Small Business Taxes & Management
Selling Assets to Raise Cash
Small Business Taxes & ManagementTM--Copyright 2010, A/N Group, Inc.
With the recession dragging on for many businesses, there is often a need to raise cash. Selling unneeded assets can be a quick way to do so. However, there are tax considerations to keep in mind. Here are some points to consider.
- If you took the Section 179 expense election on the asset in the year purchased, your basis in the asset may be zero. That means anything you receive for the asset would be taxable income. Check your tax return for the year the asset was acquired to determine the amount expensed and your remaining basis. (Most accountants expense the entire cost of an asset, if possible.)
- You should also be aware that converting an asset on which the Section 179 expense election was made to personal use can result in recapture (immediate income) of at least a portion of the amount expensed.
- If you sell tangible personal property that you depreciated, any amount you receive in excess of your basis and up to your original cost will be depreciation recapture and taxed as ordinary income.
Example--Madison Inc. purchased a backhoe for $60,000 some years ago. It took depreciation of $42,720 on the equipment, reducing its basis to $17,280. Madison sells the backhoe for $40,000. Madison has a gain of $22,720 ($40,000 less basis of $17,280), all depreciation recapture and all taxed as ordinary income. Now assume Madison sells the equipment for $75,000. The total gain is $57,720 ($75,000 less basis of $17,280). All the depreciation of $42,720 is recaptured and taxed as ordinary income and the remaining recognized profit, $15,000, ($75,000 selling price less $60,000 cost) is taxed as long-term capital gain.
- Recapture of Section 1231 losses. Gains and losses on business property receive different treatment than stocks or personal assets. (It's called Section 1231 gains or losses.) If you sell business property at a net gain (gains from the sale of business property exceed losses from such sales) for the year you get favorable long-term capital gain treatment. Sell it at a net loss and the loss reduces ordinary income dollar-for-dollar. It can be a win-win situation, but there's a catch. If you have a net gain, you've got to look back to the five preceding years. If you had any net Section 1231 losses during the period you've got to report that portion of the current year's gain as ordinary income. Thus, in the example above, if Madison had $5,000 of Section 1231 losses in the past 5 years, $5,000 of that gain would be taxed as ordinary income; $10,000 of the gain would be long-term capital gain. Best to discuss this issue with your tax adviser.
- Your basis in any property is usually your cost (but see the discussion about trade-ins, below) plus any capitalized costs (e.g., a new motor for a machine), less any depreciation. Knowing your basis is critical to computing your gain.
- If you acquired the asset by means of a trade-in, your basis will depend on the basis of the equipment traded in as well as any additional cash put up and depreciation taken on the new equipment. This can get complicated. Check with your accountant.
- An installment sale of equipment can actually backfire. You must recapture all depreciation in the year of sale, even if you'll receive payments over time. For example, you sell a machine for $5,000, $1,000 payable up front, the rest over four years. The machine cost you $8,000 but it's fully depreciated (i.e., your basis is zero). You'll have $5,000 of taxable income in the year of sale. That could mean paying taxes of $2,000 (at 40%, combined federal and state), while only getting $1,000 in the first year. After taxes, your cash flow would be negative for the first year. (See below for a discussion of an asset with an outstanding liability.)
- While the depreciation recapture rules are somewhat more favorable for real estate, a sale of real property still presents problems. Depreciation recapture (actually called "unrecaptured Sec. 1250 gain") is limited to 25% of the gain attributable to the depreciation. Gain in excess of that would be taxed at 15% (if you owned the property personally or through an LLC, S corporation; 2010 rules, go to Corporate and Individual Tax Data for the latest rates.) In addition, with real property you should carefully evaluate the net cash you'll receive. If the property was subject to a mortgage, that will reduce your net cash. If the property was refinanced and money taken out, you could actually end up owing more, after taxes, than you'd receive.
Example--You bought a building in 1995 for $500,000 and have taken $150,000 of depreciation. You're now selling the property for $800,000. Your basis is $350,000 ($500,000 less depreciation of $150,000) so your total gain is $450,000. The property is subject to two mortgages one for $400,000 and another for $375,000. The tax would be 25% of $150,000 plus 15% of the remaining $300,000 gain. Thus, the total tax bill would be $82,500 ($37,500 plus $45,000). Since the proceeds are $800,000 less the payoff of the mortgages for $775,000 you're left with $25,000 at closing. But your tax bill is $82,500, leaving you with a net cash outflow of $57,500.
Before the downturn in real estate this example may have been a little farfetched. But in the current environment it's not that unusual even for commercial properties. Get good advice here. Once you've agreed to sell it may be costly to back out.
- Selling your stock in an S corporation or your interest in a partnership or LLC can also prove tricky. In both cases losses and distributions reduce your basis; income and capital contributions increase your basis. Thus, your current basis for gain or loss purposes may be materially different from your original cost. That could be good or bad. Computing your exact basis in an S corporation or partnership can be very complex. Getting a rough idea of your basis can be easier. Contact your tax advisor.
- Selling off obsolete inventory can generate some cash and some tax savings. You generally can't get a deduction for that inventory until it's sold or scrapped. For example, you paid $100 for 8 valves. If you accounted for them correctly, you never deducted the $100. Auction them off for $20 for the lot and you've got $20 cash and an $80 loss you can take on your tax return. The loss could produce $32 in tax savings (depending on your bracket). If you're doing an auction or a sale, talk it up and consider selling current goods at the same time.
- Abandoning assets can also reduce taxes. There are two points to keep in mind. If the asset is fully depreciated there's no tax benefit since there's nothing left to write off. Second, you've got to affirmatively abandon the asset. That requires more than just putting the equipment in the corner of the shop and not using it. Send it to the scrap yard to be sure. (Get a receipt.) If there's no real market for the asset try to sell it at a nominal price just to establish a sale. In any event, you must be able to show you relinquished all your rights in the property.
- There are other issues to consider. If you have a net operating loss carryforward, current operating losses, capital loss carryforwards, or anticipate a loss in the next year, any gains may be absorbed. For example, you've got significant personal losses in the market amounting to some $250,000. If your S corporation (you're the sole shareholder) generates $250,000 in long-term capital gains from the sale of a building, those gains would be passed through and reported on your personal return. Result? The gains and losses offset and you've raised cash without any tax consequences. (If you do business as a regular corporation, check with your tax adviser.) Or you sell that backhoe and generate $40,000 in depreciation recapture income. If the business has a big loss for the year (or loss carryforwards from prior years) that income may be totally offset by losses. Result? You raise cash with no current tax consequences.
- A net operating loss (NOL) for the year may be carried back to offset income in prior years. Check with your tax adviser on the current rules and how an NOL can be applied. Selling assets at a loss generally doesn't make sense if the only reason is to create a loss for tax purposes but if the asset isn't being used and declining in value, a sale might be advisable.
Talk to your tax adviser. He should be able to review your situation and suggest which assets can be sold with the best tax effect.
Copyright 2010 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 06/28/10