Section 1231 gains and Opportunity Zones

A §1231 gain is gain on the sale of depreciable property or real property used in a trade or business and held more than one year, such as a rental building, business land, or equipment.¹

Section 1231 is a hybrid. At year-end, a taxpayer nets all §1231 gains and losses: a net gain is treated as long-term capital gain, and a net loss is ordinary. A lookback rule then recharacterizes net §1231 gain as ordinary income to the extent of net §1231 losses deducted in the prior five years. Separately, depreciation recapture under §1245 (equipment) and §1250 (certain real property) is carved out first and taxed as ordinary income.²

Yes. Under the regulations, the gross amount of eligible §1231 gain, unreduced by §1231 losses, can be invested in a Qualified Opportunity Fund (QOF), and the 180-day period begins on the date of each sale.^1,3

A QOF is a corporation or partnership that holds at least 90% of its assets in Opportunity Zone property.⁴ The regulations treat §1231 gain sale by sale, which removes the year-end timing problem: you do not have to wait until December to know whether you have a net gain. The eligible amount is limited to the §1231 gain that exceeds any amount treated as ordinary income under §1245 or §1250.^2,5

The regulation is at 26 CFR 1.1400Z2(a)-1.⁶ The statute requires that eligible gain come from a sale or exchange with an unrelated person, using the tests of §267(b) and §707(b)(1) with 20% in place of 50%.⁷ For amounts invested after December 31, 2026, the deferred gain is included on the earlier of a disposition or the fifth anniversary of the investment.⁸ See which gains qualify.

Subtract ordinary recapture from the total gain; what remains is §1231 gain you can defer, including any unrecaptured §1250 gain on a building.

Example 1: a rental or industrial building

A building (excluding land) bought for $2,000,000 and depreciated straight-line by $500,000 is sold for $3,000,000. Adjusted basis is $1,500,000, so total gain is $1,500,000. Real property depreciated straight-line generally has no §1250 ordinary recapture, so the entire $1,500,000 is §1231 gain. Of that, $500,000 is unrecaptured §1250 gain (taxed at up to 25%) and $1,000,000 is taxed at long-term capital gain rates. All $1,500,000 is eligible to invest.

Example 2: equipment

Equipment bought for $500,000 and depreciated by $300,000 has an adjusted basis of $200,000. Sold for $600,000, the gain is $400,000. The first $300,000 (the depreciation taken) is §1245 recapture, ordinary income, and not eligible. The remaining $100,000 is §1231 gain and can be deferred. If the same equipment sold for $400,000, the entire $200,000 gain would be recapture and nothing could be deferred.

Example 3: a business asset sale with mixed assets

Selling an operating business as an asset sale produces a mix: gain on goodwill (generally capital gain), gain on real estate and equipment (§1231 plus any recapture), and ordinary income on inventory and receivables. Each piece is tested separately. The purchase price allocation therefore drives how much of the sale can go into a QOF. See Opportunity Zones for business owners selling a company.

A deferred §1231 gain is not recognized in the year of sale, so it stays out of that year's §1231 netting; the deferred amount keeps its tax attributes and is recognized when included.^1,3

That has two practical effects. First, if you have §1231 losses in the same year, they are netted without the deferred gain, which can leave a net §1231 loss that is deductible as ordinary. Second, the five-year lookback rule may recharacterize later net §1231 gains as ordinary to the extent of net §1231 losses taken in the prior five years. How a deferred §1231 gain is netted in the inclusion year, including under the lookback rule, is technical; model it with your tax adviser before choosing how much to defer.

Rates are those in effect for the inclusion year. For amounts invested after December 31, 2026, inclusion is on the fifth anniversary at the latest, after a 10% basis step-up, or 30% in a Qualified Rural Opportunity Fund.⁹ See the five-year deferral.

Pass-through owners can defer their share of an entity's §1231 gain with the same three start-date choices as other pass-through gains, and installment sellers can invest as payments arrive.^3,10

• If a partnership or S corporation does not invest the gain itself, each owner can defer its share. The 180-day period starts by default on the last day of the entity's tax year, or by election on the entity's sale date or the entity's return due date without extensions (March 15 for a calendar-year partnership).¹⁰
• Real estate partnerships often sell buildings mid-year. A partner who wants to invest quickly can use the sale date; one who needs the K-1 first can use the due date window.
• For an installment sale, the 180-day period can run from each payment received or from year-end, so each payment can be invested separately.⁵

See partnership and K-1 gains and the 180-day rule.

Report the sale on Form 4797 as usual and make the deferral election on Form 8949 with the return for the year of the sale, then track the investment on Form 8997 each year.^11,12

The deferral line on Form 8949 shows the QOF's EIN, the date of the investment and the deferred amount as a negative adjustment.¹¹ Keep the closing statement, the depreciation schedule that supports the recapture calculation, and the QOF's confirmation of the investment date. See Form 8996 and Form 8997.

Farmland, ranchland and business land sold for a data center campus usually produces §1231 gain (land used in a business) or capital gain (land held for investment), and both can be deferred in a QOF within 180 days of the sale.¹

Land is not depreciable, so a land sale has no §1245 or §1250 recapture; farm buildings and equipment sold with the land may. Large campuses can produce very large gains for landowners because developers seek big sites near transmission. Two cautions: plan the QOF investment before closing so the 180 days are not lost to diligence, and watch the related-party rules if the landowner will also invest in the fund that buys the land. The gain must come from a sale to an unrelated person, and a QOZB must buy its property from an unrelated party, each tested at a 20% ownership threshold.^7,13 See Opportunity Zones for landowners and related-party rules.