What Are Capital Gains (and Losses)?
A capital asset is anything of value that your business owns, such as buildings, machinery, equipment, and vehicles. It can be used for investment or to make a profit. You can sell a capital asset at a gain or loss. The difference between the original cost (called the basis) and the sales price is either a capital gain or a capital loss. You may add to the basis of business equipment by upgrading the equipment, or you can reduce its basis by taking certain deductions and by depreciation. The cost at purchase plus these changes create an adjusted basis at the time you sell the equipment. The difference in this adjusted basis and the sales price is either a capital gain or a capital loss.
How the Capital Gains Tax Works
Capital gains tax is charged on all capital gains. These gains are taxed differently from regular income, depending on how long they’re held. Your capital gain is long term if you own the asset for more than a year before you sell it. It’s short term if you hold it for one year or less. You must separate short-term and long-term capital gains on all the assets you sell during the year to get a net short-term and/or net long-term capital gain (or loss) that you can use to calculate your capital gains tax rate. A net short-term capital gain is usually taxed as ordinary income, based on your tax rate. A net long-term capital gain is taxed is usually no higher than 15% for most taxpayers, but there are some exceptions for high earners.
Selling Business Assets in the Sale of a Business
Here’s where it gets complicated: You sell many different types of assets when you sell your business, and each is treated as being sold separately to figure the capital gain or loss you incur. The process of selling business assets is complicated because each type of business asset is handled differently. For example, property for sale to customers, such as inventory, is handled differently from real property, such as land and buildings. Each asset must also be looked at to see if it’s a short-term or a long-term capital gain/loss. The next step after the individual assets have been analyzed and capital gains and losses have been determined is to allocate the price of the business to each business asset transferred from the seller to the buyer. The term “consideration” means what each party gives in exchange. The buyer’s consideration is the cost of the assets being purchased. The seller’s consideration is the amount realized (money plus the fair market value of property received) from the sale of assets. This process is used to figure out how much of the consideration is for business goodwill and other intangible property. Goodwill is taxed differently when selling a business.
Example of Capital Gains in a Business Sale
Let’s say the purchase price of a small business is $500,000. The fair market value of all the assets being sold as part of the package is $350,000, including individual assets and the capital gain or loss on each less the fair market value of liabilities at $100,000, which equals $50,000: $500,000 less $350,000 less $100,000. The difference of $50,000 is for goodwill and other intangible assets.
Selling a Corporation or Partnership
The interest or investment of an owner in a partnership or corporation is treated as a capital asset when it’s sold by the owner. The capital gain of a partner or a shareholder is not the capital gain of the business. It’s the gain or loss to the owner.
For a Partner in a Partnership
Capital gains taxes may be due on any gain received from the sale of the individual’s partnership interest or from the sale of the partnership as a whole. Using the example above, a two-person partnership might split their share of the proceeds from the sale of the partnership 50/50. Each partner might have capital gains of $25,000 in this case.
For an Owner of a Corporation
Owners of a corporation are shareholders. They have capital gains or losses when they sell their shares, not necessarily when the business is sold.
Tips for Selling Your Small Business
You’ll want to take steps to minimize your capital gains and to gather all the information you need to prepare your tax return or to turn over to your accountant or other tax professional.
Gather Information on Your Assets
Find all the records relating to your purchase and improvement of each business asset. Include costs to purchase the asset and set it up (like training costs) and costs for improvements (but not maintenance). The higher the basis for each asset, the lower your gain when you sell it.
Take Inventory
Take inventory so you know the value of each asset if you have products, parts, or materials for products you sell.
Get a Business Valuation
Find an appraiser and get a valuation of your business, including the value of all assets. This will help you get to a realistic selling price and to estimate your possible capital gains tax.
IRS Publication 544 for tax implications on the sale of business assetsIRS Publication 541 Partnerships for capital gains on partnership sharesIRS Publication 550 Investment Income and Expenses for capital gains for corporate shareholders
