Sale of Schedule C business

[dixontaxvt]

Hi Community,

I have a client who ran an early learning center, Schedule C, that she just sold - using two installment agreements. The first is for the real estate. The second is for the "business" - includes the classroom supplies but is mostly intangible - her clientele, and a noncompete. My client retained her trade name and her LLC, her business checking account, and the buyer is operating the business as an extension of their pre-existing business.

My question is - for the second, smaller installment agreement - I don't think that my client has any basis. Any tangible assets included in this were expensed - the only assets placed in service were as they pertained to the real estate, which has its own note. Once I have the books reconciled up to the date of sale, she may have some capital in the LLC (or may not) but even in that case I don't see that this would constitute cost basis - what she sold were supplies/equipment that were expensed, and the intangible clientele and noncompete - no basis.

This is concerning for 2024, because although the ongoing income from the second note will be smaller, on that installment note she received a $70K downpayment. I'm thinking that is straight income, no cost basis, and taxed at ordinary income rates. Before I make that judgement call, I am doing my research and wanted any input that another practitioner may have. Thanks!

[sjrcpa]

All ordinary income is taxed in the year of sale, whether or not she received all of the cash.

[rbynaker]

If it wasn't part of the buy/sell agreement, both buyer and seller should meet to discuss the purchase price allocation.  See IRS Form 8594 (which will need to be filed with both buyer's and seller's tax returns so you can get the data now or you can be scrambling next tax season for it):

https://www.irs.gov/forms-pubs/about-form-8594

I would guess that the supplies were fairly inconsequential and a big chunk of the sale price was for intangible assets/goodwill.  But no need for strangers on the Internet to guess when you can obtain the facts from your client. 🙂

Rick

[dixontaxvt]

Thank you very much for your input! 

There was a specified buy/sell agreement - all fine and good - here's where I go off the rails a little bit:

She is effectively disposing of this business. Had this been a sale of her stake in an S Corp, for instance, her basis in the S Corp would normally be her cost basis for the asset that she sold.

In this particular transaction, as of now I am not inclined to calculate any cost basis. On the tangible goods side, she has absolutely no basis whatsoever. For the remainder of the value of the business she sold, even if she did have capital on the balance sheet in the LLC, she did not sell the LLC - she sold her clientele, noncompete, etc... no cost basis?

That's my thought process, and in an effort to keep in reporting compliance and also not have my client miss out on the tax advantages of a potential for cost basis, I wanted to see what anyone else's take was.

Thank you again!

[dixontaxvt]

Thank you for your response, would you mind going into a little more detail?

This transaction took place in 2024 and to provide my client with a tax projection (eventually) I am running a dummy file in my 2023 software as though the transaction took place then.

I have drafted a two separate Forms 6252 (installment sales),

one for Buildings and Land,

and one for Noncompete and Consulting Agreement. 

In ProSeries there is a box to check - "check if ordinary gain from non-capital asset" - I have that box checked, the current year payments filled in, and the principal portion of the note paid in "2023" if flowing through to Form 4797 and then my 1040 - not in total ($265,000) but reflecting the current principal payments received ($77,722).

I have worked through installment sales in the past and don't have reason to believe my entries are incorrect - I also came here for input on how I'm handling this transaction, however, so if you don't mind I appreciate any guidance you are referring to in the form of Software Tips or IRS code.

[sjrcpa]

Noncompete and consulting are ordinary income. You pick this up each year as she receives it.

Goodwill, client base are capital assets. As you indicate, zero basis.

What is the purchase price for equipment and supplies? To the extent previously expensed, this is ordinary income, too. If the equipment was fully depreciated, gain to the extent of depreciation is also ordinary Section 1245 income.