Except inventory and property held for sale in the ordinary course of business, Section 1231 property in federal income tax includes assets held for more than 12 months for use in a business; coal , timber and domestic iron ore; livestock held for more than one year and horses held for more than two years; and crops not harvested.
Section 1231 allows businesses to enjoy the best tax treatment for properties covered by this section either in case of gains or in the event of losses. For net profits on Section 1231 property the taxpayer avails of long term capital gains treatment that is liable to lower tax rates than ordinary income.
Similarly net losses on 1231 property are treated as ordinary losses instead of capital losses to the advantage of the taxpayer. Capital losses are deductible only against capital gains. So in the absence or inadequacy of capital gains such capital losses are bound to remain unabsorbed. However, ordinary loss can be set off against any taxable income without any fetters or restriction.
Through the introduction of Section 1231(c) the congress has put checks on balances on taxpayers. Before the insertion of this section a taxpayer could report net loss on Section 1231 assets in the immediately preceding year only to have net gains on such assets in the very next year. While such net loss reported was considered as ordinary loss, said net gains on 1231 properties enjoyed the status of long term capital gains taxable at lower rates.
However, in the wake of Section 1231(c) if a taxpayer claims 1231 loss in the 1st year but reports 1231 gain in any one of the 2nd to 6th years that is less than the loss of the 1st year, such gain would be treated as ordinary income instead of long term capital gain. It is no gainsaying that ordinary income suffers higher rate of tax than long term capital gain that enjoys preferential tax treatment.
(More:http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00001231----000-.html)
| 
