Am I overthinking this?

[joanmcq]

New client sold a biz in 2012. Investment was $22,000; losses taken for several years and then sold the biz for $15,000. I don't have a balance sheet.

Basis calculation:

$22,000

- losses

-------------

basis

Yes? No? I just asked for a balance sheet. Biz was a Sch C.

[jainen]

Am I overthinking this?<<

Under-thinking. You have to allocate the $15000 to the individual assets. Inventory first (ordinary income). Then equipment, with recapture of depreciation/179 if applicable. I assume he already allocated the $22000 when he started. Operating losses as such don't change the basis for Schedule C, other than accumulated depreciation. You might need a quick review of Section 195 rules.

[joanmcq]

No inventory, no depreciable assets. It was an internet sales biz, but didn't hold inventory.

[Guest Taxed]

Then it looks like a loss. Pub 544 and Form 4797

[taxtrio]

What did he spend the 22,000.00 on? If he wrote off the 22,000.00 as expenses as it was spent; i.e. operating expenses that are not depreciable then he would not have any basis left to claim upon the sale of the business.

Can't write off the 22,000.00 twice.

Just a thought.

[Guest Taxed]

Good point, unless the startup and acquisition costs have not been fully amortised, plus the cost of sale.

[OldJack]

Sounds like he has expensed/written off all investment and now selling the web page/business name which would therefore be a $15,000 capital gain for form 4797.

[joanmcq]

Thanks all. I requested a balance sheet so that I could see if there was any OE left. I'll take a look at Pub 544 & Sec 195.

I just realized I haven't had any clients actually sell a Sch C biz before. Usually they just close the doors.

[mcb39]

I had one two years ago. The client had borrowed the money for the basis. I know it was a complicated deal and computation was done at the request of the state. I had to create the calculations starting with beginning basis, add or subtract for end result of each year going forward. The remaining debt was allowed as a loss. Fortunately the accountant who did the business returns had a P&L for each year. Therefore, because money was borrowed and principal payments were not deductible yearly, she ended up with a loss. This may not pertain to your situation ; but gives credence to the fact that sometimes you can't over think these things.

[joanmcq]

The $22,000 was a loan. $15,000 was repaid from the sale proceeds.

[jainen]

>>$22,000 was a loan. $15,000 was repaid<<

Neither the source of funds nor the disposition of sale proceeds is at issue. Are you saying there was a cancellation of debt? It sounds like the investment went to intangibles, perhaps customer lists, domain name, or goodwill. Presumably those would have been deducted or amortized. A sole proprietorship has no basis as such, the way there might be for a partnership or corporation. Gain or loss will be found only with the adjusted basis and allocated sales price of individual assets.

[joanmcq]

I've received a balance sheet, such as there is, but the loan wasn't booked (of course!). I've asked if there was and 8594; the balance sheet lists A/R, as well as 'software development' as an asset, but I haven't seen any startup costs amortized. The prior year returns were done by hand.

[OldJack]

>>$22,000 was a loan. $15,000 was repaid<<

Neither the source of funds nor the disposition of sale proceeds is at issue. Are you saying there was a cancellation of debt? It sounds like the investment went to intangibles, perhaps customer lists, domain name, or goodwill. Presumably those would have been deducted or amortized. A sole proprietorship has no basis as such, the way there might be for a partnership or corporation. Gain or loss will be found only with the adjusted basis and allocated sales price of individual assets.

I disagree. A sole proprietorship has the same basic 'cost basis' in a business as any other business organization. True if the sole proprietorship is not keeping proper accounting records it is difficult to determine basis. It does not matter if the loan/capital contribution was "booked" as it was indeed an investment in the business or the business would not have had the cash to operate. It is not too late to book the investment/loan if it can be proved that it was made and not already been deducted or repaid. The transaction of repaying the loan with the sale proceeds has nothing to do with the recognizing of business operating income or loss but would effect gain/loss on disposition/liquidation of the business. Therefore, there are two issues, possible income/loss of the business on Sch-C and/or form 4797 and possible gain/loss on form 1040 sch-D.

[jklcpa]

Old Jack, while I agree with you that a sole proprietorship may keep a complete set of books including tracking the cash invested or loaned by the owner to the business, that really isn't necessary because at all times the cash belongs to the owner and does not affect the basis of the company.

A sole proprietorship reports its activities on whatever tax form is applicable to each component of its activity. It could be Schedule C for its ordinary income from operations, Schedule B for interest or dividends earned on investments in its name, or on Schedule 4797/D if it sells fixed assets used in the business, 6252 if business asset sold is structured as an installment sale.

The basis of a sole proprietorship is the basis in its underlying assets, and unless the purchaser assumes debt that is against an asset (for example, a loan on a fixed asset purchase) the amount of the debt is disregarded. For tax reporting when a sole proprietorship is sold, the seller is considered to be selling the assets of the business, not the business itself.

[joanmcq]

I have documentation of the loan. The balance was considered a gift per the lender (bank of dad). Old Jack, my comment that the loan wasn't booked was just an aside, as a comment on the completeness of the records. I'm doing a journal entry, at least in my calculations, to add the loan to fix the balance sheet.

The income/loss on the Sch C is not an issue either. I sent a question to the client regarding the A/R on the balance sheet, as well as the asset 'software development costs'-which may be startup costs. It doesn't appear startup costs were amortized. Might be easier just to get the QB file from the client and see what's in there.

[OldJack]

A sole proprietorship reports its activities on whatever tax form is applicable to each component of its activity. It could be Schedule C for its ordinary income from operations, Schedule B for interest or dividends earned on investments in its name, or on Schedule 4797/D if it sells fixed assets used in the business, 6252 if business asset sold is structured as an installment sale.

The basis of a sole proprietorship is the basis in its underlying assets, and unless the purchaser assumes debt that is against an asset (for example, a loan on a fixed asset purchase) the amount of the debt is disregarded. For tax reporting when a sole proprietorship is sold, the seller is considered to be selling the assets of the business, not the business itself.

Thank you for the lesson on a sole proprietorship as I must have been doing it wrong these last 45 years. It seems a little strange that you don't think a sole proprietorship could have a long-term capital gain from the transactions involved with the sale of a proprietorship business. True that the business must recognize gain/loss from the sale of assets but that does not preclude a "individual owner basis" gain/loss from the sale and from other items like sec. 1221 assets. In the case of the example in this post it was stated that the only assets were A/R, and software development. We don't know any values but I would guess that the A/Rec were not sold as individuals usually like to keep that. It would be nice to know if allocating the sale price to software development would be a reasonable allocation amount or if the sale price should also be allocated to something else such as the value of the going business. I would remind you that a partnership is nothing more than two or more sole proprietorships and there is nothing that says an owner does not have a tax basis in a partnership or proprietorship.

>>Sec. 1221. Capital asset defined

-STATUTE-

(a) In general

For purposes of this subtitle, the term "capital asset" means

property held by the taxpayer (whether or not connected with his

trade or business), but does not include -<<

[Guest Taxed]

>>> Might be easier just to get the QB file from the client and see what's in there <<<

Given what you have told us about this client's recordkeeping, you may find a lot of surprises on the actual QB file.

Every time I get a QB file from some of my clients, I have to scratch my head and make more followup calls.

[kcjenkins]

Ain't that the truth !!!! Even in larger businesses, if they use QB I always find errors, because QB just makes it so easy.

[joanmcq]

Just got a response that she stopped using QB so the software development costs are correct, but the A/R weren't sold. She just sold the website, blog articles, & graphic art files.

So we are back to basis calculations from what I've got.

[jainen]

>>back to basis calculations<<

You mean basis of the specific assets she sold, right? Because only part of the business was sold? If the blog articles and art files were self-made, associated costs were likely already deducted so their basis is zero. The sales proceeds must be allocated according to FMV. OldJack's 45 years notwithstanding, a sole proprietorship doesn't have an "outside basis" like a partnership interest, or stock or similar ownership like a corporation. Those can be sold independent of the business assets.

So she may very well have a taxable gain, and additional income if she doesn't repay the loan. But no bad debts on uncollected AR--without her QB nobody will believe she paid tax on income under accrual method.

[joanmcq]

She actually didn't have A/R. Just had a phone call, and she sent me the wrong balance sheet! She's subsequently set up a new biz, which is the partial B/S I got.

Had a nice conversation, and she did contribute more than the $22k from Bank of Dad. She did repay the loan with the proceeds of the sale. All of her contributions were booked again OE but it loos like expensed on the other side.

So no basis in the website?

[jainen]

>>So no basis in the website?<<

How would I know? Her story keeps changing. I'm still waiting for an answer to Taxtrio's question from first thing Friday morning, "What did she spend the 22,000.00 on?"

[OldJack]

>>back to basis calculations<<

OldJack's 45 years notwithstanding, a sole proprietorship doesn't have an "outside basis" like a partnership interest, or stock or similar ownership like a corporation. Those can be sold independent of the business assets.

So she may very well have a taxable gain, and additional income if she doesn't repay the loan. But no bad debts on uncollected AR--without her QB nobody will believe she paid tax on income under accrual method.

Despite Jainen's experience and reputation he has been on occasion proved wrong. To rely only on an income and expense statement to prepare a proprietorship tax return without a balance sheet reflecting owner equity basis should be, and could be, malpractice. As in this case the loan/owner equity was not on the books and is an amount in determining outside basis until corrected on the business books. True that the inside basis and outside basis are normally the same in a proprietorship/(dba), as they are usually in a S-Corp or SMLLC, but there are always exceptions to everything. Due to tax rules it is a myth among accountants that a proprietorship is not a legal entity. Check court cases and you will find the proprietorship entity and the owner both listed in the cases.