 Income tax 2023-2024. Dispositions of business property, tax software example. Get ready and some coffee because we need extreme concentration when doing income tax preparation 2023-2024. Here we are. First, a word from our sponsor. Yeah, actually we're sponsoring ourselves on this one because apparently the merchandisers, they don't want to be seen with us. But that's okay, whatever, because our merchandise is better than their stupid stuff anyways. Like our crunching numbers is my cardio product line. Now, I'm not saying that subscribing to this channel, crunching numbers with us, will make you thin, fit, and healthy or anything. However, it does seem like it worked for her, just saying. So yeah, subscribe, hit the bell thing and buy some merchandise so you can make the world a better place by sharing your accounting instruction exercise routine. If you would like a commercial free experience, consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com. Or in our forum, 1040 Example Problems using Listert tax software. You don't need tax software to follow along, but if you have access to software, it's a great tool to run scenarios with. You can also get access to forms, schedules, instructions at the IRS website, iris.gov, iris.gov. Starting at our standard starting point, taxpayer Adam Taxman, just trying to avoid a dang Taxman, living in Beverly Hills 90210, single file or no dependence. We're starting this time with the Schedule C sole proprietor business, which ultimately rolls into line number eight, additional income from Schedule One. The Schedule One over here is the additional income and adjustments to income. Part number one, line number three, is where we have business income or loss from the Schedule C. If we then go to the Schedule C called the profit or loss from business, we have an income statement format to the Schedule Business Income currently at 120,000 in this example problem minus the expenses or business deductions, 20,000. So far, that gets us in essence to our net business income, the 100,000, which is what is pulling into the Schedule One and then into the form 1040 line number eight. We also note that we're gonna have to deal with self-employment taxes with our Schedule C. So that's on the Schedule SE, where we take the bottom line and then apply the Social Security and Medicare, basically employee E and employer portion to it, get into the tax of 14229. So if I go to my form 1040 page number two, we now have the federal income tax plus the other tax, which is going to be the self-employment tax coming from Schedule Two. So that came from the Schedule Additional Taxes, part number two, self-employment tax. There's the 14129 that's coming from the Schedule SE. Also, if we go to the Schedule SE, we get to have half of that tax deductible that's gonna be 7065. You would think that would go on the Schedule C, but no, because that would make a circle reference. Therefore, instead, it goes to the Schedule One, page number two, where we have part two, adjustments to income, line 15, deductible part of self-employment tax. There's the 7065, which ultimately goes to the form 1040 as an adjustment to income or above the line deduction. That gives us the 100000 minus the 7065 gives us the adjusted gross income, 92935. Standard deduction, we're gonna say, is for the single filer, the 13850. We also have the system calculating for us to qualified business income deduction from form 8995, 15817, subtotal 29667 to get finally to the taxable income, the 63268, and then page two calculating both the federal income tax, 9228, and the Social Security and Medicare, the self-employment taxes, for a total tax of 23357. So that is our starting point. So now, of course, our focus is over here on the Schedule C, and we noted that when we first start the Schedule C, we might choose or we need to choose an accounting method, typically a cash or a cruel method or possibly some other method, some combination of the two methods. Noting cash method is typically easier to do. However, certain types of businesses force us to do a cruel things, in which case the code sometimes might force us to go away from a cash-based method, the most common example of that being inventory. Because if we track inventory, we can't just expense it when we buy it, but rather put it on the books as an asset, which is an accrual thing to do, as opposed to a cash-based thing to do, and then we would expense it as we consume it in the form of cost of goods sold. So that's one of the deviations if we deal with accounts receivable or accounts payable, more likely accounts receivable for small businesses, then we might have to do the accrual thing and that case as well, because we're basically tracking our income on an accrual basis. So you see we have the 120,000 income minus the expenses. Now, the two things that we might have to say capitalize, and when I say capitalize in this sense, I'm saying instead of expensing it possibly when we pay for it, we put it on the books as an asset and therefore have to do an accrual thing. One is gonna be inventory and two is gonna be depreciable assets like property, plant, and equipment. So let's first just take a quick look at the inventory. So if I go to page number two, you see we have a cost of goods sold calculation. Note what we do not have here, we don't have a balance sheet, but certain things have balance sheet items on them. So when I do a cost of goods sold calculation, it's gonna include the beginning inventory, we're assuming at the beginning of the year and ending inventory in the calculation and those two accounts are basically balance sheet accounts or inventory is a balance sheet account. And when we deal with depreciation, although we don't have a balance sheet, we do have a depreciation schedule which is tracking the balance sheet accounts of the fixed assets and the accumulated depreciation. So let's imagine that we have to deal with this cost of goods sold. If you have cost of goods sold, then you might be using some kind of software to help you to do your books so that you can get the income statement to help you populate into the schedule C. So if you were to do that, you might already have a number for cost of goods sold because it's on your income statement. So you might be able to actually fill out this part of the form and say, I could just plug cost of goods sold in right here. What you don't have possibly is the cost of goods sold calculation because that calculation for taxes is on a periodic system for the entire year basically. So in other words, you might need to back into that number. You might be in this problem saying, I know what this number should be, but I need to then back into the beginning or this calculation so I can put this page number two because I have to deal with inventory. So let's just imagine, you know, that was the situation. Let's imagine that this inventory was, was let's say 30,000 of inventory for the cost of goods sold. Well, if I was to jump to that data input and I'm gonna go, let's go to that data input, it won't let me jump there. If I go to my income statement, schedule C, I have the cost of goods sold calculation. Now, if I didn't have any beginning inventory, I could start by saying, hey, look, I'm just gonna put the number in that I know it should be 30,000, let's say, and then I'm gonna go back on over here and there's the 30,000 and that will allow me to tie out my ending balance to what I had on my worksheet. But the page two doesn't really make sense because you don't have any beginning number and ending number. So that's gonna kind of confuse the IRS, right? They're gonna say, hey, there should be an issue. What should the beginning number be? It should be the same number as it was last year for the ending number. So in other words, if I go back to this software again, you might say, hey, look, the beginning number, if I rolled this forward, is gonna be same as the ending number last year. So it might already be populated. Let's say it was 5,000 that was already in here. Well, then if I put 30,000 in place, it's gonna calculate 35,000 and that's gonna make it so I can't even reconcile because now it's at 35,000 and I want it to be at 30,000. So you might first say, hey, look, I'm just gonna make this work and then I'm gonna go back in and fix my cost of good sold calculation. So I'm gonna say, I'm gonna make this work so I can get my net income correct and then I'll go fix page two. How could I do that? Well, I don't wanna adjust the beginning balance number there. I'm just gonna put the same ending number so that if I started and stopped at the same point, then the 30,000 is what is gonna populate here. And so now I can say, okay, that number is correct and I can get to my bottom line net income and then I could go to page two and say, okay, can I need to fix this schedule to be in alignment with this cost to good sold calculation that the IRS wants to have so they can kind of give a double verification of the beginning and ending balances of inventory on a periodic system, even though my software might be using like a perpetual inventory system. So then I'm left with this problem. Now, if I go back on over here, just a quick look at this, what's this cost to good sold calculation? It goes like this, beginning inventory, this is the short form plus purchases and that's gonna give us the cost of goods available for sale. That's what we could have sold during the year, less, let's say minus ending inventory. I'm probably spelling this wrong. Oh man, it doesn't like that I had an equal sign there. Get over it, man. This is gonna be plus and this is gonna be equals the cost of goods sold or COGS. So if I say the beginning, if I know the beginning inventory, then what I don't know is this 5,000, is this purchases, I actually do know the cost to good sold. So because that was calculated in my software possibly on a perpetual method. So I know the 30,000, right? And then the ending inventory, I should know the ending inventory because my software would also give me that on the balance sheet. It wouldn't be on the income statement, but that's something I should be able to look on the balance sheet and pick that up. So let's say that it was 6,000 and what, wait, hold on, I don't know the cost of goods available for sale. I know the cost to good sold, which was, I said 30,000 and this is just a subtotal, which is gonna be this plus the purchases. So we can do this calculation and try to back into this number. If I take out this subtotal, of course, what we end up is beginning inventory plus purchases is less minus ending inventory is gonna equal cost of goods sold. So if I put these same numbers in here, I have the five, I don't know what this is, that's gonna be X and then ending inventory is the six and I actually know the cost of goods sold. So the cost of goods sold is this. So then the question is what is gonna be the purchases in order to figure that out? And if I write this out algebraically, we would have 5,000 plus X minus 6,000 is gonna equal the 30,000. And then of course we can solve for X and that's gonna be, let me see what's that gonna be? That's gonna be, this is gonna be equal to 30,000 and then I would subtract this from both sides. So minus 5,000 and then add this to both sides plus 6,000. So this should be 31,000. We're gonna say let's double check that. So it would be 5,000, 31,000 and then 6,000. That means this would be equal to the beginning balance plus purchases minus ending inventory gets us to the 30,000. So then I can go back in here and say, okay, let me fix this cost of goods sold to tie out to my worksheet cost to goods sold is gonna be the beginning balance of 5,000 but the purchases need to be, we're gonna say 31,000, 31,000 because the ending inventory is 6,000. And if I go back on over, so now I come up with the same 30,000 and now my beginning balance is correct and hopefully I have the right breakout between these two items. So that's just logistically what you might need to do from a data input standpoint on inventory because like I say, this is basically on a periodic inventory system and the IRS is trying to tie into last year's ending inventory to begin the beginning balance pulling in a balance sheet account and having a proper categorization or calculation of ending inventory which means you actually might have to back in because you might be using a perpetual inventory system. Now, if you have a job cost system, then you have work in process and so on and it's a little bit more complex because you have to deal with materials and labor and whatnot as part of your cost of goods sold but a similar concept might apply because you'll be doing that calculation hopefully in your software and then you have to basically put it in a format here that is appropriate for the cost of goods sold calculation which you might do actually after you do the data input for the tax for the first page because I'm just gonna try to get this number to be correct first just from a data input standpoint to get my net income correct and then I'm gonna note that I'm gonna shore that number up in the supporting schedule making sure that it still results in the same ending number that's on the income statement. Okay, so that's one thing that we might have to capitalize in a little bit of logistics related to it. If I purchase something that's a large thing I can't just expense it but have to put it on the books as an asset and then depreciate it which will talk a lot more about depreciation in the future right now we just wanna take a look at the sales side of things. So for example, let's say we bought like equipment I'm gonna go over here and say that we bought to do and we're gonna say it's depreciable stuff. And I'm just gonna call it five year property for now. We'll get into how long you have to depreciate it and so on later. It's going to the schedule C and it's gonna be business one. The category I'm gonna call it is going to be then I'm gonna put it into machinery. We're gonna say let's start putting it as if we bought it in the current year, 2023. So I'm gonna say 060623 and let's say we bought it for $10,000 and I'm not gonna put anything in for the 179. The method we're gonna say is five years makers for office equipment rental and so on and let's just see how that populates. We're gonna go to the forms and you can see in here we've got the depreciation now populating at 8,400 even though I put it on the books at 10,000. If I go to my depreciation schedules now we've basically capitalized it because we put it on the books as an asset and then expensed it. If I look at the regular depreciation which is a little bit smaller schedule we've got the 10,000 that it was put on the books for. Note that it took this special depreciation which we'll talk more about later. This is a deviation from normal accounting practices and so in other words normally what happens is you're putting it on the books as an asset so that you can expense it over the useful life which is an accrual concept. But then the IRS code is keeps on trying to say hey look we would like to have special depreciation because it's popular to do that number one because people like that, right? That's gonna, and two they're saying the argument is that it stimulates the economy if you can deduct more in the current year. So they actually defeat their own purpose of putting on the books as an asset by basically allowing almost all of it to be depreciated right in the current year. So that's the general idea. We'll get into those different depreciation methods makers depreciation, types of depreciation assets, property, plant and equipment, how it should be categorized and whatnot in a future presentation in more detail. For now we wanna think about what would happen if we disposed of some property that is already on the books. Now just a couple other things to note since we're here on the depreciation, one is that you would never wanna put the depreciation on the books for just a five year property because I can't identify that property to what's actually physically in the business which isn't so much of a problem when I first put it on the books but imagine what happens when I dispose of this property now, I can't dispose of it because I don't know which property I disposed of or I can dispose of it but I can't take it off of the schedule because I can't identify it. So it becomes a problem down the road. We also have to be careful about grouping depreciable items into one group. So if I bought like 10 computers, if I put them all on the books as 10 computers, then again that'll be fine for the current year but if I dispose of one or two computers in the future, how am I gonna take one or two computers off the books off the depreciation schedule when they're on there in one line item, right? So what we wanna do is break out each piece of equipment, physical piece in our depreciation schedule so that in the future when we dispose of them it will be easy for us to select the item that's being disposed of and account for it. It's already hard enough to deal with dispositions of property without the added problem of not being able to identify the property on the worksheet because of these because we didn't put it on there clearly. We would also like to have our categories here on the depreciation schedule to be supporting the same category structure on the software such as like a QuickBooks for example and that will once again make it easier for us to enter the depreciation adjustments into the software. Just a couple things to keep in mind. Okay, so now let's put this piece of equipment on the books from a prior year and then we'll imagine that we're selling it. So I'm gonna go back to our books here and I'm just gonna say that this was purchased sometime in the past. So let's say it was purchased in 2000, let's say, and we're gonna say the cost is still 10,000. Same method, but I'm just gonna then allocate the prior depreciation, the prior year depreciation will be, I'm just gonna say 6,000, right? So now this was on the books from the last year. This also becomes very important to use the same accounting software because the depreciation schedules are gonna complicate things. And if you pick up a new client getting the depreciation schedules is important so that you can basically enter that into the system, you probably wanna make sure that you enter it into the prior software to try to match up the depreciation perfectly and then perform it forward to the current year to try to get the roll over as best you can situated. Any case, this is the 10,000, this is the depreciation prior year depreciation we're imagining is 6,000. So the current depreciation, we're using basically a double declining method for the maker's method, we'll talk more about that later, but that would be the current year depreciation. So still on the current year schedule C, we would now have depreciation that's being allocated for something purchased in the past because we're trying to allocate it to the time period that it was consumed. Now we're gonna imagine that we sell that piece of property in the current time period. So what if we sold it? So let's say we sold it for $8,000. So $8,000, that's gonna be our sales price that we sold the equipment in let's say 06, 1524, and so there we have it. So now if I go back to the software, we're gonna say if I go to my depreciation schedule and we go to the regular depreciation, it's on the books here for the 10,000. And then in 2024, hold on, I sold it in 2024. We need to sell it in 2023. That's the tax year that we're on. We sold it in 2023. So now it's off of the 2024 depreciation schedule is gone. And if I go to 2023 depreciation schedule, here's the date acquired and here's the date sold. You can see there's been an adjustment to the current year depreciation because we sold it basically in the middle of the year. We'll get into those calculations a little bit more later. For now we wanna go to this schedule 47, 97. And so if I go to page two, we have basically our calculation. So we've got the gross profit, the cost or other basis, and then the depreciation, here's the adjusted basis and the total gain. And then we have the allocation section 1245 gain and so on. So let me try to just give a little bit of a summary on this. So let's say we bought it for $10,000. We said that the depreciation, if I go back on over here, we could say let's go to my depreciation schedule, pay the regular was prior years, was 6,000. In the prior years, 6,000 and the current year, we depreciated 576. So 576, so the total depreciation is gonna be those two. So that means the book value is gonna be this minus this. That's in essence, the book value. We sold it for, what did we say, 8,000? So that means we have a gain of 8,000 minus the book value of the 4,576, which in essence is pulling over here to page two, which they're calling a 1245 property. Now this gets into the issue of, well, where should that gain go? Because you'd think if I go over to the schedule C, you see that we have this deduction here, but we don't have that gain up top in income. It's not being put on the schedule C. Where is it going instead? If we go to the schedule one, we see it right here, line number four, other gains or losses. So now we have this coming from form 4797, which is gonna be part of this, going to the 74,000 here, which is pulling into the form 1040. There's the 74,000. Now the point of this is that if I go to page number two, you're gonna say, hey, what about my tax calculation because we sold property, should it be calculated at different rates? And you can see here that we don't have that more complicated calculation breaking out something other than just the ordinary income rates. In other words, it looks like it got taxed at ordinary income rates. And you might say, well, why isn't it taxed? It's taxed at capital gains rates. And here's where kind of the issue comes in. If I go back on over here, you could see the argument would be, if it's a long-term sale, it should be at capital gains rates. But you could see what happened is basically the only reason I sold it out of the gain is because I over depreciated it. And possibly I over depreciated it because the tax code is giving us these accelerated depreciations. In other words, if you let me buy a 10-year piece of equipment and expense the entire thing in the first period, you're gonna allow me to get a deduction at ordinary income rates. And then if I sell it, then if you allow me to take it, I'm gonna have a gain because you let me over depreciate it in the first year. And then when I sell it, I could sell it at a gain, but the gain would be subject to the lower capital gains rates. So you could see how people would play games with that if you allowed that to happen. In other words, over here, the $8,000 is not, what I sold it for is not higher than the cost of the property, but it is higher than the book value of the property after I wrote off the depreciation. And so I shouldn't, when I wrote off the depreciation, I got ordinary income rates. So the argument is that, well, you can't then sell it and then get a gain, which you're obviously gonna get because you over depreciated it and get favorable capital gains rates. That's why this gain is being taxed at ordinary income rates. Now, most property is going to be in that category where it's gonna go down in value. It's not likely I'm gonna buy a forklift for $10,000, use it for two years, and then sell it for more than $10,000. But if it was a building or something like that, that's when that can happen. So let's imagine I sold it then, let's just imagine I did sell it for more than the $10,000. Let's say I sold it for $12,000. So now if I go back on over and say, okay, let's imagine we sold this thing for, let's say $12,000. Da, da, da. So now I'm gonna go back on over and say, okay, on the schedule C, I still have the depreciation. I don't see the income over here. On the depreciation schedule, we of course still have that it is sold. At the same time, we still have our calculation. And then on the form 4797, we see the 2000 gain, if any, from line 32 now being populated, let's go to the 4797 part two. So now we have the 12,000 cost or other basis was 10,000. The depreciation, 6,576 adjusted basis, 3,424. So the gain is now at 8,576. But the 1245 property is at that 6,576. So let me show you that. So if this was our cost, right? So now we still have the book value is at that 3,464. We sold it for the $12,000. That gives us a gain of, a total gain of 8,576. But 2,000 of that gain was over and above the cost. So 2,000 of that gain was over and above the cost. And therefore the difference is this 6,000. So this 6,000 is kind of, you could think of it as recapturing or basically part of the amount that we over depreciated and therefore should be subject to ordinary income. Whereas this 2,000 is over and above the cost and therefore might have more favorable rates, the capital gains rates, which are lower tax rates, which would be better. So then we could say, okay, there's the 2,000 that is breaking out the 8,576 minus the 6,576. It gives us that 2,000. So then if I go back then to the schedule one, you can see what's included here, only the 6,576, not the full 8,576 that is being included and pulled down to the 76,000, which is pulling to the form 1040, which is pulling in here on line number eight. The other amount you can see is right there, the 2,000 is being populated on the Schedule D. Now the Schedule D for most individual income tax preparers is associated with the sale of stocks and bonds oftentimes where you have these capital gains and loss rules where if you have a gain, it might have a more favorable tax. So here's the gain that's being pulled in from form 4797 and that's pulling into the first page of the form 1040. You might say, well, what does it matter if I put it at this 2,000 or included in this 76,000? Why don't I just make this 76,000, 78,000? And the issue is that if I go to page number two, when we actually calculate the tax, you'll see that we have a more complex tax calculation, not just the progressive rates, but now breaking out that 2,000 so we can tax it at the more favorable capital gains rates. So that whole thing gets fairly complicated both from a bookkeeping standpoint, as well as a tax standpoint, especially when you throw in this issue of over depreciation because of 179 and special depreciation, which results in the likelihood of selling things at a gain and then having to deal with the fact that you're gonna have to tax part of it at ordinary income and part of it at the capital gains favorable rate and so on. Now it could be that you sell it at a loss. So if I say my book value over here is the 3,000, let's say we sold it for 2,000 or maybe we just disposed of it, we didn't sell it at all, we just like threw it away, it became worthless. But let's just say we sold it for 2,000. So then if I go back on over, we're gonna say, okay, the depreciation schedule should be in essence the same. And if I go up to the 47.97, now we have the sale, the gross proceeds, here's the depreciation, 6,576, the cost or basis, and we have the loss of 1,424, which we can calculate over here. We have the same book value, but now I sold it for 2,000. So there's our loss now, instead of a gain of 1,424. So if I pull that on over, so it's like, okay, well, if I have a loss, where does that go? Does that go on the schedule C as like an expense? No, it's not going to the schedule C as an expense. If I go to the schedule one, we can see it here in line four. Other gains or losses attached form 47.97, which is netting out against the net income slowed in from the schedule C to the 68,000, which is now being populated on the form 1040. So there's the 68,000. And if I go to page two, you could see that we have the, back to the normal simplified worksheet. In other words, the loss, I got to take basically at ordinary income rates, which is kind of nice if you had a loss. Now again, the likelihood of having a loss is greatly reduced if we were allowed special and 179 depreciation, because we would have written a huge amount off at the point of purchase. Once those things go away, if they ever go away and they go back like to normal, then it might be more likely that we have situations when we sell property that we're at a loss. However, you might often see a loss if they like dispose of property, which hasn't fully been depreciated, right? Now that's the general idea. Now the other thing we touched on in the prior presentations is the idea of an installment sale, but we're running a little long, so I don't wanna go into it in detail right now, but just to note that if you're selling equipment over here, then it's likely that you might be selling things for large dollar amounts, right? And if you sold it for a large dollar amount, you might say, well, I'm gonna sell it, and then you can pay me in the future, which means you're paying, you're receiving it in basically installment payments. In that situation, if you sold a large thing like a $10,000 or like a $100,000 piece of equipment and you would have to recognize the $100,000 normally under a revenue recognition principle at the time of sale, but you might not have the money to actually pay for it because you've basically financed it because they're gonna be paying you in future payments. So you might end up setting up basically an installment sale kind of situation that will then allow you to recognize the revenue basically as you get the payments. That's not a really common thing to happen for many businesses, but could happen somewhat commonly. So maybe we'll do a presentation on installment sales in the future just to see how that calculation could be set up.