Publication 544 |
2001 Tax Year |
Other Dispositions
This section discusses rules for determining the treatment of gain
or loss from various dispositions of property.
Sale of a Business
The sale of a business is not usually a sale of one asset. Instead,
all 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). 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,
Partnerships.
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 any nontaxable 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.
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 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 under section 743(b) of the Internal Revenue Code. Section 743(b)
applies if a partnership has an election in effect under section 754
of the Internal Revenue Code.
A group of assets constitutes a trade or business if either of the
following applies.
- Goodwill or going concern value could, under any
circumstances, attach to them.
- The use of the assets would constitute an active trade or
business under section 355 of the Internal Revenue Code.
The residual method provides for the consideration to be
reduced first by the cash and general deposit accounts (including
checking and savings accounts but excluding certificates of deposit).
The consideration remaining after this reduction must be allocated
among the various business assets in a certain order.
For asset acquisitions occurring after March 15, 2001,
make the allocation among the following assets in proportion to
(but not more than) their fair market value on the purchase date in
the following order.
- Certificates of deposit, U.S. Government securities, foreign
currency, and actively traded personal property, including stock and
securities.
- Accounts receivable, other debt instruments, and assets that
you mark to market at least annually for federal income tax purposes.
However, see section 1.338-6(b)(2)(iii) of the regulations for
exceptions that apply to debt instruments issued by persons related to
a target corporation, contingent debt instruments, and debt
instruments convertible into stock or other property.
- Property of a kind that would properly be included in
inventory if on hand at the end of the tax year or property held by
the taxpayer primarily for sale to customers in the ordinary course of
business.
- All other assets except section 197 intangibles.
- Section 197 intangibles (other than goodwill and going
concern value).
- Goodwill and going concern value (whether the goodwill or
going concern value qualifies as a section 197 intangible).
If an asset described in (1) through (6) is includible in more
than one category, include it in the lower number category. For
example, if an asset is described in both (4) and in (6), include it
in (4).
For asset acquisitions occurring after January 5, 2000, and
before March 16, 2001, make the allocation among the following
assets in proportion to (but not more than) their fair market value on
the purchase date in the following order.
- Certificates of deposit, U.S. Government securities, foreign
currency, and actively traded personal property, including stock and
securities.
- Accounts receivable, mortgages, and credit card receivables
that arose in the ordinary course of business.
- Property of a kind that would properly be included in
inventory if on hand at the end of the tax year and property held by
the taxpayer primarily for sale to customers in the ordinary course of
business.
- All other assets except section 197 intangibles, goodwill,
and going concern value.
- Section 197 intangibles except goodwill and going concern
value.
- Goodwill and going concern value (whether or not they
qualify as section 197 intangibles).
Example.
The total paid in the January 12, 2001, sale of the assets of
Company SKB is $21,000. No cash or deposit accounts or similar
accounts were sold. The company's U.S. Government securities sold had
a fair market value of $3,200. The only other asset transferred (other
than goodwill and going concern value) was inventory with a fair
market value of $15,000. Of the $21,000 paid for the assets of Company
SKB, $3,200 is allocated to U.S. Government securities, $15,000 to
inventory assets, and the remaining $2,800 to goodwill and going
concern value.
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 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,
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
Intangible property is any personal property that has value but
cannot be seen or touched. It includes such items as patents,
copyrights, and the goodwill value of a business.
Gain or loss on the sale or exchange of amortizable or depreciable
intangible property held longer than 1 year (other than an amount
recaptured as ordinary income) is a section 1231 gain or loss. The
treatment of section 1231 gain or loss and the recapture of
amortization and depreciation as ordinary income are explained in
chapter 3. See chapter 9 of Publication 535,
Business Expenses,
for information on amortizable intangible property and chapter 1
of Publication 946,
How To Depreciate Property, for
information on intangible property that can and cannot be depreciated.
Gain or loss on dispositions of other intangible property is ordinary
or capital depending on whether the property is a capital asset or a
noncapital asset.
The following discussions explain special rules that apply to
certain dispositions of intangible property.
Section 197 Intangibles
Section 197 intangibles are certain intangible assets acquired
after August 10, 1993 (after July 25, 1991, if chosen), and held in
connection with the conduct of a trade or business or an activity
entered into for profit whose costs are amortized over 15 years. They
include the following assets.
- Goodwill.
- Going concern value.
- Workforce in place.
- Business books and records, operating systems, and other
information bases.
- Patents, copyrights, formulas, processes, designs, patterns,
know how, formats, and similar items.
- Customer-based intangibles.
- Supplier-based intangibles.
- Licenses, permits, and other rights granted by a
governmental unit.
- Covenants not to compete entered into in connection with the
acquisition of a business.
- Franchises, trademarks, and trade names.
For more information, see chapter 9 of Publication 535.
Dispositions.
The following rules apply to dispositions of section 197
intangibles.
Covenant not to compete.
A covenant not to compete (or similar arrangement) that is a
section 197 intangible cannot be treated as disposed of or worthless
before you have disposed of your entire interest in the trade or
business for which the covenant was entered into. Members of the same
controlled group of corporations and commonly controlled businesses
are treated as a single entity in determining whether a member has
disposed of its entire interest in a trade or business.
Nondeductible loss.
You cannot deduct a loss from the disposition or worthlessness of a
section 197 intangible you acquired in the same transaction (or series
of related transactions) as another section 197 intangible you still
hold. Instead, you must increase the adjusted basis of your retained
section 197 intangible by the nondeductible loss. If you retain more
than one section 197 intangible, increase each intangible's adjusted
basis. Figure the increase by multiplying the nondeductible loss by a
fraction, the numerator of which is the retained intangible's adjusted
basis on the date of the loss and the denominator of which is the
total adjusted basis of all retained intangibles on the date of the
loss.
In applying this rule, members of the same controlled group of
corporations and commonly controlled businesses are treated as a
single entity. For example, a corporation cannot deduct a loss on the
sale of a section 197 intangible if, after the sale, a member of the
same controlled group retains other section 197 intangibles acquired
in the same transaction as the intangible sold.
Anti-churning rules.
Anti-churning rules prevent a taxpayer from converting section 197
intangibles that do not qualify for amortization into property that
would qualify for amortization. However, these rules do not apply to
part of the basis of property acquired by certain related persons if
the transferor chooses to do both the following.
- Recognize gain on the transfer of the property.
- Pay income tax on the gain at the highest tax rate.
If the transferor is a partnership or S corporation, the
partnership or S corporation (not the partners or shareholders) can
make the choice. But each partner or shareholder must pay the tax on
his or her share of gain.
To make the choice, you, as the transferor, must attach a statement
containing certain information to your income tax return for the year
of the transfer. You must file the tax return by the due date
(including extensions). You must also notify the transferee of the
choice in writing by the due date of the return.
If you timely filed your return without making the choice, you can
make the choice by filing an amended return within 6 months after the
due date of the return (excluding extensions). Attach the statement to
the amended return and write "Filed pursuant to section
301.9100-2" at the top of the statement. File the amended
return at the same address the original return was filed.
For more information about making the choice, see section
1.197-2(h)(9) of the regulations. For information about
reporting the tax on your income tax return, see the instructions for
Form 4797.
Patents
The transfer of a patent by an individual is treated as a sale or
exchange of a capital asset held longer than 1 year. This applies even
if the payments for the patent are made periodically during the
transferee's use or are contingent on the productivity, use, or
disposition of the patent. For information on the treatment of gain or
loss on the transfer of capital assets, see chapter 4.
This treatment applies to your transfer of a patent if you meet all
the following conditions.
- You are the holder of the patent.
- You transfer the patent other than by gift, inheritance, or
devise.
- You transfer all substantial rights to the patent or an
undivided interest in all such rights.
- You do not transfer the patent to a related person.
Holder.
You are the holder of a patent if you are either of the following.
- The individual whose effort created the patent property and
who qualifies as the original and first inventor.
- The individual who bought an interest in the patent from the
inventor before the invention was tested and operated successfully
under operating conditions and who is neither related to, nor the
employer of, the inventor.
All substantial rights.
All substantial rights to patent property are all rights that have
value when they are transferred. A security interest (such as a lien),
or a reservation calling for forfeiture for nonperformance, is not
treated as a substantial right for these rules and may be kept by you
as the holder of the patent.
All substantial rights to a patent are not transferred if any of
the following apply to the transfer.
- The rights are limited geographically within a
country.
- The rights are limited to a period less than the remaining
life of the patent.
- The rights are limited to fields of use within trades or
industries and are less than all the rights that exist and have value
at the time of the transfer.
- The rights are less than all the claims or inventions
covered by the patent that exist and have value at the time of the
transfer.
Related persons.
This tax treatment does not apply if the transfer is directly or
indirectly between you and a related person as defined earlier under
Sales and Exchanges Between Related Persons and its
discussion, Nondeductible Loss, with the following changes.
- Members of your family include your spouse, ancestors, and
lineal descendants, but not your brothers, sisters, half-brothers, or
half-sisters.
- Substitute "25% or more" ownership for "more than 50%"
in that listing.
If you fit within the definition of a related person independent of
family status, the brother-sister exception in (1), earlier, does not
apply. A transfer between a brother and a sister as beneficiary and
fiduciary of the same trust is a transfer between related persons. The
brother-sister exception does not apply because the trust relationship
is independent of family status.
Franchise, Trademark,
or Trade Name
If you transfer or renew a franchise, trademark, or trade name for
a price contingent on its productivity, use, or disposition, the
amount you receive is generally treated as an amount realized from the
sale of a noncapital asset. A franchise includes an agreement that
gives one of the parties the right to distribute, sell, or provide
goods, services, or facilities within a specified area.
Significant power, right, or continuing interest.
If you keep any significant power, right, or continuing interest in
the subject matter of a franchise, trademark, or trade name that you
transfer or renew, the amount you receive is ordinary royalty income
rather than an amount realized from a sale or exchange.
A significant power, right, or continuing interest in a franchise,
trademark, or trade name includes, but is not limited to, the
following rights in the transferred interest.
- A right to disapprove any assignment of the interest, or any
part of it.
- A right to end the agreement at will.
- A right to set standards of quality for products used or
sold, or for services provided, and for the equipment and facilities
used to promote such products or services.
- A right to make the recipient sell or advertise only your
products or services.
- A right to make the recipient buy most supplies and
equipment from you.
- A right to receive payments based on the productivity, use,
or disposition of the transferred item of interest if those payments
are a substantial part of the transfer agreement.
Subdivision of Land
If you own a tract of land and, to sell or exchange it, you
subdivide it into individual lots or parcels, the gain is normally
ordinary income. However, you may receive capital gain treatment on at
least part of the proceeds provided you meet certain requirements. See
section 1237 of the Internal Revenue Code.
Timber
Standing timber held as investment property is a capital asset.
Gain or loss from its sale is reported as a capital gain or loss on
Schedule D (Form 1040). If you held the timber primarily for sale to
customers, it is not a capital asset. Gain or loss on its sale is
ordinary business income or loss. It is reported in the gross receipts
or sales and cost of goods sold items of your return.
Farmers who cut timber on their land and sell it as logs, firewood,
or pulpwood usually have no cost or other basis for that timber. These
sales constitute a very minor part of their farm businesses. In these
cases, amounts realized from such sales, and the expenses of cutting,
hauling, etc., are ordinary farm income and expenses reported on
Schedule F (Form 1040), Profit or Loss From Farming.
Different rules apply if you owned the timber longer than 1 year
and choose to either:
- Treat timber cutting as a sale or exchange, or
- Enter into a cutting contract.
Under the rules discussed below, disposition of the timber is
treated as a section 1231 transaction. See chapter 3. Gain or loss is
reported on Form 4797.
Christmas trees.
Evergreen trees, such as Christmas trees, that are more than 6
years old when severed from their roots and sold for ornamental
purposes are included in the term timber. They qualify for both rules
discussed below.
Choice to treat cutting as a sale or exchange.
Under the general rule, the cutting of timber results in no gain or
loss. It is not until a sale or exchange occurs that gain or loss is
realized. But if you owned or had a contractual right to cut timber,
you can choose to treat the cutting of timber as a section 1231
transaction in the year the timber is cut. Even though the cut timber
is not actually sold or exchanged, you report your gain or loss on the
cutting for the year the timber is cut. Any later sale results in
ordinary business income or loss. See Example, later.
To choose this treatment, you must:
- Own, or hold a contractual right to cut, the timber for a
period of more than 1 year before it is cut, and
- Cut the timber for sale or for use in your trade or
business.
Making the choice.
You make the choice on your return for the year the cutting takes
place by including in income the gain or loss on the cutting and
including a computation of the gain or loss. You do not have to make
the choice in the first year you cut timber. You can make it in any
year to which the choice would apply. If the timber is partnership
property, the choice is made on the partnership return. This choice
cannot be made on an amended return.
Once you have made the choice, it remains in effect for all later
years unless you cancel it.
Canceling a post-1986 choice.
You can cancel a choice you made for a tax year beginning after
1986 only if you can show undue hardship and get the approval of the
IRS. Thereafter, you may not make any new choice unless you have the
approval of the IRS.
Canceling a pre-1987 choice.
You can cancel a choice you made for a tax year beginning before
1987 without the approval of the IRS. You can cancel the choice by
attaching a statement to your tax return for the year the cancellation
is to be effective. If you make this cancellation, which can be made
only once, you can make a new choice without the approval of the IRS.
Any further cancellation will require the approval of the IRS.
The statement must include all the following information.
- Your name, address, and taxpayer identification
number.
- The year the cancellation is effective and the timber to
which it applies.
- That the cancellation being made is of the choice to treat
the cutting of timber as a sale or exchange under section 631(a) of
the Internal Revenue Code.
- That the cancellation is being made under section 311(d) of
Public Law 99-514.
- That you are entitled to make the cancellation under section
311(d) of Public Law 99-514 and temporary regulations section
301.9100-7T.
Gain or loss.
Your gain or loss on the cutting of standing timber is the
difference between its adjusted basis for depletion and its fair
market value on the first day of your tax year in which it is cut.
Your adjusted basis for depletion of cut timber is based on the
number of units (feet board measure, log scale, or other units) of
timber cut during the tax year and considered to be sold or exchanged.
Your adjusted basis for depletion is also based on the depletion unit
of timber in the account used for the cut timber, and should be
figured in the same manner as shown in section 611 of the Internal
Revenue Code and regulation section 1.611-3.
Timber depletion is discussed in chapter 10 in Publication 535.
Example.
In April 2001, you had owned 4,000 MBF (1,000 board feet) of
standing timber longer than 1 year. It had an adjusted basis for
depletion of $40 per MBF. You are a calendar year taxpayer. On January
1, 2001, the timber had a fair market value (FMV) of $350 per MBF. It
was cut in April for sale. On your 2001 tax return, you choose to
treat the cutting of the timber as a sale or exchange. You report the
difference between the fair market value and your adjusted basis for
depletion as a gain. This amount is reported on Form 4797 along with
your other section 1231 gains and losses to figure whether it is
treated as capital gain or as ordinary gain. You figure your gain as
follows.
FMV of timber January 1, 2001 |
$1,400,000 |
Minus: Adjusted basis for depletion |
160,000 |
Section 1231 gain |
$1,240,000 |
The fair market value becomes your basis in the cut timber and
a later sale of the cut timber including any by-product or tree tops
will result in ordinary business income or loss.
Cutting contract.
You must treat the disposal of standing timber under a cutting
contract as a section 1231 transaction if all the following apply to
you.
- You are the owner of the timber.
- You held the timber longer than 1 year before its
disposal.
- You kept an economic interest in the timber.
The difference between the amount realized from the disposal of the
timber and its adjusted basis for depletion is treated as gain or loss
on its sale. Include this amount on Form 4797 along with your other
section 1231 gains or losses to figure whether it is treated as
capital or ordinary gain or loss.
Date of disposal.
The date of disposal is the date the timber is cut. However, if you
receive payment under the contract before the timber is cut, you can
choose to treat the date of payment as the date of disposal.
This choice applies only to figure the holding period of the
timber. It has no effect on the time for reporting gain or loss
(generally when the timber is sold or exchanged).
To make this choice, attach a statement to the tax return filed by
the due date (including extensions) for the year payment is received.
The statement must identify the advance payments subject to the choice
and the contract under which they were made.
If you timely filed your return for the year you received payment
without making the choice, you can still make the choice by filing an
amended return within 6 months after the due date for that year's
return (excluding extensions). Attach the statement to the amended
return and write "Filed pursuant to section 301.9100-2" at
the top of the statement. File the amended return at the same address
the original return was filed.
Owner.
The owner of timber is any person who owns an interest in it,
including a sublessor and the holder of a contract to cut the timber.
You own an interest in timber if you have the right to cut it for sale
on your own account or for use in your business.
Economic interest.
You have kept an economic interest in standing timber if, under the
cutting contract, the expected return on your investment is
conditioned on the cutting of the timber.
Tree stumps.
Tree stumps are a capital asset if they are on land held by an
investor who is not in the timber or stump business as a buyer,
seller, or processor. Gain from the sale of stumps sold in one lot by
such a holder is taxed as a capital gain. However, tree stumps held by
timber operators after the saleable standing timber was cut and
removed from the land are considered by-products. Gain from the sale
of stumps in lots or tonnage by such operators is taxed as ordinary
income.
Precious Metals and
Stones, Stamps, and Coins
Gold, silver, gems, stamps, coins, etc., are capital assets except
when they are held for sale by a dealer. Any gain or loss from their
sale or exchange is generally a capital gain or loss. If you are a
dealer, the amount received from the sale is ordinary business income.
Coal and Iron Ore
You must treat the disposal of coal (including lignite) or iron ore
mined in the United States as a section 1231 transaction if both the
following apply to you.
- You owned the coal or iron ore longer than 1 year before its
disposal.
- You kept an economic interest in the coal or iron
ore.
For this rule, the date the coal or iron ore is mined is
considered the date of its disposal.
Your gain or loss is the difference between the amount realized
from disposal of the coal or iron ore and the adjusted basis you use
to figure cost depletion (increased by certain expenses not allowed as
deductions for the tax year). This amount is included on Form 4797
along with your other section 1231 gains and losses.
You are considered an owner if you own or sublet an
economic interest in the coal or iron ore in place. If you own only an
option to buy the coal in place, you do not qualify as an owner. In
addition, this gain or loss treatment does not apply to income
realized by an owner who is a co-adventurer, partner, or principal in
the mining of coal or iron ore.
The expenses of making and administering the contract under which
the coal or iron ore was disposed of and the expenses of preserving
the economic interest kept under the contract are not allowed as
deductions in figuring taxable income. Rather, their total, along with
the adjusted depletion basis, is deducted from the amount received to
determine gain. If the total of these expenses plus the adjusted
depletion basis is more than the amount received, the result is a
loss.
Special rule.
The above treatment does not apply if you directly or indirectly
dispose of the iron ore or coal to any of the following persons.
- A related person whose relationship to you would result in
the disallowance of a loss (see Nondeductible Loss under
Sales and Exchanges Between Related Persons, earlier).
- An individual, trust, estate, partnership, association,
company, or corporation owned or controlled directly or indirectly by
the same interests that own or control your business.
Conversion Transactions
Recognized gain on the disposition or termination of any position
held as part of certain conversion transactions is treated as ordinary
income. This applies if substantially all your expected return is
attributable to the time value of your net investment (like interest
on a loan) and the transaction is any of the following.
- An applicable straddle (generally, any set of offsetting
positions with respect to personal property, including stock).
- A transaction in which you acquire property and, at or about
the same time, you contract to sell the same or substantially
identical property at a specified price.
- Any other transaction that is marketed and sold as producing
capital gain from a transaction in which substantially all of your
expected return is due to the time value of your net
investment.
For more information, see chapter 4 of Publication 550.
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