Disposing of Business Assets
Many taxpayers fail to understand the tax ramifications of disposing of personal property such as equipment, furniture and autos used in business and end up with unpleasant surprises at tax time. The tax consequences depend upon how the property was used, how long it was owned and the method of disposition. There are numerous ways of disposing of an asset, such as selling, scrapping, converting to personal use, contributing to a charity, exchanging for another like business item, or even giving it away. We cannot cover all of the aspects of dispositions here but we can give you an overview.
The key to knowing the tax ramifications of dispositions is understanding the tax term “adjusted basis.” Any gain or loss from the disposition of a business asset is measured from adjusted basis. Adjusted basis is generally the cost of the item reduced by any business deductions taken for the item. For example, you purchase computer equipment for $1,000 and it is in a class of business property that must be depreciated over 5 years. You can elect to write-off any portion of the item the first year (within the Sec. 179 expense limitations) and depreciate the balance over five years. If you elected to depreciate the item instead of taking the Sec. 179 expense election, your depreciation deduction would be $200, and your adjusted basis after the first year would be $800 ($1,000 - $200). If you then sold the equipment for $900, you would have a $100 ($900 - $800) taxable gain. Why? Because you recovered $100 of your cost as the depreciation you had previously taken as a deduction. On the other hand, if you had sold it for $500, you would have a $300 deductible loss. So, as you can see, you must take into account how much of the cost of the asset you have already written off to determine any subsequent gain or loss.
Favorite and frequently encountered deductions for taxpayers are non-cash contributions to charity. Although there are some special rules, taxpayers can generally deduct the lesser of cost or fair market value (FMV) for personal items contributed to a charitable organization. For business assets, adjusted basis is substituted for cost. For example, if a taxpayer contributes to charity a desk which was used only for personal purposes, and never for business, that had cost $150 and has a FMV of $50, the taxpayer can take a $50 charitable deduction. However, if the desk had been a business asset, and its cost had been fully deducted (depreciated), the taxpayer’s charitable deduction would be zero since the adjusted basis would have been zero and was less than the FMV.
When a business asset is exchanged (traded-in) for a like-kind item, generally any gain or loss that would have resulted from the sale of the asset increases or decreases the adjusted basis of the replacement property. Thus, where a sale would result in a gain, the gain can be avoided by exchanging the item, such as trading in one business vehicle for another. On the other hand, if a sale would result in a loss, it is probably to the taxpayer’s advantage to actually sell the business asset so a loss can be taken.
Gains and losses from the sale of business assets are not included on the business schedule in the tax return where net profit or loss from operating the business is figured, and generally do not affect the taxpayer’s self-employment tax. Generally, losses from selling business assets are fully deductible in the year of sale. Gains to the extent they are attributable to depreciation are generally treated as ordinary income (but still not taxable for self-employment tax purposes), and any additional gain is treated as capital gain. If the asset was held for over a year, the long-term capital gains rates will apply.
Sometimes you may simply scrap an item because it has no further use in your business and has no resale value. When this happens, you treat the disposition as a sale for no money, which will produce a loss equal to the balance of the adjusted basis at that time. If you stop using an item for business purposes and convert it to personal use, your personal basis becomes the adjusted basis at the time of conversion with no additional deduction for the business. If you subsequently dispose of the item, any amount received in excess of the adjusted basis would be taxable but any loss would not be deductible.
If you simply give the item away to an individual, neither the business nor you as an individual taxpayer is allowed a deduction. The general rule is that the recipient’s basis will be the asset’s adjusted basis at the time of the gift. However, where a sale in the hands of the recipient would result in a loss, the loss would be based on the lower of the item’s adjusted basis or FMV at the time of the gift. If the value of the asset, plus other gifts you give the same individual during the year, exceeds $14,000 (2014 and 2015), a gift tax return generally will be required.
As you can see, disposing of personal property business assets can be complicated and the results might not be as you expect or would like. Please give us a call for additional information.
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