Items That Are Not Income
In some cases the property or money you receive is not income.
Loans. Money borrowed through a bona fide loan is not income.
Sales tax. State and local sales taxes imposed on the buyer, which you were required to collect and pay over to state or local governments, are not income.
Appreciation. Increases in value of your property are not income until you realize the increases through a sale or other taxable disposition.
Leasehold improvements. If a tenant erects buildings or makes improvements to your property, the increase in the value of the property due to the improvements is not income to you. However, if the facts indicate that the improvements are a payment of rent to you, then the increase in value would be income.
Exchange of like-kind property. If you exchange your business property or property you hold for investment solely for property of a like kind to be used in your business or to be held for investment, no gain or loss is recognized. This means that the gain is not taxable and the loss is not deductible. A common type of nontaxable exchange is the trade-in of a business automobile for another business automobile. See Nontaxable exchanges in chapter 3.
Consignments. Consignments of merchandise to others to sell for you are not sales. The title of merchandise remains with you, the consignor, even after the consignee possesses the merchandise. Therefore, if you ship goods on consignment, you have no profit or loss until the consignee sells the merchandise. Merchandise you have shipped out on consignment is included in your inventory until it is sold.
Do not include merchandise you receive on consignment in your inventory. Include your profit or commission on merchandise consigned to you in your income when you sell the merchandise or when you receive your profit or commission, depending upon the method of accounting you use.
Construction allowances. If you enter into a lease after August 5, 1997, you can exclude from income the construction allowance you receive (in cash or as a rent reduction) from your landlord if you receive it under both the following conditions.
- Under a short-term lease of retail space.
- For the purpose of constructing or improving qualified long-term real property for use in your business at that retail space.
Amount you can exclude. You can exclude the construction allowance to the extent it does not exceed the amount you spent for construction or improvements.
Short-term lease. A short-term lease is a lease (or other agreement for occupancy or use) of retail space for 15 years or less. The following rules apply in determining whether the lease is for 15 years or less.
- Take into account options to renew when figuring whether the lease is for 15 years or less. But do not take into account any option to renew at fair market value determined at the time of renewal.
- Two or more successive leases that are part of the same transaction (or a series of related transactions) for the same or substantially similar retail space are treated as one lease.
Retail space. Retail space is real property leased, occupied, or otherwise used by you as a tenant in your business of selling tangible personal property or services to the general public.
Qualified long-term real property. Qualified long-term real property is nonresidential real property that is part of, or otherwise present at, your retail space and that reverts to the landlord when the lease ends.
Accounting for Your Income
Accounting for your income for income tax purposes differs at times from accounting for financial purposes. This section discusses some of the more common differences that may affect business transactions.
Figure your business income on the basis of a tax year and according to your regular method of accounting (see chapter 2). If the sale of a product is an income-producing factor in your business, you usually have to use inventories to clearly show your income. Dealers in real estate are not allowed to use inventories. For more information on inventories, see chapter 2.
Income paid to a third party. All income you earn is taxable to you. You cannot avoid tax by having the income paid to a third party.
Example. You rent out your property and the rental agreement directs the lessee to pay the rent to your son. The amount paid to your son is gross income to you.
Cash discounts. These are amounts the seller permits you to deduct from the invoice price for prompt payment. For income tax purposes you can use either of the following two methods to account for cash discounts.
- Deduct the cash discount from purchases (see Line 36 Purchases less cost of items withdrawn for personal use in chapter 6).
- Credit the cash discount to a discount income account.
You must use the chosen method every year for all your purchase discounts.
If you use the second method, the credit balance in the account at the end of your tax year is business income. Under this method, you do not reduce the cost of goods sold by the cash discounts you received. When valuing your closing inventory, you cannot reduce the invoice price of merchandise on hand at the close of the tax year by the average or estimated discounts received on the merchandise.
Trade discounts. These are reductions from list or catalog prices and usually are not written into the invoice or charged to the customer. Do not enter these discounts on your books of account. Instead, use only the net amount as the cost of the merchandise purchased. See Trade discounts in chapter 6.
Payment placed in escrow. If the buyer of your property places part or all of the purchase price in escrow, you do not include any part of it in gross sales until you actually or constructively receive it. However, upon completion of the terms of the contract and the escrow agreement, you will have taxable income, even if you do not accept the money until the next year.
Sales returns and allowances. Credits you allow customers for returned merchandise and any other allowances you make on sales are deductions from gross sales in figuring net sales.
Advance payments. Special rules dealing with an accrual method of accounting for payments received in advance are discussed in chapter 2 under Accrual Method.
Insurance proceeds. If you receive insurance or another type of reimbursement for a casualty or theft loss, you must subtract it from the loss when you figure your deduction. You cannot deduct the reimbursed part of a casualty or theft loss.
For information on casualty or theft losses, see Publication 547, Casualties, Disasters, and Thefts.
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