 Income tax 2021-2022, dispositions of business property. Get ready to get refunds to the max, diving into income tax 2021-2022. Most of this information can be found in publication 334, tax guide for small business tax year 2021. Income tax formula focused on line one, the income line, which would be supplemented by another schedule, basically an income statement, revenue and expenses, expenses basically being deductions, the net then flowing in to line one of the tax formula as well as page one of the 1040 that we see here. We would have the schedule C, the schedule C flowing into the schedule one, the schedule one, then flowing in to the first page of the form 1040 line number eight. Here is the schedule C, the profit or loss from business, basically an income statement. So now we got the dispositions of property. So this is another area that could be a little bit more confusing when you're doing the business taxes, because normally you just got the income statement, revenue and expenses, and getting down to that bottom line. But you might have some property that you have to deal with when we're thinking about property here. We're thinking about generally like depreciable type of assets now, which is one reason that's a little confusing is because the schedule C is just an income statement. And the full set of financials books would be a balance sheet and income statement. We don't see the balance sheet, but we still have to deal with those kind of depreciable type of assets, the property, plant and equipment that might go on the books as an asset. Even if you're under a cash method that is, if you purchase large pieces of things, even for cash, you can't just expense them in the current year, but rather have to put them on the books as an asset. Even though there is no balance sheet on the tax return for a schedule C sole proprietorship type of business, but there is a depreciation schedule, and then you basically depreciate those, and that's the expense that you're going to get on the tax return allocating then the cost of those larger assets over the useful life. That's the typical accounting concept, but under the tax code, they might accelerate it and do funny things to it. So if your small business don't have a lot of property plans and equipment, then not a problem, a lot more easy. But if you have a lot of property plans and equipment, large pieces of equipment that are needed in order to generate revenue, then you might be purchasing them, you might be selling them, you might have to put them on the books as a depreciable asset, and run a depreciation schedule in order to get the benefit of the cost in the form of depreciation expense. So if you dispose of business property, you may have a gain or loss that you report on your tax return. So if you dispose of the property, then you got to gain or loss that you got to deal with possibly, which is basically going to be the sales price minus the adjusted basis, which would basically be the cost minus, for example, the general deductions you already took in the form of depreciation, which can often be found in the tax software with depreciation schedules. However, in some cases, you may have a gain that is not taxable or loss that is not deductible. This chapter discusses whether you have a disposition, how to figure the gain or loss, and where to report the gain or loss. So we have publication 544, sale of other dispositions of assets. So if you've got more questions about that, you can look at that publication, publication 4797, sale of business property and schedule D, that's often where you report the capital gains form 1040. You can go to those areas as well for more information with regards to these types of sales. So what is a disposition of property? You might ask, a disposition of property includes the following transactions. You sell property for cash or other property. So obviously you're selling property, you get cash in exchange. That would be the normal kind of thing, but you might get other property in exchange. It's still a sale, still have to report it, still got income. Government still wants their share. You exchange property for other property. You receive money as a tenant for the cancellation of a lease. So now you get the money for the cancellation of the lease. You receive money for granting the exclusive use of a copyright through its life in a particular medium. You transfer property to satisfy a debt. You abandoned property. So even abandoning property in that instance, you're going to have to dispose of the property in some way, even though you kind of walked away from it. So that can be like a kind of confusing situation. And your bank or other financial institution foreclose on your mortgage or repossesses your property. So again, the property has now been gone forcefully taken action, not really a voluntary action, but you have the same kind of disposition of property kind of situation that you got to deal with from a tax standpoint. Your property is damaged, destroyed or stolen, and you receive a property or money in payment. So you got damages, possibly insurance that you got back on the property or something like that. Once again, the property is gone. You got to take it off the depreciation schedule, but you might have got some money for, for example, insurance money. How do you record that? Your property is condemned or disposed of under the threat of condemnation and you receive property or money in payment. So they condemn it. So this building is an eyesore on our and you can. So now you got the same situation. You give property away. So if you give it away in some cases, then it's still kind of a disposition that took place. So you might have to have some recording. You got to take it off the books, at least as the property on the business side of things. So what do you do with that? Your details about damage, destroyed or stolen properties. See publication 547. So you got that publication on the IRS website for details about other dispositions. See chapter one of publication 544 non taxable exchanges. So you might say, well, is I got to get rid of this property, but I want some other property. And is there any way I can do that without having a taxable exchange taking place? Because if I'm going to have a taxable component here, maybe I'll just keep the current property. The IRS wants to incentivize transactions. So you might have a non taxable exchange situation allowed. Certain exchanges of property are not taxable. This means any gain from the exchange is not recognized and you cannot deduct any loss. Your gain or loss will not be recognized until you sell or otherwise dispose of the property you receive. So this is a like kind exchange. A like kind exchange is the exchange of property for other like kind property is the most common type of non taxable exchange. To be a like kind exchange, the property traded and the property received must be both real property and business or investment property. Report the exchange of like kind property on form 8824 like kind exchanges for more information about like kind exchanges. You could see chapter one of publication 544 installment sale. So now we have an installment sale situation and 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 a sale, but it's a significant amount possibly, but you didn't get the money yet. You're going to get the money after that point in time. The problem there is you would think that you would record the sale at the point in time. The sale took place on an accrual basis. But if you did that and you didn't yet get the money, maybe you don't even have the money to pay the taxes for the sale of the property because you need the money to pay the taxes. So that's one reason they might have come up with like an installment kind of thing. 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 for more information about installment sales. You could see publication 537. So you go to 537 for more information about them. Sale of business. The sale of the business is usually not a sale of one asset. Instead, all the assets of the business are sold. So if you sold a business, you could structure the sale in like different ways. But one way, common way to structure the sale is you basically sell all the assets that are in the business. So now you got to deal with the tax consequences of that. Generally, when this occurs, each asset is treated as being sold separately for determining the treatment of the gain or loss. That could be a significant tax hurdle to jump over. It's a tall hurdle. You got to have strong legs if you want to clear that thing. Both the buyer and seller involved in the sale of the business must report to the IRS the allocation of the sale price among the business assets. Use form 859 for asset acquisition statement under section 1060 to provide this information. The buyer and seller should each attach form 859 for to their federal income tax return for the year in which the sale occurred. You could see publication 544 for more detail there. How do I figure a gain or loss? Table 31, how to figure the gain or loss? If your adjusted basis is more than the amount realized, then you have a loss. If the amount realized is more than the adjusted basis, you have a gain. Obviously, that seems somewhat straightforward. Basically, the adjusted basis is kind of like the adjusted cost. You can kind of think of it. So how much did you purchase the thing for whatever it is? If it was a tractor, how much did you purchase it for? One of the big adjustments to it to adjust the cost for the adjusted basis would be the amount of depreciation that you had taken over the life of it. Because you already got the benefit of the depreciation taking it as a deduction. Therefore, when you sell the thing, you have to have it at the adjusted basis. So you might think of it from an accounting terminology, kind of like the book value, but it's on a tax-adjusted basis type of thing. Instead of the accrual book value, because you could have differences in the accounting methods for depreciation on a tax and book basis. But note that the higher the basis, the better, generally. Because when you sell the thing, then you're going to have less of a gain because you're talking sales price minus the adjusted basis. So that means obviously as depreciation happens, your adjusted basis goes down because you're consuming some of that tax benefit getting the deduction at that point in time. Therefore, when you sell it, if you sell it for a gain, then you could have a larger gain that basically takes place. That's the general idea. So, adjusted basis, amount realized, fair value, and amount recognized are defined next. So you go into those terms in a little bit more depth. You need to know these definitions to figure your gain or loss. So what's the basis? The cost or purchase price of property is usually its basis for figuring the gain or loss from its sale or other dispositions. However, if you acquire the property by gift, by inheritance, or in some way other than buying it, you must use a basis other than its cost. More information about basis is you can see publication 554. So obviously the cost would be the starting point there, but what if someone gifted you the property? Then you've got a question of, okay, what basis am I going to use? It's not going to be zero because you didn't pay anything for it. Do I go back to the basis of the person who gave it to me and so on? Inherent and same kind of thing. Issue there is that you might have had something take place in terms of an estate tax and so on. So what happens to the basis is that the fair market value possibly of the point in time that you receive it at that point. So you dive into those more detail. Adjusted basis. The adjusted basis of property is your original cost of other basis plus certain additions and minus certain deductions such as depreciation and casualty losses. So the depreciation being the allocation of the cost which you're getting the benefit from therefore reduces your adjusted basis, which means that you're more likely to have a gain at the point in time of the sale gains being bad for taxes because you owe taxes on it possibly. And determining gain or loss to costs of transferring property to a new owner such as selling expenses are added to the adjusted basis. So if it costs you money to sell the thing that could increase your adjusted basis, which would be good. Which makes sense because your adjusted basis would be higher because you had the cost of the expenses of making the sale happen. And therefore your gain would be lower gains being bad. So that would be good that you get to include those expenses. And so so that's how that works. How to figure a gain or loss 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 receive. So when you sell something usually you sell it for like money, pretty straightforward. If not possibly a loan, then that's still kind of like income or you could get basically some kind of change value of other property which you have to value then as well to see how much you got. The amount you realize also includes any of your liabilities that were assumed by the buyer and any liabilities to which the property you transferred is subject such as real estate taxes or mortgage. So when you deal with the liabilities that are going to be involved as well, then you got to take in those into considerations. Those become more or oftentimes being most complex when you deal with transactions on real estate transactions. So fair market value fair market value is the price at which the property would change hands between a buyer and seller, neither having neither having to buy or sell and both having reasonable knowledge of all necessary facts. Well that's clear as can be. But wait a second. How could you figure that sometimes right that's that makes perfect sense. But again that's hard to do, especially if you have a unique thing like a piece of real estate, how the hell how would how would I know, you know how much I would be able to sell it for because there's no other thing that's exactly like the thing that I'm selling here. So in theory that makes perfect sense but how do you actually get to that number, you might have to get an appraisal, you got to do some kind of estimate for, for example, in order to justify your valuation. So amount recognized, your gain or loss realized from a disposition of property is usually a recognized gain or loss for tax purposes. Recognized gains must be included in gross income, recognized losses or deductible from gross income. However, a gain or loss realized from certain exchange of property is not recognized. You can see non taxable exchanges earlier. Also, you cannot deduct a loss from the disposition of property held for personal use. So when you're selling property, we're basically talking about property that was used for business to get the to get the deduction. If you sell property like you sold your TV that you're then, you know, you know, that's not a business TV unless it was a business TV. But if it's not, then like that's a personal piece of property. And if you lost money on the sale, then you don't get a deduction for that. So is my gain or loss ordinary or capital? So now we got this, why does that matter if it's ordinary or capital? Because you typically get a benefit for the capital in terms of the tax rates. So we would like to categorize it as capital usually as opposed to ordinary. So it's a big deal. The deal is large is a large deal. So we got to talk about it. So you must classify your gains and losses as either ordinary or capital gains or losses. You must do this to figure your net capital gains or losses. Generally, you will have a capital gain or loss if you dispose of a capital asset. For the most part, everything you own and use for personal purposes is investment in a capital asset. Certain property you use in your business is not a capital asset. So that would be generally not good, right? Because then you'd be at the subject to the ordinary income. A gain or loss from a disposition of this property is an ordinary gain or loss. That's generally bad because that's a higher progressive tax rate for the ordinary income as opposed to the capital gains and loss. However, 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. That would typically be good because you might be subject to slower rates than the ordinary rates. These gains and losses are called section 1231 gains and losses. So for more information about ordinary capital gains and losses, see chapter 2 and 3 of publication 544. Is my capital gain or loss short term or long term? This is going to be important as well because you could have different tax treatment between short and long term. Long term typically better because you might be subject to favorable tax rates for long term capital gains. Short term capital gains might not be as good because those will possibly be subject to the ordinary income rates. 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, 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. So how long did you hold on to it for? So for more information about short term and long term capital gains and losses, you can see chapter 4 of publication 544. So basically the general rule, if you held the property one year or less, then you have a short term capital gain or loss. If you held to the property more than a year, then you have a long term capital gain and loss. Long term better typically for taxes because possibly lower rates than the ordinary income tax rates. So where do I report gains and losses, you might ask. Report gains and losses from the following dispositions on the form indicated. The instructions for the forms explain how to fill them out. So you got dispositions of business property and depreciable property. For that you use form 4797. If you have taxable gain, you may also have to use schedule D. That's usually where you have the capital gains from like stocks and whatnot. That's on the form 1040, like a kind exchange. If you have a like kind exchange, it's like kind, you know. It's like a kind exchange. So like kind exchange. Use form 824, like kind exchange. You may also have to use form 4797, schedule D, form 1040. Then we have the installment sale. For the installment sale, use form 6252, installment sale income. You may also have to use form 4797 and schedule D, form 1040. Casualties and theft, use form 4684, casualty and theft. You may also have to use form 4797, condemned property. Use form 4797. You may also have to use schedule D, form 1040.