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I have a client that sold his business in 2024 and will receive installment payments over a few years. He operates on the accrual method. My understanding is that accrual based businesses must recognize income on inventory and depreciated items in the year of sale regardless if form 6252 is filed. If that's the case, he'll have to pay taxes on depreciation recapture ($150,000) and $20,000 in inventory. The buyer did not pay for the inventory until 2025. We filed an extension. Do you think we would be able to file form 3115 to change from accrual to cash for 2024 and avoid paying the depreciation recapture and inventory in 2024?
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And the inventory would still be sold.
He and his advisors didn't negotiate well enough if he didn't get enough cash at closing to pay the tax on the ordinary income.
The more I know the more I don’t know.
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I think I understand the question. The inventory was sold in 2024, but payment for it was not received until 2025. So, are you stuck with paying tax on it in 2024? And the funds received in 2024 were for the depreciated property, but less than the depreciation to be recaptured. Really, the question is how do accrual taxpayers use the instalment method. Sorry, I haven't had one of those, and hope I never do.
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I believe the accrual method requires 100% recapture in the year sold regardless of the installment
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That's basically correct. The sale includes the purchase of assets, inventory, and goodwill. A majority of it is goodwill which I don't think cash or accrual makes a difference. My concern is having to pay the taxes on the depreciation recapture all in one year. If they were cash, that can be spread out as the payments are received.
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My concern is having to pay the taxes on the depreciation recapture all in one year. If they were cash, that can be spread out as the payments are received.
No. Installment sale reporting is not allowed for ordinary income items- sale of inventory, AR, depreciation recapture. Cash basis or accrual doesn't matter.
The more I know the more I don’t know.
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I was thinking that the recapture gets spread out as future payments are received.
So, regardless of cash or accrual, let's say you sell an asset for $25K. You purchased that asset for $50K and have fully depreciated it. The sales contract states that you'll receive $5K for 5 years beginning in the current year. You have to recognize the full $25K recapture as ordinary income in year one?
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Mind if I ask another question?
Going back to my example, let's say the sales contract is for $200K, $25K is for the assets and $150K for goodwill. The seller receives $40K in year 1. Does the seller report the $25K on the 4797 part II and leave it off of the gross sales part I, line 5 of the 6252? If that's the case, do they include the full $40K in payments received or just $15K since we've already captured it on the 4797?
Or bypass the 4797, report it all on 6252 and include the $25K on the unrecaptured section 1250 gain worksheet to pay the difference in recapture and gain?
