Question

WEEK 2: Discussion Prompt #2 When you sell, scrap, or otherwise remove a capital asset from your business, you'll have to report the change to the IRS. The good news is that long-term capital gains are taxed at a lower rate than other income, and if you have a loss on the property, you can deduct it. The bad news is that you may have ordinary income because of expensing or depreciation. Discuss the tax implications associated with the sale of an old asset that your organization (or you personally) have considered disposing of. In your response, provide an actual example of how the sale would impact the taxes.

Answer 1

When you dispose of a capital asset, you must report the disposition to the IRS. The amount of tax that you will owe depends on a number of factors. Among these factors are the following:

• Whether you had a gain or a loss on the sale
• How long you owned the asset
• The type of asset (Special rates apply to particular types of assets.)
• Your income (Higher income taxpayers face higher capital gain tax rates.)
• Your taxable income (This may also trigger liability for the new 3.8 percent net investment income (NII) Medicare tax.)
• Whether depreciation recapture is required
• Whether you receive the payments in one year or spread over a number of years

This article, and its two companion articles ("Net Investment Tax Hits Higher Income Taxpayers" and "How to Compute Capital Gains/Losses"), address tax issues that you will face when you dispose of capital assets.

Think Ahead

The like-kind exchange rules may help you avoid tax liability when you dispose of business property.  In some cases, if you trade business property for other business property of the same asset class, you do not need to recognize a taxable gain or loss.

Instead, you'll be treated as making a nontaxable like-kind exchange, in which the tax basis of the old property becomes the tax basis of the new property.

Is Gain Long-Term or Short-Term?

Property that is held for one year or less is considered to be held on a short-term basis. Any short term gain that is not offset by losses or long-term capital gain is taxed at ordinary income tax rates.

Property held for more than one year is considered "long-term" property. This gain (after all gains and losses are netted together) will generally be treated at the far more favorable long-term capital gains.

Installment Sale Treatment May Lower Taxes

If the sale qualifies, reporting your gain using the installment method may enable you to lower your overall tax bill. The installment method can be used to defer some tax on capital gains, provided:

• you receive at least one payment for a piece of property after the year of the sale and
• the property qualifies for installment treatment.