Loss on Business Sale

[Terry D EA]

Client sold their business to an unrelated party in 2021. The business was an S-Corp and gain in the amount of $255,918.00 passed through to the single shareholder and reported on the 2021 individual tax return as a capital gain. The business is closed as expected and a final year tax return has been filed. The initial purchase agreement contained a balloon payment totaling approximately 500K to be paid sometime in 2022 to the shareholder. The buyer failed to make the ballon payment. An agreement was drawn up that reduced the amount due to the seller to $369,069.00 plus $8,003.00 in interest to be paid in 2023. The buyer once again failed to make the agreed upon reduced payment.

The reduced agreement gave the shareholder the right to seize any equipment. I am still gathering those amounts. Because the buyer defaulted on the initial required balloon payment of 500K Is the 500K the starting point to calculate the loss or the reduced agreement amount? Also, shouldn't the value of the equipment recovered be used to offset some of the loss?

I am also taking the position this transaction is a capital loss. Is my thinking correct? Any assistance is greatly appreciated.

[Lee B]

Did they sell the stock or the assets?

[Terry D EA]

Asset sale. Including all tangible and intangible items. 

Edited June 13, 2024 by Terry D EA
Correct spelling

[Lee B]

It seems to me to be an amendment of the 2021 tax return.

[jklcpa]

2 hours ago, Terry D EA said:

Client sold their business to an unrelated party in 2021. The business was an S-Corp and gain in the amount of $255,918.00 passed through to the single shareholder and reported on the 2021 individual tax return as a capital gain. The business is closed as expected and a final year tax return has been filed. The initial purchase agreement contained a balloon payment totaling approximately 500K to be paid sometime in 2022 to the shareholder. The buyer failed to make the ballon payment. An agreement was drawn up that reduced the amount due to the seller to $369,069.00 plus $8,003.00 in interest to be paid in 2023. The buyer once again failed to make the agreed upon reduced payment.

The reduced agreement gave the shareholder the right to seize any equipment. I am still gathering those amounts. Because the buyer defaulted on the initial required balloon payment of 500K Is the 500K the starting point to calculate the loss or the reduced agreement amount? Also, shouldn't the value of the equipment recovered be used to offset some of the loss?

I am also taking the position this transaction is a capital loss. Is my thinking correct? Any assistance is greatly appreciated.

Assuming the client didn't elect out of installment sale reporting, please see IRS Pub 537 for installment sale reporting where price has been reduced. You will have a recalculation of the gross profit.

There is also a section in the pub that deals with repossessions and recalculating those amounts and how to report that portion of the transaction going forward.

[Terry D EA]

1 hour ago, jklcpa said:

Assuming the client didn't elect out of installment sale reporting, please see IRS Pub 537 for installment sale reporting where price has been reduced. You will have a recalculation of the gross profit.

There is also a section in the pub that deals with repossessions and recalculating those amounts and how to report that portion of the transaction going forward.

I did not prepare anything for this client when this sale occurred. All I have is the originally filed tax return. The tax return shows the sale was reported on from 4797 from the K-1 information. Therefore, it appears the client did elect out of the installment sale. The gain was reported in the year of the sale. I do not have any of those calculations. At this point, I will ask the client for the worksheet, statement or whatever they have that shows the calculation. I did ask how the gain was determined. The response was the gross sales minus the investment for both tangible and intangible items, re-captured depreciation; etc.

So the facts that I know, the seller opted out of the installment agreement due to the sale being reported on form 4797 and not form 6252. I know the terms of the sale, sale price, and terms of the sale. I don't know how the original gain was calculated. I do know it was a capital gain  and by the Pub it should be a capital loss. A lot of extra work still needs to be done here.

 

[DANRVAN]

You do not amend the 2021 return.  

You report it as a separate transaction where a portion of the note was given up in exchange for the equipment. 

You need to know two things; the FMV of the equipment and the basis of the portion of the note that was wrote off (including any related legal expense...etc).

Since the installment method was not used you do not adjust the basis to reflect the gross profit percent.

If the FMV is greater than the basis your client will have a gain on disposition of the installment note, which is ordinary income.

If the basis of the note wrote off is greater than fmv of the equipment the loss is a bad debt (business) since the entire gain was recognized in the year of sale.

The basis of the repossessed equipment is the fmv.  The rules are different for real estate.

On 6/13/2024 at 8:34 AM, Terry D EA said:

The business is closed as expected and a final year tax return has been filed.

So gain or loss was determined on the liquidation of the S-corp and the note receivable was transferred to the shareholder?

[Lee B]

The correct approach is still kinda tenuous since it's not clear whether any of the assets sold have been taken back?

[DANRVAN]

7 hours ago, Lee B said:

it's not clear whether any of the assets sold have been taken back?

OP asked how the fmv of the equipment is accounted for.

If he is unable to repo the equipment the defaulted note is treated as bad debt.