Section 1231 Gain on Schedule K1: Tax Rules for Real Estate and Business Investors
A Schedule K1 showing Section 1231 gain does not necessarily mean the entire amount will be taxed as a long term capital gain on the investor's individual income tax return.
Partnerships, limited liability companies taxed as partnerships, and S corporations can pass Section 1231 gains and losses through to their owners. The entity calculates and reports its separately stated Section 1231 amount, but the owner's final federal tax treatment depends on additional rules applied at the owner level.
Those rules can include basis limitations, the at risk rules, passive activity limitations, other Section 1231 gains and losses from unrelated investments, and the Section 1231 five year lookback rule.
Real estate investors can also receive unrecaptured Section 1250 gain on the same K1. That amount is related to the real estate disposition, but it is not a second Section 1231 gain that should simply be added to the K1 Section 1231 amount.
For broader guidance on real estate dispositions, passive losses, depreciation, and other investor tax issues, see my Real Estate Tax Planning resource page.
Key Tax Takeaways
- Under the current finalized 2025 forms, partnerships generally report net Section 1231 gain or loss in Schedule K1 Box 10.
- S corporations generally report net Section 1231 gain or loss in Schedule K1 Box 9.
- Partners and S corporation shareholders generally report the applicable K1 Section 1231 amount through Part I of Form 4797.
- The K1 amount is not necessarily the owner's final long term capital gain.
- The owner combines applicable Section 1231 amounts from different entities and directly owned activities on Form 4797.
- A current net Section 1231 gain can become ordinary income to the extent of nonrecaptured Section 1231 losses from the preceding five taxable years.
- Partnership K1 Box 9c and S corporation K1 Box 8c can separately report unrecaptured Section 1250 gain.
- Unrecaptured Section 1250 gain is character and rate information and should not simply be added to Section 1231 gain as a separate sale gain.
- Section 1231 gain from a passive activity can constitute passive activity income, subject to the Section 469 rules and possible income recharacterization provisions.
- A Section 1231 loss shown on a K1 is not automatically deductible.
- Basis, at risk, and passive activity limitations can restrict a K1 Section 1231 loss at the owner level.
- Publicly traded partnerships have separate passive activity rules and require separate tracking.
- Supplemental K1 statements can be essential when one entity conducts several separate activities.
What Does Section 1231 Gain on a Schedule K1 Mean?
Section 1231 generally applies to qualifying depreciable property and real property used in a trade or business and held for more than one year, along with certain other property described in the statute.
A partnership or S corporation that disposes of qualifying property first performs its own applicable depreciation recapture and Section 1231 calculations. The resulting net Section 1231 gain or loss is then separately stated to the owners.
The amount reported on Schedule K1 represents the owner's share of the entity's net Section 1231 result. It does not mean that the amount bypasses the owner's own Form 4797 calculation.
A K1 Section 1231 Gain Is an Input, Not the Final Tax Character
The partnership or S corporation generally does not know the owner's complete Section 1231 history from other investments or prior tax years.
The owner must apply the individual Form 4797 rules after combining the applicable Section 1231 amounts from the K1 with other Section 1231 items reported on the owner's return.
Where Is Section 1231 Gain Reported on a Partnership K1?
Under the finalized 2025 Schedule K1 for Form 1065, a partnership reports the partner's share of net Section 1231 gain or loss in Box 10.
The partnership's amount comes from its Form 4797 Part I calculation and is separately stated because the partner may have other Section 1231 transactions and owner level tax rules that affect the final result.
Where Is Section 1231 Gain Reported on an S Corporation K1?
Under the finalized 2025 Schedule K1 for Form 1120S, an S corporation reports the shareholder's share of net Section 1231 gain or loss in Box 9.
Like a partnership K1 amount, the S corporation Section 1231 amount flows into the shareholder's own Form 4797 calculation.
| Pass Through Entity | 2025 K1 Location | Owner Level Reporting |
|---|---|---|
| Partnership or LLC taxed as a partnership | Box 10 | Generally Form 4797 Part I |
| S corporation | Box 9 | Generally Form 4797 Part I |
Where Do I Report K1 Section 1231 Gain on Form 1040?
For an individual partner or S corporation shareholder, the current K1 instructions generally direct a Section 1231 gain to Form 4797, line 2, column (g).
Form 4797 then combines the owner's applicable Section 1231 items in Part I. Line 7 determines the current net Section 1231 gain or loss.
If line 7 is a net gain, the taxpayer must then determine whether nonrecaptured Section 1231 losses from the preceding five taxable years require part of the gain to be treated as ordinary income under Section 1231(c).
The remaining net Section 1231 gain generally enters the long term capital gain computation, subject to the other applicable capital gain rules.
Do Not Enter Box 10 or Box 9 Directly as a Schedule D Capital Gain
Section 1231 gain from a partnership or S corporation generally must pass through Form 4797 before the final character of the gain is determined.
Is K1 Section 1231 Gain Automatically Long Term Capital Gain?
No.
Section 1231 provides favorable treatment only after the applicable annual netting and lookback rules are completed.
The owner can have Section 1231 amounts from:
- Several partnerships
- Several S corporations
- Personally owned rental or business property
- Installment sales
- Like kind exchanges
- Other qualifying Section 1231 transactions
These applicable amounts ultimately meet in the owner's Form 4797 calculation.
Example: Section 1231 Amounts From Several Investments
Assume an investor has the following current year Section 1231 items:
| Source | Section 1231 Result |
|---|---|
| Real estate Partnership A | $75,000 gain |
| Real estate Partnership B | $30,000 loss |
| S corporation | $10,000 gain |
| Personally owned business property | $15,000 loss |
Ignoring passive activity and other loss limitations for purposes of this simplified example, the taxpayer has:
$75,000 minus $30,000 plus $10,000 minus $15,000 = $40,000 net Section 1231 gain.
The taxpayer then applies the Section 1231 five year lookback rule to the $40,000 current net gain.
Can Prior Section 1231 Losses Turn K1 Gain Into Ordinary Income?
Yes.
Section 1231(c) requires current net Section 1231 gain to be treated as ordinary income to the extent of the taxpayer's remaining nonrecaptured net Section 1231 losses from the five preceding taxable years.
This is an owner level calculation. The pass through entity generally cannot perform it for an individual investor because the entity does not know the investor's Section 1231 activity from other entities and prior years.
Example: K1 Gain Affected by the Five Year Lookback
Assume a real estate partnership reports $120,000 of net Section 1231 gain to an investor in partnership Schedule K1 Box 10.
The investor has no other current Section 1231 items but has $35,000 of remaining nonrecaptured net Section 1231 loss from 2023.
The investor's Form 4797 can generally treat:
- $35,000 as ordinary income under Section 1231(c)
- $85,000 as remaining net Section 1231 gain with long term capital gain character, subject to the other applicable capital gain rules
The partnership K1 can therefore correctly report $120,000 of Section 1231 gain even though the investor's final return treats part of that amount as ordinary income.
For a complete explanation of this calculation, see Section 1231 Five Year Lookback Rule: When Property Gain Becomes Ordinary Income .
What Is the Difference Between K1 Section 1231 Gain and Unrecaptured Section 1250 Gain?
These are related tax concepts, but they serve different purposes.
Under the current finalized partnership Schedule K1:
- Box 10 reports net Section 1231 gain or loss.
- Box 9c reports unrecaptured Section 1250 gain information.
Under the current finalized S corporation Schedule K1:
- Box 9 reports net Section 1231 gain or loss.
- Box 8c reports unrecaptured Section 1250 gain information.
| Item | Partnership K1 | S Corporation K1 | Primary Function |
|---|---|---|---|
| Net Section 1231 gain or loss | Box 10 | Box 9 | Enters the owner's Form 4797 Section 1231 calculation |
| Unrecaptured Section 1250 gain | Box 9c | Box 8c | Provides information for the Schedule D Unrecaptured Section 1250 Gain Worksheet |
Do Not Add the Two K1 Amounts Together as Separate Gains
Unrecaptured Section 1250 gain generally represents rate character information associated with qualifying gain from depreciated real property. It is not simply another amount of sale gain that should be added to the Section 1231 amount.
The Section 1231 amount is reported through Form 4797. The unrecaptured Section 1250 amount separately enters the applicable Schedule D worksheet used to determine how much long term capital gain falls within the special maximum 25 percent federal rate category.
Why Can a Real Estate K1 Show Both Box 10 and Box 9c?
A real estate partnership can sell depreciated Section 1250 property and generate net Section 1231 gain. The partnership must also separately provide the investor with information needed to identify the portion of applicable gain associated with prior depreciation on Section 1250 property.
The two amounts therefore answer different questions:
- Section 1231 determines the general character of the annual net gain or loss.
- Unrecaptured Section 1250 gain helps determine the applicable capital gain rate category for qualifying real estate gain.
For a detailed explanation, see Depreciation Recapture on Rental Property: Sections 1245, 1250, and the 25 Percent Rate .
Example: Apartment Syndication Sale
Section 1231 and Unrecaptured Section 1250 Gain on the Same K1
Assume a partnership owns an apartment complex and sells the property after holding it for more than one year.
After the partnership applies the applicable depreciation recapture rules and calculates its Section 1231 result, an investor receives:
- $90,000 of net Section 1231 gain in partnership Schedule K1 Box 10
- $40,000 of unrecaptured Section 1250 gain information in Box 9c
The investor generally does not report $130,000 of gain merely by adding the two boxes.
The $90,000 Section 1231 amount enters the investor's Form 4797 calculation. The $40,000 Box 9c amount supplies information for the Unrecaptured Section 1250 Gain Worksheet and helps determine the character of the applicable long term gain for rate purposes.
The investor must still consider other Section 1231 items, prior Section 1231 losses, capital gains and losses, and the other applicable individual tax rules.
Is Section 1231 Gain From a Rental Partnership Passive Income?
It generally can be.
The current partnership and S corporation K1 instructions state that a Section 1231 amount is generally passive when it comes from:
- A rental activity
- A trade or business activity in which the owner did not materially participate
An amount from rental real estate is not passive when the taxpayer qualifies as a real estate professional and materially participates in the rental real estate activity.
The passive activity classification is separate from the Section 1231 character calculation. A gain can be Section 1231 gain and also constitute income from a passive activity for purposes of Section 469.
Can Passive Section 1231 Gain Allow Suspended Passive Losses to Be Used?
It can.
Form 8582 generally takes passive activity income into account when determining how much passive activity loss is allowed. IRS guidance specifically includes gain from property used in a passive activity within passive activity income, subject to the statutory and regulatory exceptions and income recharacterization rules.
As a result, passive Section 1231 gain can provide passive activity income against which otherwise allowable suspended passive losses may be deducted.
The amount and source of the passive gain matter. Special rules can apply to publicly traded partnerships, self rental arrangements, significant participation activities, and other activities subject to passive income recharacterization.
An Asset Sale by the Partnership Is Not Necessarily a Complete Disposition by the Investor
A partnership selling a rental building does not automatically mean the investor disposed of the investor's entire partnership interest.
The special Section 469(g) rule that can release all suspended losses upon a qualifying fully taxable disposition generally requires a disposition of the taxpayer's entire interest in the passive activity to an unrelated person.
A gain from a property sale inside the partnership can create passive income without necessarily satisfying the complete disposition rule.
For more information, see Suspended Passive Rental Losses: Four Ways Real Estate Investors Can Use Them .
What if the Investor Is a Real Estate Professional?
Real estate professional status can change the passive activity classification of rental real estate, but it does not eliminate the Section 1231 rules.
For rental real estate to be nonpassive, the investor must satisfy the real estate professional requirements and materially participate in the applicable rental activity.
If those requirements are satisfied, the Section 1231 gain or loss attributable to that rental activity can be nonpassive for Section 469 purposes.
The amount still enters the investor's Form 4797 and remains subject to the Section 1231 annual netting and five year lookback rules.
For the qualification and participation rules, see Real Estate Professional Status: How Rental Property Owners Qualify and Deduct Losses .
Is a Section 1231 Loss on a K1 Automatically Deductible?
No.
A pass through entity reports the owner's allocated share of the Section 1231 loss without necessarily applying every limitation that exists on the owner's individual tax return.
For an individual partner or S corporation shareholder, several owner level limitations can apply before the loss is deductible.
Partnership Loss Limitation Order
The current IRS partner instructions describe the general order of the major loss limitations as:
- Partnership outside basis under Section 704(d)
- At risk limitation under Section 465
- Passive activity limitation under Section 469
- Excess business loss limitation under Section 461 when applicable
S Corporation Loss Limitation Order
For an S corporation shareholder, the comparable sequence generally includes:
- Stock and debt basis limitation under Section 1366(d)
- At risk limitation under Section 465
- Passive activity limitation under Section 469
- Excess business loss limitation under Section 461 when applicable
Example: K1 Reports a Loss but the Investor Cannot Deduct All of It
Assume a partnership reports a $60,000 Section 1231 loss to an individual partner.
The partner has only $25,000 of available outside basis before considering the loss.
The partner cannot assume that all $60,000 reaches Form 4797 merely because the K1 reports the full amount. The Section 704(d) basis limitation must first be applied.
Any loss surviving the basis limitation can still be subject to the at risk and passive activity limitations.
Schedule K1 Capital Is Not the Same as Partnership Outside Basis
The capital account shown on a partnership Schedule K1 does not by itself determine the partner's tax basis in the partnership interest.
Partnership outside basis can also reflect items such as contributions, distributions, liabilities, separately stated income and loss, and other adjustments under the partnership basis rules.
How Do Basis and At Risk Rules Affect a Section 1231 Loss?
Basis and at risk are separate limitations.
A partner can have sufficient partnership outside basis but still have an at risk limitation. Conversely, a loss cannot reach the at risk or passive activity analysis if it is already disallowed by an earlier basis limitation.
The at risk rules generally restrict losses to amounts the taxpayer actually has at economic risk in the activity, subject to special statutory rules including qualified nonrecourse financing for certain real estate activities.
A passive Section 1231 loss that survives the basis and at risk limitations can then be limited under Section 469.
What if My K1 Reports Section 1231 Amounts From Several Activities?
The attached K1 statements can be as important as the number printed in the main box.
The IRS requires a partnership or S corporation conducting more than one relevant activity to provide information that identifies the income, deductions, gains, losses, and other items attributable to the separate activities when required for application of the passive activity and at risk rules.
The current K1 instructions specifically provide that when net Section 1231 gain or loss comes from more than one activity, the entity provides a statement identifying the Section 1231 amount from each activity.
Read the K1 Statements Before Entering the Return
A single partnership can own several rental properties or conduct several businesses. The investor may materially participate in one activity but not another, or have different suspended passive losses associated with each activity.
Combining the activity detail too early can produce the wrong passive activity result.
How Is Section 1231 From a Publicly Traded Partnership Treated?
Publicly traded partnerships are subject to special passive activity rules.
The passive activity limitations are generally applied separately to each publicly traded partnership. A passive loss from one publicly traded partnership generally cannot be used against passive income from another publicly traded partnership or from another passive activity.
Instead, an unused passive loss is generally carried forward for use against passive income from the same publicly traded partnership, subject to the rules governing a disposition of the investor's entire interest.
IRS guidance also provides special treatment when the publicly traded partnership produces an overall gain. The net gain portion can be treated as nonpassive income.
Do Not Use PTP Section 1231 Gain as a General Passive Income Bucket
The separate publicly traded partnership rules mean an investor should not assume that a Section 1231 gain from a publicly traded partnership can automatically absorb suspended losses from unrelated passive activities.
Does Section 1231 Gain Increase Partnership Basis?
Generally, yes.
Section 705 increases a partner's adjusted basis in the partnership interest for the partner's distributive share of taxable partnership income.
The current IRS partnership basis worksheet specifically includes positive net Section 1231 gain as an increase to the partner's outside basis.
This basis increase is separate from the question of whether the owner's ultimate Section 1231 gain receives long term capital gain character or is recharacterized as ordinary income under the five year lookback rule.
Does Section 1231 Gain Increase S Corporation Stock Basis?
Generally, yes.
Section 1367 increases shareholder stock basis for applicable pass through income items. IRS basis guidance identifies separately stated income items as increases to S corporation stock basis.
A positive Section 1231 gain passing through from the S corporation therefore generally increases stock basis as an income item.
Do Not Increase Basis Again for Unrecaptured Section 1250 Gain
When Box 9c of a partnership K1 or Box 8c of an S corporation K1 reports unrecaptured Section 1250 gain associated with the entity's real estate sale, that amount generally provides character information concerning the underlying gain.
It is not generally a second separate income item that should be added again to the Section 1231 gain solely for purposes of increasing basis.
Can a Real Estate Syndication Generate Section 1231 Gain?
Yes.
A real estate partnership or syndication that sells qualifying depreciable real estate held for more than one year can generate Section 1231 gain after applying the applicable depreciation recapture rules.
An investor can therefore receive several related items from the same property sale, including:
- Net Section 1231 gain
- Unrecaptured Section 1250 gain information
- Ordinary income items associated with applicable depreciation recapture
- Current rental income or loss
- Other separately stated tax items
The K1 and supplemental statements should be read as one package rather than entering each box without considering how the items relate to the underlying property disposition.
How Does Depreciation Recapture Reach the Investor?
The pass through entity generally applies Sections 1245 and 1250 when it disposes of its assets before calculating its net Section 1231 result.
Ordinary income that must be separately stated to the owners is generally reported separately from the net Section 1231 amount.
The remaining qualifying gains and losses enter the entity's Section 1231 calculation and the resulting net amount is passed through on Schedule K1.
This ordering is why an investor should not assume that the Section 1231 box represents every tax consequence from the entity's real estate sale.
For the property level rules, see Section 1231 Tax Rules for Rental Property and Business Real Estate .
What Should Be Reviewed When a Real Estate K1 Reports Section 1231 Gain or Loss?
A complete K1 review should generally consider:
- Whether the entity is a partnership, S corporation, or publicly traded partnership
- The Section 1231 amount shown on the K1
- Unrecaptured Section 1250 gain reported separately
- Any attached statements related to the property disposition
- Whether the entity reports more than one activity
- The passive or nonpassive character of each activity to the investor
- Real estate professional status when relevant
- Material participation
- Prior year suspended passive losses
- Partnership outside basis or S corporation stock and debt basis
- The investor's at risk amount
- Other current year Section 1231 gains and losses
- Nonrecaptured Section 1231 losses from the five preceding taxable years
- Capital loss carryovers and other capital gain items
- Potential net investment income tax when applicable
- State income tax treatment
The investor's final tax result cannot always be determined from the face of one K1 because several of these rules depend on information maintained only at the owner level.
Frequently Asked Questions About Section 1231 Gain on Schedule K1
What does Section 1231 gain on a Schedule K1 mean?
It generally represents the owner's share of the partnership's or S corporation's net Section 1231 gain after the entity applies its property disposition rules. The amount generally enters the owner's Form 4797 calculation and is not necessarily the owner's final long term capital gain.
Where is Section 1231 gain reported on a partnership K1?
Under the finalized 2025 Schedule K1 for Form 1065, net Section 1231 gain or loss is reported in Box 10.
Where is Section 1231 gain reported on an S corporation K1?
Under the finalized 2025 Schedule K1 for Form 1120S, net Section 1231 gain or loss is reported in Box 9.
Is K1 Section 1231 gain automatically a long term capital gain?
No. The owner must combine applicable Section 1231 items on Form 4797 and then apply the five year lookback rule. Current net gain can be ordinary income to the extent of nonrecaptured net Section 1231 losses from the preceding five taxable years.
Where do I report K1 Section 1231 gain on Form 1040?
The current K1 instructions generally direct gain to Form 4797 Part I. Form 4797 determines the owner's current net Section 1231 result and applies the prior loss lookback before any remaining qualifying gain enters the long term capital gain calculation.
What is the difference between K1 Section 1231 gain and unrecaptured Section 1250 gain?
Section 1231 gain enters the owner's Form 4797 annual netting calculation. Unrecaptured Section 1250 gain is separately stated information used in the Schedule D rate calculation for qualifying gain associated with depreciation on Section 1250 real property.
Why did my real estate K1 report both Box 10 and Box 9c?
On a partnership K1, Box 10 can report the investor's share of net Section 1231 gain while Box 9c separately reports unrecaptured Section 1250 gain information. The amounts serve different tax reporting functions and should not simply be added together as separate gains.
Can Section 1231 gain from different K1s be netted together?
Applicable Section 1231 gains and losses from different pass through entities and directly owned activities ultimately enter the taxpayer's Form 4797 annual calculation. Loss limitations and passive activity rules must be applied where required before assuming every reported K1 loss is available for that calculation.
Can prior Section 1231 losses turn K1 gain into ordinary income?
Yes. Section 1231(c) can convert current net Section 1231 gain into ordinary income to the extent of nonrecaptured net Section 1231 losses deducted during the five preceding taxable years.
Is Section 1231 gain from a rental partnership passive income?
It generally can be passive when it comes from a rental activity. Rental real estate can be nonpassive when the investor qualifies as a real estate professional and materially participates in the applicable rental activity. Other passive income recharacterization rules can also apply.
Can passive Section 1231 gain allow suspended passive losses to be used?
Passive activity gain can provide passive activity income that allows otherwise allowable passive losses to be deducted, subject to Section 469, the applicable activity groupings, passive income recharacterization rules, and special publicly traded partnership rules.
Does a partnership property sale release all of my suspended passive losses?
Not necessarily. A partnership selling property is different from the investor disposing of the investor's entire interest in the passive activity. The complete disposition rule under Section 469(g) has its own requirements. A property sale inside the partnership can generate passive income without necessarily producing a complete disposition by the partner.
Is a Section 1231 loss on a K1 automatically deductible?
No. A partner can be limited by outside basis, at risk, passive activity, and excess business loss rules. An S corporation shareholder can be limited by stock and debt basis, at risk, passive activity, and excess business loss rules.
How do basis, at risk, and passive activity limitations affect a K1 Section 1231 loss?
For an individual investor, basis limitations generally apply first, followed by the at risk limitation and then the passive activity limitation. An excess business loss limitation can apply after those rules when applicable. A loss disallowed under an earlier limitation does not simply enter Form 4797 as though it were currently deductible.
What if my K1 reports Section 1231 amounts from several activities?
Review the attached statements. The entity can be required to identify Section 1231 amounts separately by activity so the investor can correctly apply the at risk and passive activity rules.
How is Section 1231 from a publicly traded partnership treated?
Publicly traded partnerships have separate passive activity rules. Passive losses from one publicly traded partnership generally cannot offset passive income from another activity. Unused losses are separately tracked for that publicly traded partnership, and special rules apply when the partnership activity produces an overall gain.
Does Section 1231 gain increase my partnership basis?
Generally, yes. Positive net Section 1231 gain is an income item that generally increases a partner's outside basis under the partnership basis rules. The investor remains responsible for maintaining the complete outside basis calculation.
Does Section 1231 gain increase S corporation stock basis?
Generally, yes. Separately stated income items passing through an S corporation generally increase shareholder stock basis under Section 1367.
Can a real estate syndication generate Section 1231 gain?
Yes. When a real estate partnership sells qualifying property used in its trade or business and held for more than one year, the remaining qualifying gain after applicable recapture can enter the Section 1231 calculation and be passed through to investors on Schedule K1.
Final Takeaway
Section 1231 gain on a Schedule K1 should not be treated as a stand alone capital gain entry.
The partnership or S corporation reports the owner's share of its Section 1231 result, but the owner must complete the remaining tax analysis.
That analysis can require combining Section 1231 amounts from multiple investments, applying basis and at risk limitations to losses, determining whether an activity is passive, reviewing suspended passive losses, applying the five year Section 1231 lookback, and separately accounting for unrecaptured Section 1250 gain.
For real estate partnerships and syndications, the supplemental K1 statements can be particularly important because one entity can report several rental activities, depreciation related items, and multiple components of gain from the same property sale.
A complete review therefore looks beyond the number printed in one K1 box and determines how the entire pass through package interacts with the investor's individual tax history.
Review Complex Real Estate and Investment K1s Before Filing
I assist real estate and business investors with Schedule K1 tax analysis, including Section 1231 gain and loss, unrecaptured Section 1250 gain, depreciation related items, passive activity limitations, partnership and S corporation basis, at risk limitations, prior Section 1231 losses, publicly traded partnerships, and supplemental activity statements.
The objective is to determine how the K1 items actually flow through the investor's individual return rather than assuming that the tax treatment is determined solely by the boxes printed on the K1.
Schedule a ConsultationThis article provides general federal income tax information. The treatment of Schedule K1 Section 1231 items depends on the entity, underlying activity, investor's basis and at risk amount, passive activity status, prior Section 1231 losses, other current year transactions, supplemental K1 statements, and other facts. State income tax treatment can differ from federal treatment.
