 Income tax 2023-2024. Dispositions of business property. Get ready and some coffee because we need to save money for vacation with the help of income tax preparation 2023-2024. Most of this information can be found 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 this CPA thinking cap for example. CPA thinking CAP. You see what we did with like with the letters. And this CPA thinking cap is not just for CPAs either. Anyone can and should have at least one possibly multiple CPA thinking caps. Why? Because based on our scientific survey of five people all of whom directly profit from the sale of these CPA thinking caps wearing this CPA thinking cap without a doubt according to the survey. Increases accounting productivity tenfold. Yeah at least. Apparently the hat actually channels like accounting energy from the quantum field ether directly into your head allowing you to navigate spreadsheets faster. It's kind of like how in like the matrix when Neo learns kung fu. Or at least that's what the scientific survey saying. So get one because the scientific survey participants could really use some extra cash. If you would like a commercial free experience consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com. 334 tax guide for small business for individuals who use Schedule C tax year 2023 which you can find on the IRS website at iris.gov iris.gov. Looking at the income tax formula the first half basically being an income statement most income statements having income minus expenses resulting in net income here having income minus various deductions resulting in taxable income. So proprietor schedule C rolling into line one income which is kind of unusual because the schedule C itself is basically an income statement. Business income minus business expenses otherwise known as business deductions resulting in in essence net business income which then rolls into line one income of the income tax formula which basically is reflected on the form. 1040 page number one which we see here schedule C ultimately rolling into line eight additional income from schedule one schedule one here additional income and adjustments to income part number one schedule C rolling into line three business income or loss from the schedule C here is a schedule C profit or loss from business which has an income and expense part which means it's formatted like a profit and loss or income statement. All right so now we're looking at dispositions of business property. Remember when we're thinking about the schedule C we're looking at in essence one of the financial statements the performance statement having the income statement income minus expenses the other one being the balance sheet. We don't really see a balance sheet when we're doing a sole proprietorship schedule C but we have some things that we kind of have to track that are balanced sheet items such as for example if we have inventory. Then we have the beginning and ending inventory reported on the cost of good sold calculation. And if we're purchasing large items property plant and equipment buildings for cliffs and so on then we're going to have to have a depreciation schedule which will allocate the cost over the useful life in the form of depreciation expense. Now that that also leads to more complications because now we have to have this whole other schedule which is going to be listing out the types of assets that we have and if we sell those assets we also had depreciation on them. So if we dispose of them or sell them we have to calculate if there's any gain on that and that could be a little bit complex because of the depreciation that we took on it. So we have to be very careful when we have our depreciation schedules to put our assets on them properly in such a way that we can actually tie them out to the actual asset in real life. Meaning we want to make sure that we break up the assets as we put them onto the depreciation schedule rather than grouping a bunch of different fixed assets into one line item. So that when we sell them or dispose of them we can pick each individual one that we sold and disposed. We also want to be adding detailed descriptions as well as any reference numbers that will help us to identify what's on the depreciation schedule to what is there in actual physical fact. So that again when we sell or dispose of them we can figure which item we're selling and disposing of. And then of course once we have that we have to calculate if there's any kind of gain or loss on the sale and then we have the problem of how do we recognize that gain or loss. Do we have favorable capital gains rates or is it going to be ordinary income rates that we're going to have with regards to any gains or losses for example. All right so 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. Now just realize of course that a simple type of business might not have a lot of depreciable property. If you just are a gig worker for example you might not have a whole lot of depreciable property. Some businesses will have a lot more detailed depreciable property such as construction for example because they might have a lot of equipment that is necessary to do their business. So as tax preparers part of our job again is to say what kind of industries do we want to be focused in on and do we want to restrict our focus to particular types of areas because we have a specialization in them or possibly we're trying to be more general and not get too specialized just something to keep in mind. 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 useful items so you could go for more information here this is a big topic. You've got the publications you've got the publication 544 sale and other dispositions of assets form and instructions. You can look at form 4797 sales of business property and the related instructions for more information schedule D form 1040 that's the capital gains and losses. So a disposition of property includes the following transactions you sell property for cash or other property. So now again we have property we're selling it we might be thinking mainly depreciable type of property such as equipment for example if we sell it then we're probably going to get cash for it. But oftentimes you might have a trade type of situation or you might get some other property other than cash as we saw with the accounting methods. You still have basically a sale taking place because value has transferred in a like kind of exchange both ways. So you'd still have to basically calculate you think a gain or a loss although in some cases you might have like a like kind situation which we might talk about more in the future. You exchange property for other property so you receive money as a tenant for the cancellation of a lease. You receive money for granting the exclusive use of a copyright through its life in a particular medium. So copyright is basically an asset but it's going to be basically a legal asset you might call it an intangible asset. You transfer property to satisfy a debt. So now we saw this debt situation a little bit when we talked about accounting methods as well. It could be a little bit confusing when we don't get paid basically with cash. But obviously if a debt is canceled then that would be similar to getting cash and you can see that oftentimes if you just kind of infuse the cash within the transaction. Meaning it would be like you got paid for something if you sold the property and then you paid off the debt right instead of the cash going back and forth. You just eliminate the cash but if you imagine the cash involved then you can see why it would be categorized as like a sale for example. You abandoned property so there could be situations where you're saying the property is no use to me anymore. I'm going to abandon it like a piece of equipment or possibly a piece of a building for example. Well then you're still going to have to basically account for that on the accounting side as though basically kind of like you sold it but you didn't get any money for it. It would be kind of like a disposal generally but we still have to take it off the books as a depreciable asset and account for it. So your bank or other financial institution forecloses on your mortgage or repossesses your property. So this was of course an involuntary sale. They came after the office building or whatever because you didn't pay the loan on it. But from a bookkeeping standpoint it's still basically kind of like a sale of the property that we're going to have to account for in a similar way taken the depreciable property off the books. So your property is damaged destroyed or stolen and you receive property or money in payment. So we have a damage to the property possibly we receive money from it from a legal type of standpoint for the damage caused or possibly from insurance or something like that. Once again we can imagine we might have a depreciable property on the books and it's been removed. We're going to have to remove it from the books so we're still treating it kind of like a sale type of transaction that has happened although it's not like a normal sale for cash. Your property is condemned or disposed of under the threat of condemnation and you receive property or money in payment. So similar situation possibly involuntary here but it's still treated kind of like a sale situation with regards to us taking the property off the books as a depreciable asset. You give property away so this would be like disposing of it. You didn't get any money for it but you gave it away. It'd be like even if you threw it in the trash or something like that you disposed of it. We're still going to have to take it off the books and deal with it if there's any undepreciated amount that is still there at the point in time that that happens. For details about damaged destroyed or stolen property you can see publication 547 casualties disaster and thefts for details about the dispositions C chapter one of publication 544 non taxable exchanges. So obviously one of the things that we want to be careful of with property is the fact that if we sell the property and we have a gain on it then that could be a tax situation where we're going to have to pay taxes on it. So you might have a situation sometimes you might be saying hey look I would like to sell something or or make a move here or upgrade my property or something like that. But I don't want to sell it because I'm going to trigger a gain and then I won't even have enough money to replace the property that I need to replace it with. So you can imagine the tax code has come up with situations scenarios over the years to say hey look we don't want to discourage people from say selling their old equipment and buying like new equipment or something like that because they might be subject to like a gain. Why would they be subject to a gain instead of a loss when equipment usually goes down in value because we allowed them an accelerated depreciation. So you can see the tax code gets all complicated because of its own making in other words they separated capital gains versus ordinary income which causes all kind of complications and then instead of using normal depreciation rules for things like equipment. We put in accelerated depreciation rules to try to incentivize growth in the economy and so on and so forth most likely because lobbyists you know got in there or something like that. So what happens then is that that means that we took expenses greater than we otherwise would which means the value of the book value of the property is now lower than it otherwise would be. And then if you sell the property it's more likely that you're going to have a gain on the sale because you over depreciated it in which case you're going to have a gain. And if there's a gain that's going to disincentivize people from selling the property. So then they're like well how can we incentivize people to sell the property. Well maybe we can kind of eliminate the gain with a light kind exchange kind of system right so this all kind of builds on itself. So in any case certain exchanges of property are not taxable. This means any gain from the exchange is not recognized and you cannot deduct any losses. Your gain or loss will not be recognized until you sell or otherwise dispose of the property you've received. So the general idea would be hey look instead of adjusting the basis of the property. We're just going to say the new property is going to in some way or form take on the basis of the old property so that you will defer the gain until you sell the new property. So then you're then you'll be kind of like in the same situation so that when you sell the new property that's when you'll get hit with the game. All right like kind exchanges. So we have a light kind exchange is the exchange of property for other like kind property. It is the most common type of non taxable exchange to be a light kind exchange the property traded and the property received must be both a real property and be business or investment property. So you get so often times the light kind exchanges gets in place with like real estate for example. And it has a whole world in and of itself to make sure that you qualify for the light kind exchange and when it might be an appropriate thing to do the rules with regards to light kind exchanges have changed basically over time. But you get the general idea of it is that when when in order to facilitate trade and allow people to have transactions. They want to defer the game that's going to be involved because that will cause people not to do the business transactions that they otherwise would because of the taxes. But obviously once you have the light kind changes exchanges in place people will try to be creative to come up with ways that they could maximize their tax benefits from them. So report the exchange of light kind property on form 8 824 light kind exchanges for more information about like kind exchanges. See chapter one of publication 544 installment sales. So an installment sale is a sale of property where you receive at least one payment after the tax year of the sale. So installment sales can cause a problem because if you're selling like a big piece of property for example and you say I'm going to I'm going to collect $100,000 on the piece of property. But you only get part of the money in the current year and then you're going to get a series of payments in the future to pay for the property. Well under an accrual accounting method you should record the sale at the point in time that you delivered the property. But from a tax standpoint you didn't actually get paid for it yet. You're going to get paid in the future you have basically an IOU. But because we're talking about large dollar amount items if I sold it for 100,000 and I had a big gain on it or something like that. I wouldn't even have the money to pay the taxes because I just haven't accounts receivable. I have an IOU I don't have the money yet. So then there's a question in terms of well is there a way we can have an installment sale so I can recognize the gain over the life of when I'm actually going to receive the payments. Not at the point in time that the sale took place in terms of exchanging the property. So once again an installment sale is a sale of property where you receive at least one payment after the tax year of the sale. So if you finance the buyer's purchase of the property instead of having the buyer get a loan or mortgage from the third party you probably have an installment sale. So in other words if you think about real estate generally what happens is one person the seller of the real estate owns the property but also has a mortgage alone where the property is collateral on it. The buyer is going to buy the property. So instead of basically what the buyer is going to do is pay for the full amount of the property. And then when the when the seller gets that if it was a hundred thousand dollars they'll take the whole hundred thousand dollars pay off the mortgage. And that's how they'll deal with it. The buyer in order to get the hundred thousand dollars is going to take out their own loan. Right. So the buyer is going to take out a loan to pay off the seller. Once they pay off the seller the seller is going to pay off their loan. But you could imagine a situation where the payments are happening like in installments. Right. So if you if you have the hundred thousand dollars that are going to be paid and you imagine that those are going to be made in installments then the seller is basically financing right the sale. And so you kind of have an installment kind of situation because you made the sale but you've got like an IOU at that point. Okay. So for more information about installment sales you can see publication five three seven. So sale of a business the sale of a business is usually not a sale of one asset. Instead all the assets of the business are sold. So the sale of a business is something that's going to happen when you go out of business and then you're going to sell the property. Sometimes this is going to be an easy thing if you're a sole proprietorship you're a gig worker or something you don't have much to sell. Right. It's done. But if you're in a large business that has a lot of capital assets such as construction you're going to have a lot of equipment and whatnot that you're going to have to basically sell. So so or and or you could sell for example the entire business right. And if we're thinking about selling our entire business if we're if we're going out of business or we want to sell the business we can think about the sale of our business to someone else kind of like. It's one thing but in reality you can also think about it as it's basically a bunch of assets that you're basically selling when you sell the business. So when you have larger businesses that are going to be sold the valuation of the business is often something that you're going to hire a third party. To help you specialize in valuing the business and and and then figuring out what kind of gains and what not are going to be resulting from the sale of a business. Okay. So that's kind of a specialty area. Generally when this occurs each asset is treated as being sold separately for determining the treatment of gain or loss. Now this becomes kind of an issue because you'll recall that some types of income might be taxed at different rates. So like capital gains rates are different possibly than ordinary income. So you run into some of these problems in terms of well if there's income one problem is calculating the income and the other problem is are some of the income going to be subject to different rates and so on. Possibly more favorable rates in some cases. So in any case both the buyer and seller involved in the sale of the business must report to the IRS the allocation of the sales price among the business assets. So when the sales price occurs basically you're saying this is the list of equipment and so on that you have and these are the sales prices that are going to be allocated to those pieces of equipment because you can imagine that the new person, the person that buys the business which now has a list of assets if it's a construction company like a bunch of forklifts and whatnot. They're going to have to depreciate those assets right in their business now based on the cost that they paid for those things. So you can use form 8594 asset acquisition statement under section 1016 to provide this information. The buyer and seller should each attach form 8594 to the federal income tax return for the year in which the sale occurred. For more information about the sale of a business you can see publication 544. That's obviously somewhat of a specialty kind of area. How to figure a gain or loss. So if your adjusted basis is more than the amount realized then you have a loss. If your amount realized is more than the adjusted basis you have a gain. So that seems fairly straightforward but you might ask well what is the adjusted basis. So if you sold a piece of equipment then if you got 100,000 for a piece of equipment you're going to subtract out the adjusted basis. What is the adjusted basis? Well it starts with the cost typically what you paid for the equipment. The cost is what you put on the books though and when you bought it even if you paid cash we did not just expense it at the point in time we purchased it but rather we put it on the books as an asset. If you expensed it you would have already got the tax benefit at the point in time that you bought it but if you put it on the books as an asset then you didn't get a deduction for it. You don't get a deduction until you depreciate it. So as you depreciate it you're getting a tax benefit and you're eating into the basis. So the basis is actually good. That's the cost that you haven't eaten up yet that's going to eat into the gain. The gain being bad for taxes right. So the adjusted basis is the cost minus the depreciation that has been consumed as the basis gets lower. It's more and more likely that the sales price that you sell it for will be greater than the adjusted basis resulting in a gain. Gains being bad for taxes. Now if you're talking about real estate often times you might have a gain because real estate might have gone up in value even though the building could have depreciated in value. But most other kinds of equipment like equipment goes down in value like a forklift, a car, anything goes down in value pretty quickly. So you would think you wouldn't have a gain on those items unless you over depreciate. But over depreciating is quite common because the tax code keeps putting in these accelerated depreciation things in place which means that if you sell something before it's fully depreciated you're probably going to over depreciate it resulting in a gain. So basis adjusted basis amount realized fair market value and amount recognized are defined next. You need to know these definitions to figure your gain or loss basis. The cost or purchase price of property is usually its basis for figuring the gain or loss from its sale or other disposition. 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 cost. So in other words, when you bought it that's usually going to be your starting point for the basis. However, what if you didn't buy it? What if you've got it from an inheritance or something? Is the basis then zero? Well, that would not be good for you if it were because the basis is actually good. We want to have a higher basis so that when I sell it I have a less of a gain. So what's going to be the basis on inheritance? Is it the basis of the person that gave it to me? What about if it was a gift? How do I figure the basis in that case? And again, is it the basis of the person who gave it to me? Inheritance, is it the basis of the value at the point in time of death possibly? So again those can get into more complicated, can be quite complicated. So for more information about basis, you can see publication 551, basis of assets, adjusted basis. So this would be the straight basis. Now we're talking about the adjusted basis to it. So straight basis basically cost and then adjustments, adjusted basis. The adjusted basis of property generally is your original cost or other basis plus certain additions and minus certain deductions such as depreciation and casualty losses. So when we talk about adjusted basis, we're taking the cost which you can think of as usually the basis and we're usually depreciating it, meaning we're taking the value of the depreciation method that we had to apply for taxes, typically being for most property a double declining balance in the form of maker's depreciation which we'll talk about in future presentations. In determining gain or loss, the costs of transferring property to a new owner such as selling expenses are added to the adjusted basis of the property so selling expenses can be worked into the calculation as well. Amount realized, generally the amount you realize from a disposition is the total of all money you receive plus the fair market value of all properties or services you receive. So in other words, you're selling property. What's the amount realized? That's basically the sales price. In other words, what did you get for the sale? Usually you would think in dollars but you might have gotten paid in something other than dollars or in addition to dollars in which case if it was property you'd have to take into consideration the fair market value of the property that you have received or you might have gotten paid in services which again you would have to add to the value of the amount realized. The amount realized 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 on the other side of things, you might have been relieved of debt. So this is the one that often is a little more confusing to people. But if debt was removed from you, they assumed a loan or something like that, then again that would be kind of like they paid you the money and then you paid off your debt. So if you've been relieved of things that you owe, liabilities, debts, that's also going to be included in the amount realized. Alright, so the fair market value. What does that mean? Because now we have a situation if I sell stuff for cash, not a problem. But if I sell it for property or services, I have to figure the fair market value because whatever property I've received, I'm going to have to put on my books at fair market value. If services were received, I'm going to have to expense them at the fair market value. How do I calculate 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. So that's a great theoretical understanding in practice, difficult because some transactions are unique in nature. Meaning, if I get a car, I could look at the book value of the car, the Kelly Blue Book or something, but they might have taken better or worse care of the car and therefore it's unique in nature. So it's difficult to kind of come up to the fair market value exactly a lot of times. But in theory and in practice, that's what we're trying to do. Sometimes we might need an appraisal if it's going to be a large item so that we can at least have a professional try to help us value the property. Amount recognized. So 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 are deductible from gross income. So obviously if we do this calculation, we've got the amount that we received minus the adjusted basis. If it results in a gain amount received over the adjusted basis, you're going to have a gain which you might have to recognize, of course, in gross income. If it was a loss, then you would think you'd be able to deduct it from the gross income. So however, a gain or loss realized from certain exchanges of property is not recognized. See non-taxable exchanges we talked about earlier such as the like kind exchanges. Also, you cannot deduct a loss from the disposition of property held for personal use. So in other words, we're talking here about the schedule C, business property. If you sold your personal car, not your business car, then that would be personal use property and that would have a different situation. If you had a gain or something on a sale of personal property, you might still have to record it maybe as a gain or something, but it would be on the schedule D and it's not really what we're focused on now. We're talking about the business property at this point in time related to the schedule C sole proprietorship. So in my gain or loss, is my gain or loss capital or ordinary? Ordinary or capital, what's that mean? Well, for taxes, normally if we sell things like stock, then we might have gains which we would then call capital gains versus ordinary gains. Why is there a difference? The capital gains might have a favorable tax rate. So if possible, we would like the gain to be subject to capital gain because the tax rates are typically lower than if it was ordinary income in which the tax rates are higher. 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 gain or loss. Generally, you will have to capital gain or loss if you dispose of capital asset. For the most part, everything you own and use for personal purposes or investment is a capital asset. 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. So ordinary gain or loss meaning it's going to be reported on like ordinary gain or loss from the Schedule C at ordinary income rates. 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. So that's often a rule for the capital gains or loss. If you held it for an extended period of time, part of the argument for having a more favorable rate is that if you held something for a longer period of time and then sold it like real estate, then you might end up with a large gain. But if you recognize that gain in one year, it's going to push you up into higher tax brackets because of the progressive tax system. And in reality, you didn't get all the gain in one year. It might have taken 10 years to get it, right? And if you were to allocate the gain over 10 years, it wouldn't push you up into as high of tax brackets as taking the 10 years worth of gains and realizing them in one year, right? So that's one of the arguments why people might say, well, capital gains being a lower rate makes some sense for the income tax. So these gains and losses are called, these are section 1231 gains and losses. So for more information about ordering capital gains and losses, you can see chapter 2 and 3 of publication 544. 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 or short term depends on how long you own the property before you dispose of it. So the time you own property before disposing of it is called the holding period. So do I have short term or long term gain or losses? If you hold the property one year or less, then you have short term capital gain or loss, which is typically not as good because it will be more likely subject to ordinary income rather than favorable capital gains rates. If you held the property more than one year, then you have a long term capital gain or loss. Now this actually gets a little bit more complex than this. I don't want to dive into every scenario in detail, but note that if you have a gain, what you would like to do is have the gain at the favorable tax rates, paying less taxes. If you have a loss, then you would like to take the loss against income that's subject to the higher tax rate to the ordinary income tax rates. So it actually gets a little bit complex in terms of the pros and cons with it, but I don't want to get, we're running kind of long here. So for more information about short term and long term capital gains and losses, you can see chapter four of publication 544. Where do I report gains and losses? I'll report gains and losses from the following dispositions on the forms indicated. The instructions for the forms explain how to fill them out. So you got dispositions of business property and depreciable property. So when we have the depreciable property equipment, for example, we're going to use form 4797. If you have taxable gain, you may also have to use the schedule D form 1040. The schedule C form D form 1040 for individual taxpayers is most commonly thought of probably when you have sale of stocks and bonds, for example. And then we have the like kind exchange. So in that situation, you're going to use form 8824. We have installment sales. I'm sorry, the 8824. You may also have to use the form 4797 and schedule D for like kind exchange, which again is kind of a special area. So you might do your research on that one. Installment sale use form 6252. So that's the one where you made a sale, but you're going to get paid in installments. So recognizing all the gain up front would be a problem because you don't have the income yet and possibly you can use the installments to be able to recognize the gain as you get the income. So you can actually pay it possibly. Use form 6252, installment sale income. You may also have to use form 4797 and schedule D form 1040. Casualty and thefts use form 4684 or casualties and theft. You may also have to use form 4797, condemned property. Use form 4797. You may also have to use schedule D.