Fixed Assets and a Common Misconception

3 minute read time.

Which of the following is a true statement? Or, are they both true?

1>    All personal property is Section 1245 property.

2>    All Section 1245 property is personal property.

Only the first statement is correct! The second statement should be revised to read “Most Section 1245 property is personal property” and then, it also would be correct.

Since I always like to give a little background, I found it interesting that the origins of Section 1245 and Section 1250 (real) property have to do with the creation of the depreciation recapture rules when property is disposed.

Prior to the creation of Code Sections 1245 and 1250, all gain from the sale of depreciated property was considered capital gain. However, the depreciation claimed on such property has always been an ordinary expense, thereby offsetting ordinary income. Since capital gain income is often taxed at a lower rate, this was quite advantageous to the taxpayer. The purpose of the depreciation recapture rules was to close the loophole. (This explains the lasso pictured above <that, plus the fact the word “recapturing” always makes me think of escaped livestock, which, by the way, is Section 1245 property>.). With the creation of the recapture rules, when property is disposed of at a gain, the amount of the gain attributed to past depreciation expense is, for the most part, now considered ordinary gain and is taxed accordingly. (The actual recapture rules may be the subject of a future blog!)

So, let’s return to the fact that not all Section 1245 property is personal property. Although for the most part, Section 1250 property is real property (that is, buildings, land, and anything attached to the land), there is other real property that is treated as Section 1245 property:

  • Tangible real property (except for buildings and their structural components) used as:
    • An integral part of the following activities: manufacturing, production, extraction, or furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services, or
    • A research facility used in any of the above activities, or
    • A facility used in any of the above activities for the bulk storage of fungible commodities (that is, interchangeable goods).
    • A single purpose agricultural or horticultural structure.
    • A storage facility (not including a building or its structural components) used in connection with the distribution of petroleum or any primary product of petroleum.
    • A railroad grading or tunnel bore (as defined in Section 168(e)(4)).
    • Qualified timber property, meaning a lot located in the U.S. containing trees in significant quantities that are intended for planting, cultivating, caring for, and cutting for sale or use in the commercial production of timber products. (Section 194(c)(1))
    • That part of any real property (other than buildings and their structural components) which is subject to amortization or expensing under Sections 169, 179,179A (pre-2006), 179B, 179C, 179D, 179E, 185 (repealed after 1986), 188 (pre- Revenue Reconciliation Act of 1990), 190, 193, or 194. Note such property is only considered Section 1245 real property to the extent amortization is claimed on it, rather than the property in its entirety. Examples of such property are certified pollution control facilities and qualifying architectural and transportation barrier removal expenses.

 

Fascinating Fixed Assets Fact: When determining if machinery and equipment is Section 1245 property rather than a structural component (even if located outside of a building), the taxpayer must look at whether it is commonly used in the particular industry and whether removing it would not affect the building’s operation. An example of such property that would be subject to Section 1245 is a night depository facility for a bank.