Changing Your Business or Getting Out of Business
Selling Your Business
The sale of a business is not usually a sale of one asset. Instead,
all of the assets of the business are sold. Generally, when this occurs, each asset is
treated as being sold separately for determining the treatment of gain or loss.
A business usually has many assets. When sold, these assets
must be classified as capital assets, depreciable property used
in the business, real property used in the business, or property
held for sale to customers, such as inventory or stock in trade.
The gain or loss on each asset is figured separately. The sale of
capital assets results in capital gain or loss. The sale of real
property or depreciable property used in the business and held longer
than 1 year results in gain or loss from a section 1231 transaction
(discussed in Chapter 3 of Publication 544). The sale of inventory results in ordinary income or loss.
Partnership Interests. An interest in a partnership
or joint venture is treated as a capital asset when sold. The part
of any gain or loss from unrealized receivables or inventory items
will be treated as ordinary gain or loss. For more information,
see Disposition of Partner's Interest in Publication
541.
Corporation Interests. Your interest in a corporation
is represented by stock certificates. When you sell these certificates,
you usually realize capital gain or loss. For information on the
sale of stock, see chapter 4 in Publication
550.
Corporate liquidations. Corporate liquidations of property
are generally treated as a sale or exchange. Gain or loss is generally recognized by the
corporation on a liquidating sale of its assets. Gain or loss is also generally recognized
on a liquidating distribution of assets as if the corporation sold the assets to the
distributee at fair market value. In certain cases in which the distributee is a
corporation in control of the distributing corporation, the distribution may not be
taxable. For more information, see Internal Revenue Code section 332 and its regulations.
Allocation of consideration paid for a business. The sale of
a trade or business for a lump sum is considered a sale of each individual asset rather
than a single asset. Except for assets exchanged under the like-kind exchange rules, both
the buyer and seller of a business must use the residual method (explained later) to
allocate the consideration to each business asset transferred. This method determines gain
or loss from the transfer of each asset and how much of the consideration is for goodwill
and certain other intangible property. It also determines the buyer's basis in the
business assets.
The residual method must be used for any transfer of a group of
assets that constitutes a trade or business and for which the buyer's basis is determined
only by the amount paid for the assets. This applies to both direct and indirect
transfers, such as the sale of a business or the sale of a partnership interest in which
the basis of the buyer's share of the partnership assets is adjusted for the amount paid.
A group of assets constitutes a trade or business if goodwill or going concern value
could, under any circumstances, attach to them.
Consideration. The buyer's consideration is the cost
of the assets acquired. The seller's consideration is the amount realized (money plus the
fair market value of property received) from the sale of assets.
Residual method. The residual method provides for the
consideration to be reduced first by the amount of cash, demand deposits, and similar
accounts transferred by the seller. The amount of consideration remaining after this
reduction must be allocated among the various business assets in a certain order.
The allocation must be made among the following assets in proportion
to (but not more than) their fair market value on the purchase date in the following
order.
1) Certificates of deposit, U.S. Government securities, readily
marketable stock or securities, and foreign currency.
2) All other assets except section 197 intangibles.
3) Section 197 intangibles (other than goodwill and going concern
value).
4) Section 197 intangibles in the nature of goodwill and going
concern value.
Example. The total amount paid in the sale of Company
SKB is $21,000. No cash or demand deposits were sold. The company's U.S. Government
securities had a fair market value of $3,200. Other tangible business assets had a fair
market value of $15,000. Of the $21,000 paid for Company SKB, $3,200 is allocated to U.S.
Government securities, $15,000 to other tangible business assets, and the remaining $2,800
to section 197 intangibles in the order shown in the previous list.
Agreement. The buyer and seller may enter into a
written agreement as to the allocation of any consideration or the fair market value of
any of the assets. This agreement is binding on both parties unless the IRS determines
that the amounts are not appropriate.
Reporting requirement. Both the buyer
and seller involved in the sale of business assets must report to
the IRS the allocation of the sales price among section 197 intangibles
and the other business assets. Use Form
8594, Asset Acquisition Statement Under Section 1060,
to provide this information. The buyer and seller should each attach
Form 8594 to their federal income tax return for the year
in which the sale occurred.
Dispositions
of Intangible Property
Patents
Franchise,
Trademark, or Trade Name
Important References
Publication
544
Sales and Other Dispositions of Assets
Publication
541 Partnerships
Form
4797 Sales
of Business Property
Form
8594 Asset
Acquisition Statement Under Section 1060
Schedule
D (Form 1040) Capital Gains and losses