Sale of Equipment: Gain or Loss, Ordinary Income, and Form 4797

The tax treatment of the sale of equipment turns on three figures: your adjusted basis in the asset, your net sale price, and the depreciation you have already claimed. In most cases the gain is taxed as ordinary income rather than at the lower long-term capital gains rate, because Section 1245 depreciation recapture applies before any capital gains treatment is available. Losses, by contrast, are generally ordinary and offset your other income with no annual dollar cap. Getting the math wrong exposes you to an accuracy-related penalty of 20% of the underpayment, rising to 40% for gross misstatements.¹

Start With the Adjusted Basis

Your adjusted basis is the slice of your original investment that has not yet been written off. Take the original cost, add any capital improvements, and subtract every dollar of depreciation you have claimed.²

Original cost is more than the sticker price. Include sales tax, freight, installation, and anything else required to put the equipment into working condition. A $50,000 machine with $2,000 in shipping and $3,000 in installation has an original cost of $55,000.

Capital improvements are upgrades that extend useful life or expand capability, such as a new motor that adds years of service. Routine maintenance like oil changes and filter replacements is deducted as a current expense and never touches basis.

Accumulated depreciation covers every deduction you have taken on the asset, whether through regular MACRS, Section 179 expensing, or bonus depreciation. If you claimed $40,000 on that $55,000 machine, your adjusted basis is $15,000. That is the number you measure the sale against.

One timing note worth knowing before you plan the sale: Section 1031 like-kind exchanges no longer apply to equipment. The Tax Cuts and Jobs Act limited Section 1031 to real property beginning January 1, 2018, so selling equipment, vehicles, or machinery produces a fully taxable event with no deferral mechanism available.³

Calculate the Gain or Loss

The arithmetic is simple. Take the gross selling price, subtract direct selling expenses, then subtract the adjusted basis. A positive number is your realized gain. A negative number is your realized loss.

Selling expenses are costs tied directly to the transaction: broker commissions, advertising, and legal fees for the transfer. The IRS treats these as a reduction of the amount realized rather than a separate deduction.²

Carrying the example forward: sell the equipment for $25,000 gross, pay $1,000 in broker fees, and your net proceeds are $24,000. Subtract the $15,000 adjusted basis and you have a $9,000 realized gain. If the same equipment sold for only $12,000 with no selling expenses, you would have a $3,000 realized loss.

Knowing the dollar amount is only half the work. How that amount is taxed is the harder question.

Why the Gain Is Usually Ordinary Income

When you sell equipment at a gain, the IRS does not let you treat the gain as a capital gain to the extent of depreciation you previously claimed. Instead, Section 1245 recaptures the gain as ordinary income up to the total depreciation you have deducted. The rule applies to all depreciable tangible personal property used in a business.⁴

In the running example, you claimed $40,000 in depreciation and realized a $9,000 gain. Because the gain is smaller than total depreciation, every dollar of it is ordinary income taxed at your regular marginal rate.

Only gain exceeding total depreciation escapes recapture. If the same equipment sold for $70,000, producing a $55,000 gain on the $15,000 basis, the first $40,000 would still be ordinary income under Section 1245 and only the remaining $15,000 would move on to Section 1231 for possible capital gains treatment.

Bonus depreciation makes this nearly universal for recent purchases. Under the One Big Beautiful Bill, 100% bonus depreciation is permanently available for qualifying property acquired after January 19, 2025.⁵ If you expensed the full cost in year one through bonus depreciation or Section 179, your basis is essentially zero. The entire net sale price is gain, and all of it is ordinary income under Section 1245.

When Any of the Gain Qualifies for Capital Gains Rates

Equipment held more than a year and used in your business is Section 1231 property. If your net result from all Section 1231 sales during the year is a gain, that net gain gets long-term capital gains treatment. If the net result is a loss, it is ordinary and offsets regular income.⁶

In practice, most equipment gains never make it to Section 1231 because recapture eats them first. The capital gains benefit only reaches the slice of gain exceeding total accumulated depreciation, which is uncommon with tangible equipment.

A five-year lookback limits the benefit even when a gain does qualify. If you claimed net Section 1231 losses in any of the five preceding tax years, your current-year Section 1231 gain is recharacterized as ordinary income to the extent of those prior losses.⁶ You cannot take ordinary loss treatment in bad years and capital gains treatment in good years without the earlier losses clawing back the advantage.

For the portion that does qualify, the 2026 long-term capital gains rates are 0%, 15%, or 20% depending on taxable income. Single filers pay 0% up to $49,450, 15% up to $545,500, and 20% above that. Joint filers reach 15% at $98,900 and 20% at $613,700.

An additional 3.8% net investment income tax under Section 1411 can apply to Section 1231 gains treated as capital gains, because the statute includes net gain from the disposition of property in its definition of investment income.⁷ If you materially participate in the business that owns the equipment, the gain is generally excluded. Passive investors and owners of rental equipment who do not actively manage the business pay the 3.8% on top of the capital gains rate.

If You Sold at a Loss

A realized loss on Section 1231 property is treated as an ordinary loss. That matters because capital losses are capped at $3,000 per year against ordinary income for individuals, while an ordinary loss offsets wages, business income, and other ordinary income with no dollar limit in the year of the sale. Equipment worth less than its adjusted basis can produce meaningful tax relief when sold.

Situations That Change the Result

Installment Sales

If the buyer pays over time, you report the gain under the installment method on Form 6252. You calculate a gross profit percentage by dividing total gross profit by the contract price, and each payment (less interest) is taxable in that proportion.⁸

Depreciation recapture is the critical exception. The entire Section 1245 recapture amount must be reported as ordinary income in the year of sale, even if you have not received a dollar in payment yet.⁸ Only gain exceeding the recapture amount gets installment treatment. If your equipment carries significant depreciation, structure the first payment to cover the tax bill or reserve cash for it.

Sales to Related Parties

Selling to a family member, a corporation you control, or another related entity triggers two different traps depending on whether you have a gain or a loss.

A loss on a sale to a related party is completely disallowed. Section 267 blocks losses on sales between family members, between an individual and a corporation they own more than 50% of, and between other related persons.⁹ If the buyer later resells to an unrelated party at a gain, that gain is recognized only to the extent it exceeds the previously disallowed loss.

A gain on a sale to a related party that will depreciate the equipment is treated entirely as ordinary income under Section 1239, regardless of what Section 1231 would otherwise provide.¹⁰ This neutralizes any strategy of selling at capital gains rates to a controlled company that would then depreciate the stepped-up basis against ordinary income.

Reporting on Form 4797

The sale of depreciable business equipment is reported on IRS Form 4797, Sales of Business Property. Where you report depends on whether you have a gain or a loss.¹¹

Gain on sale: start in Part III, which calculates Section 1245 recapture. The ordinary income portion flows to Part II. Any gain exceeding total depreciation goes to Part I for Section 1231 netting.
Loss on sale: report in Part I for Section 1231 treatment, with supporting detail in Part II.
Installment sale: also file Form 6252 to calculate the taxable portion of each payment. Depreciation recapture still flows 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 Is a Separate Question

Federal income tax is only part of the picture. Most states impose sales tax on transfers of tangible personal property, and a business selling used equipment may be required to collect and remit it. Many states offer an “occasional sale” or “casual sale” exemption for non-dealers who sell only a few items within a 12-month period, but thresholds vary. Businesses that sell equipment regularly usually do not qualify. Check with your state’s department of revenue before the sale rather than after.

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. Like-Kind Exchanges – Real Estate Tax Tips
4
Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property
5
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One Big Beautiful Bill
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. 2025 Instructions for Form 4797