Posted by Fred Lake

Capital Gains Tax On The Sale of a Business

Capital Gains Tax On The Sale of a Business

Capital gains are a different type of income from normal corporate profit income. Capital gains taxes come into play in the sale of a business because the capital assets are being sold. This article focuses on capital gains on company assets in the context of the sale of a company.


What are capital gains (and losses)?

An asset is something of value your business owns, such as buildings, machinery, equipment, and vehicles. When you sell a fixed asset (used for investment or profit), you either sell it for a profit or a loss. The difference between the initial cost (called the basis) and the selling price is a capital gain or loss.

For example, if you have business equipment, you can add to the basis by upgrading the equipment or reduce the basis by making certain deductions and depreciation. The cost of acquisition plus modifications creates an adjusted basis when the equipment is sold. The difference between this adjusted basis and the selling price is a capital gain or loss.


How the capital gains tax works

Capital gains tax is a tax that applies to all capital gains. This income is taxed differently, depending on how long you have held it. If you hold the asset for more than a year before selling it, your capital gain is long-term. If you keep it for a year or less, the payoff is short-term.

To calculate the capital gains tax rate on your income tax return, you must separate the short-term and long-term capital gains of all assets sold during the year into a gain (or loss) in short-term and long-term capital

  • A net short-term gain is generally taxed like ordinary income, depending on its tax rate.

  • Long-term net capital gains generally do not exceed 15% for most taxpayers, with a few exceptions.


Sale of business property as part of the sale of a business

Here it gets difficult: when you sell a business, you sell many different types of assets. Each asset is considered to be sold separately to calculate the capital gain or loss.

The IRS says: "Selling a business or trade for a fixed amount is considered a sale of each asset rather than a single asset."

The process of selling business assets is complicated because each type of business asset is treated differently. For example, properties for sale to customers (e.g., inventory) are treated differently from properties (land and buildings). Each asset should also be analyzed to see if it is a short or long-term capital gain/loss.

Once the individual assets have been analyzed, and the gains and losses have been determined, the next step is to assign the trade price to each business transferred from seller to buyer.

The term "consideration" is a contractual term that means what each party gives in return. The buyer's consideration is the cost of the goods purchased. The seller's consideration is the value obtained (money plus the fair market value of the goods received) from the sale of the asset.

This process is used to determine the extent to which value corresponds to goodwill and other intangible properties.


Example of capital gain from the sale of a business

This is a simplified example of capital gains when selling a business. The purchase price for a small business is $500,000. The fair market value of all assets sold as part of the package is $350,000 (including the individual assets and the gain or loss of each) less the fair market value of the liabilities of $100,000, which equals $50,000. The difference of $50,000 is goodwill and other intangible assets.

This process of analyzing assets and determining how profits and losses are taxed is a task for a business appraiser and tax expert. What may seem like a simple business task can get complicated quickly, and getting your taxes wrongly is not a good idea.


Selling a business or partnership.

An owner's interest (investment) in a corporation or partnership is treated as an asset when the owner sells it. The added value of a partner or shareholder is not the capital gain of the business; it is the gain or the loss to the owner.

  • For a partner in a partnership: Capital gains tax may be paid on any capital gain received from the sale of the individual's stake or from the sale of the company as a whole. Using the example above, a two-person partnership could split their share of the profits from the sale of the partnership 50/50. If so, each partner could realize a capital gain of $25,000. But this is much simpler due to the value of the individual assets sold and whether the gains are short or long term.

  • For the business owner: The owners of a company are shareholders and experience capital gains or losses when they sell their shares, not necessarily when the company is sold.


What you need to do before selling your business

Here are some tips for minimizing your capital gains and getting all the information you need for your tax return.

  • Collect information on your assets: Find all the records related to the acquisition and improvement of each business property. Include asset acquisition costs and configuration costs (such as training costs) and upgrade costs (but not maintenance costs). The bigger the basis of each asset, the lower the profit from the sale.

  • Get a business appraisal: Find an appraiser and get an estimate of your business, including the value of all assets. This will help you achieve a realistic selling price and estimate your potential capital gains tax.

  • Take Inventory: If you have any products, parts, or materials for the products you sell, take an inventory to find out the value of that resource.

You need to know how the capital gains tax works, but it's just as important to start planning for the sale of your business with the help of tax and legal advisers to minimize capital gains.


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Fred Lake
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