Whenever you dispose of a business asset, whether you junk it, sell it, lose it, donate it, trade it in, get it repossessed, destroyed, or converted to personal use, you may have a taxable event. The decision might not be taxable, but it’s usually reportable and sometimes you might enjoy something of a tax refund.
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Every year when compiling your tax data for your tax pro, you probably bypass a page entitled “Assets” or something similar in the organizer. This page is a listing of all depreciable assets that you purchased for your business – which includes everything from computers to leasehold improvements to equipment and furniture. On this page, (that hardly anyone fills out) is a place where you can indicate that you no longer have possession of the asset, as well as the disposal date, how the item was disposed of, and remuneration received, if any. If you traded the item in – perhaps a vehicle or piece of equipment – you should include the purchase papers for the replacement asset. Then your tax pro can go to work to figure out how the transaction will impact your tax liability.
Sale. The basic formula for determining a gain or loss on a sale is to subtract your cost (basis) and your selling expenses from the selling price and pay capital gains tax on the remainder. Because capital gains caps out at 20%, you enjoy a lower tax on the sale of assets versus the tax rate for ordinary income. But because you are selling a business asset, you will have likely taken a depreciation deduction. When selling the asset, you must recapture the depreciation and pay taxes on it at the ordinary income tax rates. Of course, this applies only if you have a profit on the sale of the asset.
If you have a loss on the asset, which is usually the case, you may take a capital loss deduction on Schedule D.
Abandonment. If you abandon property that has not been fully depreciated, you will be able to take an ordinary loss. You see, it’s not just money down the drain; you at least get a tax benefit from it. But if the abandoned property is tied to debt, there are special rules, so check with your tax pro. There could be issues with cancellation of debt.
Repossession and Foreclosure. A repossession or foreclosure of business property may result in a gain or a loss depending upon the circumstances. Here again, check with your tax pro. You will have to deal with cancellation of debt which may create a taxable event.
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Trade-in and Exchanges. A trade-in is not considered a taxable event. So if you trade in your pickup truck that you use 100% in your construction business for a newer model, provide the sales information to your tax pro. This will be treated as an exchange and the only tax ramification will be an adjustment to the basis of the new vehicle.
Donations. If you make a charitable contribution of a business asset to a qualified nonprofit organization, prepare for some math to calculate the deduction. First you must assign a fair market value to the property. If we’re talking about an expensive item, it would behoove you to get an appraisal. Once you have the fair market value, you must reduce that value by the ordinary income and short term capital gain that would have resulted if you had sold the asset. Another good one for your tax pro to calculate for you.
Involuntary Conversion. An involuntary conversion such as a fire or theft of your business property will likely result in a capital loss and should be reported to your tax pro. Any reimbursement from the insurance company should also be reported. The purchase of replacement assets will become part of the equation for determining gain or loss.
Divorce Settlements. There are no tax ramifications if you are in the process of a divorce and are required to transfer capital assets to your spouse. Naturally, there are a few off-the-wall exceptions to this one, so always run these transactions by your tax pro.
For more information check out this IRS Publication: Disposing of Assets
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Follow Bonnie Lee on Twitterat BLTaxpertise and at Facebook.