Section 1231 gains and losses are the taxable gains and losses from section 1231 transactions--generally, dispositions of property used in business. Their treatment as ordinary or capital depends on whether you have a net gain or a net loss from your section 1231 transactions in the tax year.

If you have a gain from a section 1231 transaction, first determine whether any of the gain is ordinary income under the depreciation recapture rules (explained later). Do not take that gain into account as section 1231 gain.

Section 1231 transactions. Gain or loss on the following transactions is subject to section 1231 treatment.

• Sale or exchange of cattle and horses. The cattle and horses must be held for draft, breeding, dairy, or sporting and held for 2 years or longer.
• Sale or exchange of other livestock. This livestock must be held for draft, breeding, dairy, or sporting and held for 1 year or longer. Other livestock includes hogs, mules, sheep, and goats, but does not include poultry.
• Sale or exchange of depreciable personal property. This property must be used in your business and held longer than 1 year. Generally, property held for the production of rents or royalties is considered to be used in a trade or business. Examples of depreciable personal property include farm machinery and trucks. It also includes amortizable section 197 intangibles.
• Sale or exchange of real estate. This property must be used in your business and held longer than 1 year. Examples are your farm or ranch (including barns and sheds).
• Sale or exchange of unharvested crops. The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person, and the land must have been held longer than 1 year. You cannot keep any right or option to reacquire the land directly or indirectly (other than a right customarily incident to a mortgage or other security transaction). Growing crops sold with a lease on the land, even if sold to the same person in a single transaction, are not included.
• Distributive share of partnership gains and losses. Your distributive share must be from the sale or exchange of property listed earlier and held longer than 1 year (or for the required period for certain livestock).
• Cutting or disposal of timber. You must treat the cutting or disposal of timber as a sale, as described in chapter 10 under Timber.
• Condemnation. The condemned property (described in chapter 13) must have been held longer than 1 year. It must be business property or a capital asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. It cannot be property held for personal use.
• Casualty or theft. The casualty or theft must have affected business property, property held for the production of rents or royalties, or investment property (such as notes and bonds). You must have held the property longer than 1 year. However, if your casualty or theft losses are more than your casualty or theft gains, neither the gains nor the losses are taken into account in the section 1231 computation. Section 1231 does not apply to personal casualty gains and losses. See chapter 13 for information on how to treat these gains and losses.

Property for sale to customers. A sale, exchange, or involuntary conversion of property held mainly for sale to customers is not a section 1231 transaction. If you will get back all, or nearly all, of your investment in the property by selling it rather than by using it up in your business, it is property held mainly for sale to customers.

Treatment as ordinary or capital. To determine the treatment of section 1231 gains and losses, combine all your section 1231 gains and losses for the year.

• If you have a net section 1231 loss, it is an ordinary loss.
• If you have a net section 1231 gain, it is ordinary income up to your nonrecaptured section 1231 losses from previous years, explained next. The rest, if any, is long-term capital gain.

Nonrecaptured section 1231 losses. Your nonrecaptured section 1231 losses are your net section 1231 losses for the previous 5 years that have not been applied against a net section 1231 gain by treating the gain as ordinary income. These losses are applied against your net section 1231 gain beginning with the earliest loss in the 5-year period.

Example. In 2001 Ben has a $2,000 net section 1231 gain. To figure how much he has to report as ordinary income and long-term capital gain, he must first determine his section 1231 gains and losses from the previous 5-year period. From 1996 through 2000 he had the following section 1231 gains and losses.

Year			Amount
1996			-0-
1997			-0-
1998			($2,500)
1999			-0-
2000			$1,800

Using this information, Ben figures how to report his net section 1231 gain for 2001 as shown below.

1)	Net section 1231 gain (2001)		$2,000
2)	Net section 1231 loss (1998)	($2,500)
3)	Net section 1231 gain (2000)	1,800
4)	Remaining net section 1231 loss	($700)
5)	Gain treated as ordinary income		$700
6)	Gain treated as long-term capital gain		$1,300

His net section 1231 loss from 1998 is completely recaptured in 2001.

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