Sale of Equipment: Gain Calculation, Section 1231, and Form 4797

The sale of equipment used in a business is a fully taxable federal income tax event, and in most cases the gain is taxed as ordinary income rather than at long-term capital gains rates. That’s because depreciation recapture under Section 1245 applies first: every dollar of gain up to the total depreciation you previously claimed is pulled back into ordinary income. Only gain above that amount, if any, gets Section 1231 treatment. Errors on the calculation carry an accuracy-related penalty of 20% of the underpayment, rising to 40% for gross misstatements.¹

Three numbers drive the whole calculation: the equipment’s adjusted basis, the net sale price, and the total depreciation you’ve already deducted.

Working Out the Adjusted Basis

Adjusted basis is the piece of your original investment that hasn’t yet been written off. Start with the original cost, add capital improvements, and subtract all depreciation claimed.²

Original cost is more than the invoice price. It includes sales tax, freight, installation, and any other cost required to place the equipment in service. A $50,000 machine with $2,000 shipping and $3,000 installation has an original cost of $55,000.

Capital improvements are upgrades that extend useful life or boost capability, like a replacement motor that adds years of service. Routine maintenance (oil changes, filter replacements) doesn’t touch basis; it’s a current expense.

Accumulated depreciation is every deduction claimed on the asset, whether through regular MACRS, Section 179 expensing, or bonus depreciation. Claim $40,000 in depreciation on that $55,000 machine and the adjusted basis is $15,000. That $15,000 is the number you measure the sale price against.

If You Expensed the Full Cost in Year One

Under the One Big Beautiful Bill, 100% bonus depreciation is permanently available for qualifying property acquired after January 19, 2025.³ If you took bonus depreciation or Section 179 on the whole purchase price, adjusted basis is essentially zero. The entire net sale price becomes gain, and every dollar of it is recaptured as ordinary income under Section 1245. That’s the reality for most equipment bought in recent years.

Equipment You Received as a Gift

Basis for gifted equipment is generally the donor’s adjusted basis at the time of transfer. If the fair market value at gifting was lower than the donor’s basis, you use fair market value when calculating a loss.⁴ That dual-basis rule can put a sale price between the two figures into a no-gain, no-loss zone.

Calculating the Gain or Loss

Take the gross selling price, subtract direct selling expenses, then subtract the adjusted basis. Positive is a gain; negative is a loss.

Selling expenses are costs tied to the transaction itself: broker commissions, advertising the sale, legal fees for the transfer documents. They reduce the amount realized rather than being deducted separately.²

Selling the machine above for $25,000 gross, minus $1,000 in broker fees, gives net proceeds of $24,000. Subtract the $15,000 adjusted basis and you have a $9,000 gain. Sell it for $12,000 with no selling expenses and you have a $3,000 loss.

Why Most of the Gain Is Ordinary Income

Section 1245 covers all depreciable tangible personal property used in a business.⁵ When you sell at a gain, the IRS recaptures that gain as ordinary income up to the total depreciation you previously claimed. It gets taxed at your marginal rate, not the capital gains rate.

In the running example, total depreciation was $40,000 and the gain was $9,000. Because the gain is smaller than accumulated depreciation, all $9,000 is ordinary income.

The gain only escapes ordinary treatment when it exceeds total depreciation. If the same equipment sold for $70,000 (a $55,000 gain against the $15,000 basis), the first $40,000 is still recaptured as ordinary income, and only the remaining $15,000 moves on to Section 1231.

Section 1231 and the Five-Year Lookback

Equipment held more than one year and used in your business qualifies as Section 1231 property. Net Section 1231 gains for the year get long-term capital gains treatment; net Section 1231 losses are treated as ordinary, offsetting regular income with no dollar cap.⁶

In practice, most equipment gains never reach Section 1231 in a meaningful way because Section 1245 consumes them first. The capital gains benefit only applies to gain exceeding accumulated depreciation, which is uncommon with tangible equipment.

A lookback provision limits the benefit further. If you claimed net Section 1231 losses in any of the five preceding tax years, current-year Section 1231 gain is recharacterized as ordinary income up to the amount of those prior losses.⁶ Track this five-year history if your business sells assets frequently.

For gain that does reach long-term capital gains treatment, the 3.8% net investment income tax under Section 1411 can apply on top.⁷ Owners who materially participate in the business are generally excluded; passive investors and rental-equipment owners who don’t actively manage are not.

Losses on Equipment Sales

A loss on Section 1231 property is treated as an ordinary loss, which is the most valuable kind. Capital losses for individuals are capped at $3,000 per year against ordinary income, but a Section 1231 ordinary loss offsets wages, business income, and other ordinary income without a dollar limit in the year of sale. If equipment is worth less than its adjusted basis, selling and claiming the loss can produce meaningful tax relief.

Situations That Change the Answer

Installment Sales

If the buyer pays over time, you report the gain using Form 6252, calculating a gross profit percentage and applying it to each payment received.⁸

The catch: depreciation recapture cannot be spread out. The entire Section 1245 recapture amount is reported as ordinary income in the year of sale, even if you’ve received nothing yet.⁸ Only the gain exceeding recapture qualifies for installment treatment. Structure the first payment large enough to cover the tax bill, or reserve for it.

Sales to Related Parties

Selling equipment to a family member, to a corporation you control by more than 50%, or to another related person triggers two different traps.

Sell at a loss and the loss is disallowed entirely under Section 267. You cannot deduct it.⁹ If the buyer later resells to an unrelated party at a gain, that later gain is recognized only to the extent it exceeds the previously disallowed loss.

Sell at a gain to a related party that will depreciate the equipment, and Section 1239 treats the entire gain as ordinary income, overriding Section 1231.¹⁰ This blocks the strategy of selling to your own entity at capital gains rates and then depreciating a stepped-up basis against ordinary income.

Like-Kind Exchanges Don’t Apply Anymore

The Tax Cuts and Jobs Act eliminated Section 1031 for personal property. Since January 1, 2018, like-kind exchange treatment is available only for real property. Selling equipment, vehicles, or machinery is a fully taxable event with no deferral mechanism.¹¹

Reporting on Form 4797

The sale of depreciable business equipment goes on Form 4797, Sales of Business Property. Where you report depends on gain or loss.¹²

Gain: start in Part III to compute Section 1245 recapture. The ordinary income portion flows to Part II. Any gain exceeding accumulated depreciation goes to Part I for Section 1231 netting.
Loss: report in Part I for Section 1231 treatment, with supporting detail in Part II.
Installment sale: also file Form 6252. The full recapture still runs through Part III of Form 4797 in the year of sale.

Net Section 1231 gains that qualify as long-term capital gains flow from Form 4797 to Schedule D. Net Section 1231 losses appear as ordinary losses and offset other income directly.

State Sales Tax

Federal income tax isn’t the whole picture. Most states impose sales tax on transfers of tangible personal property, so a business selling used equipment may need to collect and remit sales tax. Many states offer an “occasional sale” or “casual sale” exemption for infrequent asset sales by non-dealers, but the threshold varies. If you sell equipment regularly, you probably don’t qualify. Check with your state’s department of revenue before closing the sale.

Records to Keep

Your tax position is only as strong as your documentation. Keep these for at least three years after filing the return that reports the sale, longer if a substantial understatement is possible:

Original purchase records showing the invoice price plus every cost of placing the equipment in service.
Depreciation schedules (Form 4562 or equivalent) for every year, showing method, recovery period, and deduction claimed.
Capital improvement invoices for any upgrades capitalized to basis rather than expensed.
The bill of sale, identifying buyer, equipment (with serial numbers), price, date, and any warranty terms.
Receipts for broker commissions, advertising, and legal fees tied to the sale.

For titled assets like commercial vehicles, complete the title transfer with the relevant state agency. Without a clean trail from original cost through every depreciation deduction to the final sale price, the IRS can substitute its own figures in an audit.

1
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
2
Internal Revenue Service. Publication 544 (2025), Sales and Other Dispositions of Assets
3
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One Big Beautiful Bill
4
Internal Revenue Service. Property (Basis, Sale of Home, Etc.)
5
Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property
6
Office of the Law Revision Counsel. 26 USC 1231 – Property Used in the Trade or Business and Involuntary Conversions
7
Office of the Law Revision Counsel. 26 U.S. Code 1411 – Imposition of Tax
8
Internal Revenue Service. Publication 537 (2025), Installment Sales
9
Office of the Law Revision Counsel. 26 U.S. Code 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers
10
Office of the Law Revision Counsel. 26 U.S. Code 1239 – Gain From Sale of Depreciable Property Between Certain Related Taxpayers
11
Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips
12
Internal Revenue Service. 2025 Instructions for Form 4797