 Income tax 2022-2023, dispositions of business property. Let's do some wealth preservation with some tax preparation. Support Accounting Instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course, each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Most of this information comes from the tax guide for small business for individuals who use Schedule C Publication 334 Tax Year 2022. You can find on the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're focused on line one income. Remember that the first half of the income tax formula is in essence an income statement, although just to outline other forms and schedules flowing into it, the Schedule C Small Business Income, which is in essence an income statement in and of itself income minus expenses. The net income then flowing into the first line, the income line of the income tax formula. First page of the Form 1040, we know the Schedule C would flow into the Schedule 1, which would flow into line eight of the Form 1040. First page, this is a Schedule C profit or loss from business, has an income section and expense section because it's basically... Now let's talk about the disposition of business property introduction. If you dispose of business property, you may have a gain or loss that you report on your tax return. However, in some cases, you may have a gain that is not taxable or a loss that is not deductible. So if we had a gain that wasn't taxable, that would be good because gains would typically be income, you would think. Income is bad for taxes because it might increase our tax. If we had a loss that was not deductible, that would be bad generally because losses are actually good for taxes because they might reduce the taxable income. So this chapter discusses whether you have a disposition, how to figure the gain or loss, and where to report the gain or loss. So note, then when you're reporting on a Schedule C for a small business, you in essence have an income statement. Even if you're on a cashed-based system, you might have to deviate from the cashed-based system to report, say, property, plants, and equipment, large purchases, the depreciable assets, for example. So in general, usually, most expenses are going to be the things that you're purchasing, telephone, utilities, small supplies, and whatnot, and expensing at the point in time that you purchase them. But some items are going to be such a deviation from a cashed-based system that we have to use an accrual concept, put them on the books as an asset, and then depreciate them. This would be things like building equipment is a general example for the small businesses. And so now they're on the books as an asset, and we're depreciating it, getting the expense, allocating the cost over the useful life of that asset. What happens, however, if we sell that equipment in the future? Now we have a situation where we can calculate the gain or loss of the sale. Now normally, we're not talking about inventory here. We're not talking about things that we purchased in order to sell, primarily to sell where we purchased, marked them up, and sold them. That would be inventory. We're talking about the items that we put on the books as an asset, like equipment, and then we're going to dispose of them or sell them in the future, which could result in a gain or loss. In other words, if we hadn't fully depreciated, taken the expense or allocated the full cost of those fixed assets, and we just disposed of it, we didn't get any income, then you would think that you might have a loss type of situation in that case, because we had some unused expense, but we're no longer using that piece of equipment. Or if we actually got income when we sold the equipment, that is greater than the book value of the equipment, which is quite possible, book value being the cost minus the accumulated depreciation, it's quite possible because you might have accelerated depreciation methods you could take advantage of, then you have a gain situation. And so what do you do with that? You have to record that as income. Incoming income flow. That's our general concept. Useful items you may want to see then, publication 544, sale of other dispositions of assets. So you could look at that for more detail, form and instructions. You've got the form 4797, sale of business property, schedule D, form 1040, capital gain and losses. So those are some references that if you want to drill down deeper on, you can go into. So at disposition of property includes the following transactions. You sell property for cash or other property. So when you sell the property, you might get cash for it. You might trade it in. You might get something other than cash, which still means that you had a sale take place. It's just that you had a barter situation, which still could have a tax triggering event. So you exchange property for other property. You receive money as a tenant for the cancellation of a lease. So you receive money for granting the exclusive use of a copyright throughout its life in a particular medium. That's going to be a specific situation where your asset is like that intangible asset of a copyright. You transfer property to satisfy a debt. So if you get paid by a reduction of a debt, you still got income because they reduced the debt. That would be like they gave you money and then you gave it back to them. So you abandon property. So the property, like if it was a building or land or something, and you just left it, then you're like, I'm out of here. Then, and you're not claiming it anymore, then that would be like kind of like a disposition you dispose of it. Your bank or other financial institution forecloses on your mortgage or repossesses your property. So that would be an involuntary disposition in that case, but still a disposition. Your property is damaged, destroyed, or stolen, and you receive property or money in payment. So now the property was again involuntary, most likely destroyed, stolen or something. Your property is condemned or disposed of under the threat of condemnation, and you receive property or money in payment. So you get, you gave property away. So those are the circumstances for details about damage, destroyed or stolen property. You can see publication 547 casualties, disasters and thefts for detail about other dispositions. See chapter one of publication 544. Non-taxable, non-taxable, but highly interesting. Changes. Certain exchanges of property are not taxable. This means any gain from the exchange is not recognized and you cannot deduct any losses. Gain or loss will not be recognized until you sell or otherwise dispose of the property you receive. So the big one is the like kind exchange situation. And most of the people, when they hear that, they think of like real estate type of like kind transactions. So a like kind exchange is an exchange of property for other like kind property. It is the most common type of non-taxable exchange. Like kind exchange, the property traded and property received must be both real property. So now we're talking real estate generally and business or investment property. So report the exchange of like kind property on form 8824, like kind exchanges. For more information about like kind exchanges, see publication one of publication 544. So like kind exchanges are a whole kind of world in and of themselves. So you can dive into them in more detail and do some more research on them. If you so choose publication 544. Installment sale. An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. So now you made the sale, you're getting paid after the sale. Notice what happens in that situation from a tax standpoint. If I sold something, you would think that I would recognize the revenue at the point of sale. But if I'm not going to get the money until some future point in accordance with our payment arrangement, then I might not have the money to pay the taxes. So it's not really fair that I have to record the sale in the first period when I'm not going to get the money to pay the taxes related to the sale possibly into a future period which might be some of the rationale for an installment sale situation for taxes. So if you finance the buyer's purchase of your property, instead of having the buyer get a loan or mortgage from a third party, you probably have an installment sale situation. So for more information about installment sales, you can see publication 537 and dive into them in more detail. There's a little bit more unusual situation. So sale of a business. So the sale of a business is usually not a sale of one asset. Instead all assets of the business are sold. So in other words, if you're going to sell your entire business normally you don't think the sale doesn't often take places as though I'm going to sell it as like one business entity. Oftentimes you're going to value all the assets and liabilities within the business and then basically you're going to sell the underlying value of the business, the assets and liabilities within that are underlying the business. If this occurs, each asset is treated as being sold separately for determining the treatment of gain or loss. So that can be kind of a tedious cumbersome process, but you can imagine what is happening here if the business has a bunch of different equipment and building and whatnot you're valuing all of them, you're trying to determine what the price of it is an aggregate and then in essence the sale then if you're structuring it in that way looks like basically a sale of all these of the business assets. Both the buyer and seller involved in the sale of a business must report the IRS the allocation of the sales price among the business assets. You can use form 8594 asset acquisition statement under section 1060 to provide this information. The buyer and seller should each attach form 8594 to their federal income tax return for the year in which the sale occurred. For more information about the sale of a business you can see chapter 2 of publication 544 selling a business is a whole another issue again in and of itself so you want to make sure that if you're in that situation you're doing your research there. How do I figure a gain or loss basis, adjusted basis amount realized, fair market value and amount recognized or defined next. So you need to know these definitions to figure your gain or loss. So we got the table below how to figure a gain or loss if your adjusted basis is more than the amount realized you have a loss amount realized is more than the adjusted basis you have a game. So obviously the general component that you have here when you're thinking about basis and what not is that you've got the cost what you what you paid for the piece of equipment is you can think about as your basis at the point in time that you bought it basically the cost it's the kind of like the adjusted cost and then what happens in the future typically it's going to be depreciated you're allocating the cost over the useful life as you expense it then you've got the cost minus the accumulated depreciation the amount that you've consumed that's your adjusted basis in essence and if you get paid for the sale of the equipment in an amount higher than the adjusted basis which is kind of like the value or it's the estimated fair market value but it's not really because it's the tax code and the tax code isn't really designed to be the fair market value right it's an adjusted basis but that's kind of like the value for tax purposes of the property of the basis so then you've got the amount you sold it for minus that basis if it's higher you got a gain if it's less then you got a loss possibly. Alright basis the cost or purchase price of property is usually it's basis for figuring the gain or loss from its sale or other disposition how much did you pay for the property however if you acquire the property by gift or inheritance or in some way other than buying it you must use a basis other than its cost so you can imagine situations where you can't use the cost because you inherited it so if you inherited something the IRS isn't going to you can't have a basis of zero that wouldn't really make sense because then when you sold it then you would be responsible for the entire sales price but really if you inherited it then it's kind of like it was it was given to you so you would think the logical thing to happen would be that somehow you're going to get the basis from the person that gave it to you either when they bought it or at a step up in basis when they died because then you've also got this inherited tax death tax that might be in place so that which could be a step up in basis so for more information about basis you can see publication 551 basis of assets if you want to dive into that in more detail adjusted basis then the adjusted basis of property is your original cost or other basis plus certain additions and minus certain deductions such as depreciation and casualty losses so typically the main one would be depreciation meaning you already got a benefit if you bought a $10,000 thing and then you expensed like 20,000 of it over the lifetime of the equipment you already got a benefit you got a tax benefit you deducted 20,000 that means you're going to lower your basis and if you lower your basis your adjusted cost your adjusted basis that means you're more likely to have a gain you know when you sell it which makes sense because if you sell it for a gain you've adjusted your basis your adjusted basis is now lower than the fair market value because you sold it for something higher than the adjusted basis so in determining gain or loss the cost of transferring property to a new owner such as selling expenses are added to the adjusted basis of the property so then you also have to deal with transactional costs of selling the property so if you're selling a building or something like that you can have fairly substantial transactional costs which you can add in essence to the basis. Basis being higher the adjusted basis being higher typically being better for taxes because the higher the basis the less the gain is going to be and the greater the loss would be depending if you have a gain or loss and remember gains are bad for taxes and losses are good for taxes so amount realized the amount you realize from a disposition is the total of all money you receive plus the fair market value of all property or services you received the amount you realize also includes any of your liabilities that were assumed by the buyer and any liabilities to which the property you transfer is subject such as real estate tax or a mortgage so obvious the amount you realize is the amount that you're receiving you're realizing the increase so notice if you have a building for example then it may go up in value like the building could go up in value most other assets go down in value like a forklift or any kind of equipment if it goes up in value you might say doubled in value well I forgot a gain in it but you haven't realized the gain until you sell it for a gain because equipment is unique in nature so you don't really know how much someone will pay you for it until you actually sell it so when you sell it you realize the gain now then how much did you realize well if they paid you money it's pretty clear that's how much you got but if they paid you another something other than money then you've got to value what they gave you which gets a little bit more complex and if they relieved debt that was your debt that would be the same as if they gave you money and then you paid off the debt right so that's still kind of a form of income so fair market value fair market value is the price at which the property would change hands between a buyer and seller neither having to buy or sell and both having reasonable knowledge of all necessary facts fair market value would be the thing that we would have to kind of calculate if so if we got property for example we have to figure out what the fair market value is the problem with figuring out the fair market value of property is to really know if it's unique property until you actually sell it what the fair market value is so the fair market value in concept makes sense in practice it's difficult because you need like an appraisal or something to give you some idea of what the fair market value is and any appraisal is simply an estimate only as good as the the estimator so amount recognized so your gain or loss realized from a disposition of property a recognized gain or loss for tax purposes recognized gains must be included in gross income recognized losses are deductible from gross income so losses are kind of good income is kind of bad right however a gain or loss realized from certain exchanges of property is not recognized see non-taxable exchanges earlier also you cannot deduct a loss from a disposition of property held for personal use so we're talking generally business property if it was for business then that's when you would think you might be able to get a loss related to it as opposed to if it was personal stuff so is my gain I mean obviously you couldn't just say I have all these personal stuff and I no longer need it and I disposed of it and I have this personal loss my TV broke so I threw it away and I got a loss of a thousand dollars no as a personal it's not a business thing so is my gain or loss ordinary or capital so you must classify your gains or loss as either ordinary or capital gains or losses so this is where it gets messy because because we have a progressive tax system and so ordinary income means it's going to be taxed at multiple rates and it's usually going to be higher than capital gains and capital gains is usually what we think of when we think of selling like stocks and bonds where we might have a favorable rate when we sell stocks and bonds but selling property could result in a capital gains situation and so now you've got this difference in taxes it would be more favorable to have long term capital gains rates than it would to be taxed at ordinary income rates so now figuring the gain is only half is only part of the issue now the question is do I have to charge it at ordinary income or capital gains rates so you must do this to figure your net capital gain or loss so generally you will have a capital gain or loss if you dispose of a capital assets so for the most part everything you own and use for personal purposes or investment is a capital asset so the personal side of things so certain property you use in your business is not a capital asset a gain or loss from a disposition of this property is an ordinary gain or loss however so if you held the property longer than one year you may be able to treat the gain or loss as a capital gain or loss these gains and losses are called section 1231 gains and losses where you might get like the best of both worlds in essence with the 1231 gains and losses oftentimes so for more information about ordinary capital gains and losses you can see chapter 2 and 3 of publication 544 if you want to dive into that with more detail obviously tax software can be helpful to be tracking this information you know as well and help you to calculate the gain and loss and help you to populate the forms properly and apply the proper tax but it's only as good as the data input that you put into the software so is my capital gain or loss short term or long term so if you have a capital gain or loss you must determine whether it is long term or short term whether a gain or loss is long term or short term depends on how long you own the property before you dispose of it the time you own property before disposing of it is called the holding period do I have a short so if you held the property one year or less then you have short term capital gain more than a year long term so that's just an arbitrary number that they used the concept would be kind of makes sense because if you had if you had a long term capital gain suddenly I have an opinion about the capital gains tax you can make an argument that if you had something for many years and then you had a large gain from it then at the year that you sold it you might have a lot of income because because you sold something that you've been holding on to for many years and that could increase your ordinary income rates unfairly because really you should have recognized the gains over multiple years so it becomes a problem if you tax it at ordinary income because people don't want to recognize the realize the gains because it could increase the progressive tax rates because they'll have to recognize the big gain in one year so that's kind of an argument for using long term capital gains which are less than the ordinary income rates but then they choose an arbitrary number which is a year and you know so it is what it is then you get all these messy situations where now you're trying to get things to be calculated as capital gains rates which are more favorable than the ordinary income rates and that's kind of messy so where do I report gains and losses report gains and losses from the following dispositions on the forms indicated the instructions for the forms explain how to fill them out so dispositions of business property and depreciable property you're going to use form 4797 if you have taxable gain you may also have to use schedule D that's the schedule you typically use for you know capital gains of like selling stocks right like kind exchange use form 8824 you may also have to use form 4797 and schedule D form 1040 you've got your installment sale use form 6252