fully deductible against ordinary income (i.e., none of the rules that limit the deductibility of capital losses apply).

Recapture rules. The availability of long-term capital gain treatment for Business Property Net Gain is limited by “recapture” rules-that is, rules under which amounts are treated as ordinary income rather than capital gain because of previous ordinary loss or deduction treatment for these amounts.

 Business Property Recapture. There is a special recapture rule that applies only to Business Property. Under this rule, to the extent you have had a Business Property Net Loss within the previous five years, any Business Property Net Gain is treated as ordinary income instead of as long-term capital gain. For example, say that you deducted a $10,000 Business Property Net Loss in Year 1, that you included in income an $8,000 Business Property Net Gain in Year 2 and that you included in income a $5,000 Business Property Net Gain in Year 3. The $8,000 of Year 2 gain and $2,000 of the Year 3 gain are treated as ordinary income by virtue of the $10,000 Year 1 loss. The remaining $3,000 of Year 3 gain is long-term capital gain.

 Recapture rules for Code Section 1245 Property. “Code Section 1245 Property” consists of (1) all depreciable personal property, whether tangible or intangible, and (2) certain depreciable real property (usually, real property that performs specific functions, for example, a storage tank, but not buildings or structural components of building). If you sell Code Section 1245 Property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset. For example, say you bought a machine for $50,000 and took $20,000 of depreciation deductions for the machine, reducing the machine’s “basis” (cost for tax purposes) to $30,000. If you sell the machine for $55,000, you’ll have $25,000 of gain ($55,000 minus $30,000), but $20,000 of the gain is recaptured as ordinary income and only $5,000 is taxed under the netting rules. If you sell the machine for $50,000 or less, your gain will be $20,000 or less and will be recaptured (taxed as ordinary income) entirely. (This is the most typical result, because, usually, a used machine can’t be sold for more than its original cost.)

 Recapture rules for Code Section 1250 Property. “Code Section 1250 Property” consists, generally, of buildings and their structural components.

If you sell Code Section 1250 Property that is placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to recapture. However, for most noncorporate taxpayers, the gain attributable to depreciation deductions, to the extent it doesn’t exceed Business Property Net Gain, will be taxed at a rate of 25% (rather than the no-more-than-15% rate that generally applies to long-term capital gains of noncorporate taxpayers).

If you sell Code Section 1250 property placed in service before 1987, but after 1980 (1981-to-1986 Code Section 1250 Property), the tax results depend on whether the property is residential (for example, an apartment building) or nonresidential (factories, office buildings, warehouses, stores, etc.)

If you depreciated residential 1981-to-1986 Code Section 1250 Property using just straight-line depreciation, the tax results if you sell it will be the same as for a sale of post-1986 Code Section 1250 Property, as described above. But if you used a declining balance method to depreciate the real estate, the results are as follows:

 gain, to the extent of the depreciation claimed that exceeds what would have been allowable under straight-line depreciation, will be recaptured as ordinary income and won’t be treated under the netting rules;

 the rest of the gain will be taxed as long-term capital gain to the extent that it doesn’t exceed Business Property Net Gain, with the further distinction that, for most noncorporate taxpayers, the rest of the gain, to the extent of the depreciation deductions that aren’t recaptured as ordinary income, will be taxed at a long-term capital gain rate of 25%, and any gain left over will be taxed at a rate of no more than 15%.

If you depreciated nonresidential 1981-to-1986 Code Section 1250 Property using just straight-line depreciation, the tax results if you sell it will be the same as for a sale of post-1986 Code Section 1250 Property, as described above. But if you used a declining balance method to depreciate the property, the gain on sale would be taxed as follows:

 gain, to the extent of the full amount of depreciation allowable to the time of sale, will be recaptured as ordinary income and won’t be taxed under the netting rules;

 the rest of the gain will be taxed as long-term capital gain to the extent that it doesn’t exceed Business Property Net Gain, and, for noncorporate taxpayers, will be taxed at a rate of no more than 15%.

If you sell Code Section 1250 Property placed in service before 1981:

 gain, to the extent of the excess of depreciation claimed over straight-line depreciation, will be recaptured as ordinary income and won’t be taxed under the netting rules (but the amount of excess depreciation subject to recapture may be less for certain residential real estate and for real estate which was placed in service before 1970);

 the rest of the gain will be taxed as long-term capital gain to the extent that it doesn’t exceed Business Property Net Gain, with the further distinction that, for most noncorporate taxpayers, the rest of the gain, to the extent of the depreciation deductions that aren’t recaptured as ordinary income, will be taxed at a long-term capital gain rate of 25%, and any gain left over will be taxed at a rate of no more than 15%.