Selling Your Sole Propreitorship

The sale of your sole proprietorship may involve the sale of many types of business property.

  • Inventory
  • Depreciable personal property
  • Depreciable real property
  • Non-depreciable real property
  • Intangible assets

Inventory

Inventory on hand at the time you sell your business may include:

  • Merchandise held for sale to customers
  • Materials used to manufacture or produce products for sale to customers.
  • Items used in your business, such as office supplies and shipping supplies.

When you sell your business, any gain or loss attributed to inventory included in the sale is ordinary gain or ordinary loss.

Depreciable Personal Property (Section 1245)

Depreciable personal property (Section 1245 property) includes items such as machinery, equipment, furniture, and other items subject to an allowance for depreciation.

Terminology

Personal Property:

The term personal property is a legal term. It generally refers to movable property as distinguished from unmovable property, such as land, and buildings.

Real Property:

Land and buildings are referred to as real property.

Personal-use Property:

The term personal-use property is a tax term. It refers to property held for personal purposes rather than for business purposes.

  • Depreciation may not be claimed on personal-use property
  • Gain on the sale or exchange of personal-use property is taxable.
  • A loss on the sale or disposal of personal-use property is not deductible UNLESS the loss was due to a casualty or theft loss.

Depreciable Realty (Section 1250)

Depreciable real property (realty) includes buildings and their structural components used in the conduct of a business or to produce rental income.

Selling depreciable real property:

For residential rental and nonresidential real property placed in service after 1986 there is no ordinary income recapture because only straight-line depreciation may be used.

Straight-line depreciation:

For residential rental and nonresidential real property placed in service after 1986, straight-line depreciation is used under the straight-line MACRS method.

Although straight-line depreciation for such property is not subject to ordinary income recapture, any gain on such property is subject to the section 1231 netting rules.

The gain (if any) attributed to depreciation is entered on the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions.

The unrecaptured gain from the worksheet is subject to a top rate of 25% on the Schedule D Tax Worksheet included in the Schedule D instructions.

For example, if your gain on Section 1250 property is $5,000 and you claimed $3,000 straight-line depreciation, then $3,000 of the gain is attributed to depreciation.

Therefore, you enter the $3,000 portion of the gain on the Unrecaptured Section 1250 Gain Worksheet.

Special deprecation allowances:

If any special depreciation allowances were deducted, such as bonus depreciation, it is subject to ordinary income recapture on Form 4797. This is depreciation that was allowed in addition to the straight-line depreciation that was deducted.

Non-depreciable Real Property

Land may not be depreciated; it does not wear out and and has no determinable useful life. If land is used in your business, ordinary income and/or long-term capital gain may be realized under the rules of section 1231.

If land is held for investment purposes, gain or loss is subject to capital gain treatment, and is reported on Schedule D.

Intangible Assets

Some examples of intangible assets include: the cost of acquiring a patent, a trademark, a trade name, or a franchise.

Special tax treatment for sale of patents:

If you're an inventor and transfer all substantial rights or an undivided interest in all such rights, the transfer will be treated as a sale or an exchange of a long-term capital asset even if the patent property was held one year or less.

Long-term capital gains treatment applies even if you're not the inventor if:

  • You acquired all substantial rights to a patent property and
  • The invention was not already reduced to practice before you acquired the patent property.

Payments you receive for the patent by a purchaser may be made to you in a variety of methods and still qualify for long-term capital gain treatment.

For example:

  • In a lump sum.
  • As an installment sale.
  • As a fixed percentage of all future profits from the patent.
  • As a fee per item produced.

Uncertain payment amount: Even if the total amount of the payment is uncertain, the payments still qualify for long-term capital gain treatment.


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