To print this article, all you need to do is be registered or log in to Mondaq.com.
In recent years, tax law has focused on real estate as a complex asset to own, but even more complicated to sell. Using real estate in an operating business can create many tax benefits, including the ability to claim depreciation on business use, create investment for tax credits, and even reduce certain tax rates. for qualifying business income. Recent tax legislation has added some additional problems to the sale of real estate, making tax results more dependent on how a sale is structured and whether the gain on the sale is taxable now or deferred through reinvestment.
Regardless of the reason for the sale and the scope of the business, be prepared to plan ahead if you are about to structure a real estate sale for your business. Your preparation and careful tax planning can help you determine if closing the sale poses significant tax issues.
NEED TO DETERMINE THE TAXABLE GAIN
The gain on real estate is based on the original purchase price and related improvements and capitalized costs, and the original tax base may need to be adjusted for depreciation over the life of the property. ‘asset. If the sale is simply for the property alone, the seller may have the option of whether the proceeds are fully realized and the gain will be taxable at lower tax rates. If the seller is a flow-through entity or an individual, a taxable gain may be eligible for long-term capital gain rates (15% or 20%) if the property has been held for more than one year and a gain was created from capital cost allowances may be eligible for a 25% tax rate as a section 1250 gain. In this example, the tax rate on the sale may be favorable enough to accept the tax consequences.
Other transactions may include the sale of a business with additional assets that include tangible personal property. When more than one type of asset is involved, the sale poses additional tax issues, including how to allocate the sale price and determine whether the overall gain is properly tied to the real estate or other assets in the sale. Many purchase agreements must attempt to identify how the purchase price was negotiated and may need to be supported by a valuation of the business and different asset classes. If this is the case, the agreement may need to be explained in more detail since the buyer and seller must agree on the terms of the contract.
If personal property results in a gain, tax rates are likely to be higher when depreciation is also faster due to the shorter life of the asset. With the tax advantages of bonus depreciation and Section 179 expense elections for these assets, it is important to understand whether the gain results in ordinary income on a portion of the proceeds. Deferring the taxable gain is also difficult because many tax-deferral strategies for Section 1031 exchanges (of a similar nature) do not apply to them. Effective January 1, 2018, Section 1031 similar exchange tax deferral no longer applies to exchanges of tangible personal property. Under the Tax Cuts and Jobs Act, only real estate will be eligible for tax deferral in a like-kind exchange, so the amount and distribution of the gain may need to be negotiated carefully. between buyer and seller.
NEED TO DISCLOSE ASSET ALLOCATIONS
Most tax returns have a special form for disclosing the allocation and valuation of asset sales. Both the buyer and seller of a group of assets that constitute a trade or business must report an asset sale, particularly if goodwill or going concern value is involved in the sale and if the buyer’s basis in assets is determined solely by the amount paid. for assets. Generally, the buyer and seller must file Form 8594 and attach it to their tax return when there is a transfer of a group of assets. This applies whether the group of assets constitutes a trade or a business in the hands of the seller, the buyer or both. In doing so, the IRS expects there to be consistency and support for them to rely on the value of the assets being sold in exchange.
The asset disclosure includes seven categories of assets. Class I assets are cash accounts and general deposit accounts (including savings and checking accounts). Class II assets are actively traded personal property and include certificates of deposit, foreign currency, US government securities, and publicly traded stocks. Class III assets are assets that the taxpayer marks to market at least once a year for federal income tax and debt obligation (including accounts receivable) purposes. Class IV assets are the taxpayer’s shares or other property of a type that would properly be included in the taxpayer’s inventory if available at the end of the tax year. Class V assets include furniture and fixtures, buildings, land, vehicles and equipment that constitute all or part of a trade or business. Class VI assets are all Section 197 intangible assets, except for goodwill and going concern value, which form a separate Class VII.
An allocation of the consideration purchase price must be made to determine the buyer’s basis in each asset acquired and the seller’s gain or loss on the transfer of each asset. The amount attributed to an asset, other than a Class VII asset, cannot exceed its fair market value on the date of purchase. The amount you can attribute to an asset is also subject to any applicable limits under the Internal Revenue Code or general principles of tax law. For example, cost segregation studies have been used to allocate buildings into their separate components, and the tax advantage of having separate assets is generally more favorable depreciation on shorter-lived assets.
NEED TO ASSESS TAX CONSEQUENCES
Many taxpayers assume that the taxable gain from a transaction is determined as the sum of the parts. If all the gain is from real estate, then it may be decided to reinvest the proceeds in similar real estate and to defer the gain until a subsequent sale of the reinvested property. There are time limits for identifying replacement investments, choosing and closing your new properties, and protecting the sale proceeds with a qualified intermediary to avoid taxable funds.
If all the gain comes from capital gain assets, recent tax legislation has allowed opportunity funds as an easy way for investors to contribute money to opportunity areas. These funds allow you to work with professionals and let them manage your reinvestment and defer taxable income. Investors will create new capital gains or defer tax on previous qualifying gains to the extent the money is invested in the qualifying opportunity area.
Certain taxable transactions may be accounted for using the installment method to report the gain as the proceeds are received. The payout gain can be deferred to match the time of proceeds. Since the deferral does not apply to ordinary gains, the tax consequences of the nature and timing of the gain are very important to qualify for any tax deferral and the benefits of a sale.
CONSIDER SCENARIOS AND OPTIONS
Of course, choosing the best option is important if you have a business transaction that requires negotiation for both sale and reinvestment. It’s best to determine how much time and help is needed to go through the process and whether you’ve considered all of your options.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
POPULAR ARTICLES ON: U.S. Real Estate and Construction