Installment sale advice

My client sold their restaurant earlier this year in an asset sale and handled all of the paperwork on their own. I've just seen the asset list, inventory list, and contract. She pretty much copied the attorney's paperwork from when they bought the business but used numbers applicable to today for asset and inventory values. What she did not include is a value item for Leasehold Improvements on her asset list. It was previously valued at $40,000 if their purchase price and has $28006 of accumulated depreciation. How do I handle that now? Also, do I need to include goodwill and the covenant not to compete values from their purchase in calculating the contract price and taxable gain from this sale? They were a total of $185,000 with accumulated amortization of $134670.00. Thanks for your help.

I assume all the assets are sold by one entity; and not splitup between a corporation and its stockholder.

It is unlikely, but was the downpayment (if any) allocated to specific assets? If so the sale of those assets would be reported on the 4797 whilst the remainder of assets that are sold at a gain, would each be reported on a Form 6252.

But probably, you will allocate the downpayment, and the future installment proceeds, amongst the assets based upon each asset's value in proportion to the total sales price. That would include goodwill.

A covenant not to compete is not eligible for installment sale treatment. See Balthrope v. Commissioner, 356 F.2d 28 (5th Cir. 1966); Rev. Rul. 69-643, 1969-2 C.B. 10; TAM 8009008; TAM 8007003. The gain from the sale is ordinary income and reported when the proceeds from the sale of the covenant is received. Practically speaking, though, if the covenant is paid through the same note as all the other assets; the timing for reporting the income from the covenant will be the same as if it was reported on an installment sale basis. However, the proceeds are taxed at ordinary income rates.

But: "They were a total of $185,000 with accumulated amortization of $134670.00." Does the "they" mean that a prior competition covenant is being sold by your client (along with goodwill)?. In other words, is your client (re)selling a covenant that your client bought when your client purchased the restaurant business? If so, perhaps then you have a covenant that is "property" and could be sold under Section 453 rules.

Some other assets, such as inventory and 1245 recapture assets, will not be eligible for installment sale treatment. The gains from those sales will be reported in the year of sale.


The Leasehold Improvements would be reported as a loss on the Form 4797. This is assuming the client still does not own the real estate; if the client ever did own the real estate.

The paperwork perhaps was accomplished without professional guidance? Perhaps an interest rate on the unpaid installments may not have been addressed - which will complicate your calculations.

Thanks MWPXYZ for you very informative discussion. BTW, this is an S corp, so we won't be reporting on form 4797. The downpayment is not allocated to a specific asset, she does assign an interest rate to the outstanding note and provide an amortization schedule for that. The purchase is defined in the sales contract: "The purchase price for all of the assets referred to in paragraph 1 is $180,000, attributable as follows: $16,000 to inventory and supplies on hand, $59,000 to fixtures and equipment, $2,000 to the Covenant Not to Compete contained in this Agreement, and $103,000 to the Goodwill of the business".

Her list of fixtures and equipment ($59,000) includes items that have been depreciated and items that have been expensed. I can identify the difference between those and coordinate it with my depreciation schedule so I can determine the gain for certain items that have been depreciated. The rest of the items (things like a microwave, toaster, lights, cups, coffee pots, lots of small equipment), I'm unclear of how to determine gain or loss, technically many of these items probably should be listed as supplies, but they are not.

On my worksheet right now I have Inventory and supplies at $16,000, adjusted basis at $16,000, gain equals zero. For the small equipment I have the value of $20,586, adjusted basis $20,586, gain zero. Three pieces of equipment from the depreciation schedule are not listed on the asset list, so I am going to show them as abandoned, they are fully depreciated and very likely were disposed of previously. Goodwill on my depreciation schedule is $85,000, accumulated amortization is $61,876; and Covenant Not to Compete on my depreciation schedule is $100,000, accumulated amortization is $72,794, the period it applied to is expired (it was for five years), and the current contract makes no mention of any part of that being transferred. Leasehold Improvements were from the original sales contract, are not identified in that contract, and are not included at all in the new sales contract. I've been to this facility many times, it's likely that the LHI are the lanai that was built in front and probably structural work that has long been forgotten, so they probably never really "owned" it and certainly did not retain it.

Are we able to report Goodwill and the Covenant in such a way that we can take a loss on them? When the client bought the business they were part of what they were paying for. I appreciate you help with this and your incite. It always feels better to have another opinion. Mahalo nui loa!

The inventory sale is straightforward - the proceeds would be reported on line 1a or 5 of page 1 and the inventory zeroed out.

The sales of equipments on the depreciation schedule would be on the second page of Form 4797, even for an "S" corporation, wouldn't they? Unless the sales price for any item is in excess of original cost, the gain would be taxable in the year of sale irrespective of whether the payments occur over time. I would report the remainder of the $59,000 on page 1 as revenue. Not sure how you got a tax basis of $20,586 unless that amount refers to just equipment purchased in 2018. Asset purchases in prior years would have depreciated a bit.

If the original competition covenant cost your client $100,000 and is expired; and your client is selling a covenant for a mere $2,000; it seems that the covenant your client bought is not an asset that your client is selling, but it is an asset your client is abandoning. And, your client is selling a new competition covenant restricting her, or the "S" corporation's efforts. The covenant your client purchased, I assume was a purchase by the corporation and should be reported on Form 4797 showing an ordinary loss. Since the entire business is being disposed of the loss won't be deferred under 197(f)(1)(B). Is the corporation or your client selling a new covenant for $2,000 (and is the corporation liquidating soon?)? If the corporation is selling the covenant, then I would set up a liability account, "Deferred Gain" to account for the portion of the covenant that will be reported in future years.

The goodwill could be interesting. Is the goodwill that your client purchased being sold or is it being abandoned? Has the restaurant had enough changes in format or operations in the last 11 - 12 years that the original basis for goodwill has disappeared? And the goodwill being sold - who is selling that; the corporation or your client? If the old goodwill is being sold, then the sale would create 1245 income of $61,876; taxable in the year of sale with the remaining gain reported on form 6252 as a 1231 gain. A sale of newly created goodwill would be a capital gain. A sale of a combination of new and old goodwill would produce some interesting calculations. The first issue would be determining the value of the old goodwill and the value of the new goodwill (if that determination could even be performed). I am not sure that the overall ordinary gain and capital gain amounts would change under each assumption, but you would have to "run the numbers".

Remember "Nonrecaptured 1231 losses" are carried forward for 5 years. The abandonment of leasehold improvements and goodwill will create 1231 losses. These losses will not offset ordinary income in 2018 and in the next 5 years but will offset 1231 gains which otherwise could have produced income taxed at capital gain rates.

If the corporation is selling "new" goodwill, then I would set up a liability account, "Deferred Gain" to account for the portion of the covenant that will be reported in future years.

If your client wishes to liquidate the corporation this year and receive the installment note payments personally, the gain can be reported over the term of the note (instead of at liquidation) under Section 453B(h) if Section 453(h)(1) applies.

You have a written agreement (I assume) that specifies the allocation of the sales price of the assets. You need to allocate based upon this agreement.

Lump small equipment with the other equipment. Seller has no equipment left, so zero out the balance sheet and you have your 1245 gain (thru form 4797). Inventory is a push. The basis in the leasehold will be a §1231 loss

Now you have to deal with line 12, form 6252 as to how to report the balance of the gain.

Could I just check some of these numbers please? All of the assets on the depreciation schedules have been expensed via Sec 179. All except two are older than five years and they are five year assets. Drake has recognized gain of $4450 on the K-1 which I believe is recapture only on the newest purchases. Since this is an S corp, it won't be reported on 4797. but on the K-1. Drake is also giving me a diagnostic that form 6252 isn't used for an S-Corp.

The $20,586 amount I mentioned is the difference between the values on their depreciation schedule and what the client is identifying as assets being sold. From the list she prepared, those items would generally be considered to be small equipment and supplies which were expensed in the year of purchase. So would I report that on line 5 of the 1120S as the sale of those items at that price? BTW, inventory on the BS is actually $12,000, being sold for $16,000. I could probably do a journal entry to adjust inventory to $16,000 and make it a push, or I would need to report a gain of $4,000 on that sale. Not sure if in the end there would be much of a difference taxwise.

Drake is picking up LHI and existing Goodwill on 4797 with a loss of $28,118 which is being carried over to Line 4 of the 1120S. So far Drake is not producing a carryover schedule for the non recaptured 1231 loss. Nowhere in the sales contract does it discuss how existing goodwill and new goodwill affect each other. My assumption right now is that they are abandoning the old and establishing new values. If the return were filed right now, there would be a loss of about $65,000 mostly due to the intangibles.

Client bought the business for $270,000 in 2007, and is selling it for $180,000 in 2018. So even though they have carried back a note for $160,000, I don't see a gain in that sale, so would there be no installment sale income to be reported going forward, there would be interest earned on the note. Am I right?

BTW, this is complicated, and I really appreciate the help from each person who has commented. I'd like to be able to work this out now so that when I get ready for the actual return, I'm sure I'm doing the right thing.

You can do inventory either way you suggested.

Revenue from sale of equipment and supplies expensed could go on 1120S - page 1 - line 1(a) or 5.

The 1231 loss - UltraTax corporate return for an S corporation does not seem to have a schedule for the 1231 loss that should be tracked for the next 5 years but ProSeries does for individual returns. Probably because the loss is tracked at the individual level since it may be "used" differently by different taxpayers: dependent upon each taxpayers' future 1231 gains.

Could Drake not create a Form 6252 because the transaction resulted in a loss, and losses are recognized in the year they occur even if payments are received over time? I have had Form 6252s for S corporations that sell assets at a gain on the installment basis.

Even though the current sale price is lower than the initial sale price, there still can be a gain since the initial sale price of $270,000 has been expensed, depreciated, and amortized. Furthermore, the Goodwill being sold, is sold at a gain, and on the installment basis; creating future gains that will be calculated on a Form 6252.

So you will have ordinary income from the sale of inventory and FFE. A 1231 loss from abandoned leasehold improvements, old covenant, and old goodwill; and a capital gain from the sale of your client created goodwill.

Above says: "Remember "Nonrecaptured 1231 losses" are carried forward for 5 years. The abandonment of leasehold improvements and goodwill will create 1231 losses. These losses will not offset ordinary income in 2018 and in the next 5 years but will offset 1231 gains which otherwise could have produced income taxed at capital gain rates."

And I say: "Huh?"

[Later observation: Why is "Nonrecaptured Section 1231 Loss" not is the Index of IRS's Pub 544?]

Sorry, poor wording late at night and edited too often.

Maybe this works:

These losses will not offset ordinary income in 2018; and but in the next 5 years but will transform offset 1231 gains, which otherwise could have produced income taxed at capital gain rates; into ordinary gains.

I only wish I understood it at all! Baffling.

It is simple! See:

Section 1231
(c) Recapture of net ordinary losses
(1) In general The net section 1231 gain for any taxable year shall be treated as ordinary income to the extent such
gain does not exceed the non-recaptured net section 1231 losses.

(2) Non-recaptured net section 1231 losses For purposes of this subsection, the term
“non-recaptured net section 1231 losses” means the excess of—
(A) the aggregate amount of the net section 1231 losses for the 5 most recent preceding taxable years, over
(B) the portion of such losses taken into account under paragraph (1) for such preceding taxable years.

(3) Net section 1231 gain For purposes of this subsection, the term “net section 1231 gain” means the excess of—
(A) the section 1231 gains, over
(B) the section 1231 losses.
(4) Net section 1231 loss For purposes of this subsection, the term “net section 1231 loss” means the excess of—
(A) the section 1231 losses, over
(B) the section 1231 gains.
(5) Special rules For purposes of determining the amount of the net section 1231 gain or loss for any taxable year,
the rules of paragraph (4) of subsection (a) shall apply.

Almost poetic!

I only wish I understood it at all! Baffling.

Ask Harry Boscoe, he can explain it all to you. For example,

viewtopic.php?p=24413#p24413

viewtopic.php?p=69067#p69067

I have this in the tax return now. All the parts are there, the losses on the abandoned items and the gains from the sale of all the stuff. I was able to get the 6252 to print (I was misunderstanding the diagnostic I originally had), and I have the installment sale calculated to recognize the correct amount for this year.

The only remaining problem is that Drake is showing the goodwill income as a 1231 gain, not a capital gain. I was on the phone for about an hour with a tech guy, in the end his best suggestion was to overwrite the K-1 on one of their screens. Which I could do. I'd rather have it in there correctly so the program is showing this as a capital gain. Any suggestion as to how I might get that to work? And would it be considered a long term gain or short term? The client has owned the restaurant for over ten years, but there might be an argument for the GW in the sale to be pretty new, and therefore a short term gain.

It's long term capital gain. Is there only one item (goodwill) on this input sheet? What is the property code you have?

Paula, was the goodwill an amortizable section 197 intangible? If so, it's covered under 197(f)(7) and

treated as property which is of a character subject to the allowance for depreciation provided in section 167.

Was it perhaps self created g.w.? Was it personal g.w.?

Thanks for the additional interest in helping sort this out. I was finally able to get Drake to recognize the GW that was created by the sale, as a capital gain. It was just a lengthy process of trial and error and eliminating screens that were tried and unsuccessful.