Is a Parking Lot Section 1250 Property?
When a taxpayer sells an asset, it can be difficult to determine the character of the resulting gain or loss. Does the sale of the property result in ordinary income or capital gain or some combination of both? There are many factors that go into this analysis that deserve explanation. In particular, it can be difficult for business owners to classify their commercial parking lot property. In spite of this, it is important for a business owner to understand how to classify their assets. In doing so, he or she is able to file correctly and can ensure the best possible tax rate. In this blog post, we explore the difference between Section 1245 property and Section 1250 property and identify where a parking lot falls on the tax spectrum.
Understanding the Classifications
What exactly are Section 1245 and Section 1250? These are sections of the United States Internal Revenue Code that help to identify and characterize a taxpayer’s provisions. These classifications determine whether gain is taxed at ordinary income rates, capital gains rates or some other rate in between. Before defining these sections and characterizations it is important to note that Section 1245 and Section 1250 apply only to Section 1231 assets. Once an asset has been identified as a Section 1231 asset, it can then be further identified as also either Section 1245 or Section 1250 property.
Without getting too deep into tax law, Section 1231 assets include:
- All depreciable assets that have been held for longer than one year.
- All real property (whether depreciable or not) that has been held for longer than one year.
This also includes assets that are subject to amortization, but does not include inventory property. Furthermore, all Section 1231 assets must be used in the trade or business.
Once an asset is determined to be Section 1231, it can then be further categorized as either Section 1245 or Section 1250 property. What is the difference between the two?
The following can be classified as Section 1245:
- Section 1231 depreciable property, personal or real, that is held by a business for integral use.
- Section 1231 assets that are amortizable intangibles.
If these Section 1245 assets of depreciable property have been sold at a price in excess of depreciated or salvage value, they may qualify for a more favorable capital gains tax rate.
If an asset is not Section 1245, it may be Section 1250. It is important to remember, though, that the two are mutually exclusive. An asset can be either Section 1245 or Section 1250, not both.
Essentially, Section 1250 covers what is not covered by Section 1245:
- All Section 1231 real property that is not covered by Section 1245.
Section 1250 states that a gain from selling real property that has been depreciated should be taxed as ordinary income, to the extent that the accumulated depreciation exceeds the depreciation calculated using the straight-line method.
Essentially, Section 1250 is applicable when a company depreciates its real estate using the accelerated depreciation method,* which results in larger deductions in the early life of a real asset compared with the straight-line method. If the real property sells for a purchase price that produces a taxable gain, and that property is depreciated using the accelerated depreciation method, the difference between the actual depreciation and the straight-line depreciation is taxed as ordinary income.
*Important caveat: All post-1986 real estate is required to be depreciated using the straight-line method. Because of this, the taxation of recaptured depreciation as ordinary income is increasingly rare. Section 1250 affects very few assets today.
How is a Parking Lot Classified?
Now that the differences between Sections 1245 and 1250 have been established, where does a parking lot fall? Section 1245 or Section 1250? The answer is… it depends. While a parking lot is considered real property, it does not necessarily fall under Section 1250. If a parking lot is integral to the business, it is classified under Section 1245; if it is not, it falls under Section 1250.
For example, the parking lot of a trucking company would be classified under Section 1245, as it is integral to that company’s business. By contrast, the parking lot of a retail company is not integral to the company’s business. Therefore, the lot would be classified as Section 1250.
What Exactly Does This All Mean?
If you’re still reading this, congratulations: you’re very committed to tax law. So what is the significance of this differentiation? In short, by the letter of the law, assets are potentially taxed more favorably at a capital gains rate under Section 1245. Under Section 1250, a portion of the gains could possibly be taxed at the less favorable ordinary income rate.
However, if your company has a parking lot that falls under Section 1250, do not fear. Because all post-1986 real estate is required to be depreciated using the straight-line method, it is incredibly unlikely that you will have to deal with this ordinary income taxation. Section 1250 provides a catchall for a situation that no longer really exists. So after all that, it doesn’t really matter!
But, of course, it does really matter. As a business owner, it is important that you understand these tax law classifications of your assets. It is also critical that you employ a tax specialist who understands the complicated nuances of this process. That way, you ensure that you are filing your taxes correctly, legally and as favorably as possible for your business.