Oh What to Do

[S T]

I guess sometimes it is better if we have a client on extension, as sometimes issues arrive after the fact in the subsequent year, before the prior year has been filed.

Situation: T/p had a Pizza Franchise that just was not performing, so they sold the franchise on an installment note at a considerable loss in 2005. We had decided to report the entire sale in 2005 rather than an installment note. So we would have to recaputure the 1245 property depreciation as ordinary income, right ?? and really what ended up being subject to installment sale treatment was the self achieved goodwill. So all was being netted on 4797 as section 1231 and subject to capital gain treatment.

Well I just was finishing up the return today (LP) and I received an email that was forwarded from the seller ( my t/p) that they buyer had sent notifying that they are in financial hardship as of 4/05 and will not be making the lease payment nor the note payment for 5/05 and have not paid franchise royalties since 12/05.

Does this shed a new light on how to report this sale for 2005??? I know I already advised the client to obtain a contract lawyer.

So I guess the question is would it be more advantageous to report on the installment sale knowing the above facts for 2005??? I am thinking it would be, and a lot less reporting correction and picking up losses in 2006 or 2007.

Thoughts and advise would be most welcomed.

Sandy

[JG EA]

No installment sale on loss

ST,
You had to report the loss in the year sold. No other choice. See instructions on 6252.
If they got it back, do a worksheet (NATP has one) to determine the basis.
JG

[Jiggers]

Installment Sale

Am I missing something somewhere?

1. You say that the franchise was sold at a considerable loss. If so, why would there be any 1245 recapture? And goodwill as a gain? Did your client, the seller, complete an 8594, Asset Acquisition Statement?

2. If there was non-payment in 2005 for certain items, why was the return done incorrectly showing full payment?

3. If there is a loss, there is no installment sale reporting. You don't report part of the loss in each year. You report the full loss in the year of sale. The only thing reported in future years is the interest received on the note.

[S T]

Form 8594

Equipment and fixtures show a loss, but self created goodwill shows a profit. Equipment and fixtures can't be reported on installment sale, but couldn't the goodwill . This was the 8594 allocation most to goodwill

Total sale 309,170 plus costs on 8/22/05

Allocated Leasehold 32,470 Adj Basis 52,892
Equip 26,700 Adj Basis 105,578
Goodwill 250,000

Buyers received $ 194,170 and are carrying a note of $115,000 for 3 years (P&I) with a balloon payment due 8/22/08 of $112,618.

Return is on extension and has not been filed yet. It appears that the sellers will take back the business and resell in 2006.

How to report for 2005?

Sandy

[JG EA]

Not sure

I am not sure without further research, but it is still an overall loss right. The sale price is allocated - Does this help?
Pub 537: "The residual method must be used for any transfer of a group of assets that constitutes a trade or business and for which the buyer's basis is determined only by the amount paid for the assets. This applies to both direct and indirect transfers, such as the sale of a business or the sale of a partnership interest in which the basis of the buyer's share of the partnership assets is adjusted for the amount paid under section 743(b) of the Internal Revenue Code.

A group of assets constitutes a trade or business if goodwill or going concern value could, under any circumstances, attach to the assets or if the use of the assets would constitute an active trade or business under section 355 of the Internal Revenue Code.

The residual method provides for the consideration to be reduced first by cash and general deposit accounts (including checking and savings accounts but excluding certificates of deposit). The consideration remaining after this reduction must be allocated among the various business assets in a certain order.
For asset acquisitions occurring after March 15, 2001, make the allocation among the following assets in proportion to (but not more than) their fair market value on the purchase date in the following order.
Certificates of deposit, U.S. Government securities, foreign currency, and actively traded personal property, including stock and securities.

Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. However, see section 1.338-6(b)(2)(iii) of the regulations for exceptions that apply to debt instruments issued by persons related to a target corporation, contingent debt instruments, and debt instruments convertible into stock or other property.

Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held by the taxpayer primarily for sale to customers in the ordinary course of business.

All other assets except section 197 intangibles.

Section 197 intangibles except goodwill and going concern value.

Goodwill and going concern value (whether or not they qualify as section 197 intangibles).


If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. For example, if an asset is described in both (4) and (6), include it in (4). "

Just added up your basis - No loss then? Sold for $309,170 Basis $158,470? Then it looks as if they didn't count enough in assets for the sale because the seller wanted CG treatment? That won't work I don't think. Maybe the above allocation will help with that part of it.

[jainen]

2005 return is correct

>>still an overall loss<<

ST's transaction has $150,000 overall GAIN. We assume the allocation was correct since the buyer and seller both file the 8594, although it is surprising that the FMV of depreciable assets would have dropped so far below adjusted basis in an obviously successful business. Maybe he worked like crazy and wore all his machines out.

I think your 2005 return is correct, ST, and you might as well file it. Since you are pretty sure the buyer will default, it makes sense to elect out of the installment method. If and when there is a foreclosure, you recalculate basis and gain at that time.

[JON]

There is a gain

on the sale and there will be a gain on repo also.... You will get put in the same position as you were before the sale.. Ouch-even with 1245 property does he have to??? That would be a big debit for Equipment and the credit id income. Maybe 1245 is excluded since not part of installment sale???

He must have purchased some bad equipment...

[S T]

Asset Allocation

Thanks for all of your replies.

The form 8594 was allocated as stated above, buyers insistance to close the deal. Sellers had to sell as they were losing approximately $7,000 per month on the operations. Buyer did not want to pay large amount of bulk sales tax on the transfer of the equipment and fixtures. All equipment was new in 2004 plus leasehold new in 2004.
Seemed odd that buyer wanted to allocate to Goodwill and amortize over 15 years rather than take the depreciation on equipment and fixtures over 7 years.

So on repossession due to default and when I recalculate basis, how do I allocate the basis? Allocate to goodwill or percentage out to equip/fix and goodwill. I did a quick calculation using TB page 14-9 and it appears that the new basis is approximately the amount of the note outstanding of $114,000.

Sandy

[jainen]

eager to sell

They are required to allocate the sales price according to FMV. Now we see that this deal was set up to cheat the state out of taxes. I guess your client was eager to sell on any terms, but dealing with a thief is what brought him to the point of repossession. Now he has to use the real FMV and pay taxes on the gain.

[S T]

Fmv

Well Jainen, you could look at it like it was the seller, but then what about the buyer manipulating the systems as well, and escrow on top of that. I even called State Board hoping to get a reallocation, but to no avail.

I have already advised that I was not comfortable with the allocations in this transaction, so would it be better to reallocate FMV to the equip/fix on the 8594 and then only a portion of it to goodwill. We had originally suggested that the adjusted basis close to the time of sale for the equip and fixtures be used for allocation There was no special allowance or Sect 179 taken, only MACRS from 4/04 to sale date of 8/05. I honestly don't think the buyer is going to report the 8594 on their end, seems like they just "scoot" around the rules and regs.

Sandy

[jainen]

current 2006 FMV

What the buyer does is not your concern, since he isn't a client. Your client has to use the allocation he signed for, but that is only on the 2005 sale. On the repossession, he must use the current 2006 FMV.

[Bird Legs]

S T - Repo Worksheet

There is a great worksheet for repossession of personal property Basis & Gains in the CFS Tax Tools.

[S T]

Cfs

Yes I found it and had used it to try to project. I doubt that they will be able to sell for much more than maybe the value of the equipment or the balance due on the note. The store is closed. And then of course there will be costs. Original sale consisted of business equipment, leasehold improvements and goodwill. No real estate.

once we can arrive at a fair market value, My question now is how to allocate the 2006 fmv, to equip/fix as there does not seem to be any for goodwill at this point. And then do I depreciate from the period of repossession to date of sale?

Haven't even finished 2005 and already trying to get a grasp on what 2006 holds in store for us.

thanks

Sandy

[Bird Legs]

repossession

Sandy: You would not have any depreciation from time of repossession to date of sale
unless the client is going to put it back in use. If the equipment is just sitting there, not being used, you would not take depreciation, would you?

[S T]

no depreciation

Hi Bird,
I wouldn't think so, but I have never done a repossession before, therefore all of the "crazy" questions. Just trying to plan ahead and find out where this taxpayer is going to be for 2006 and figuring out the mechanics of the tax return.

So if that is the case, the repossession would just be reported on schedule D as such and not worry about the 4797???

Thanks,

Sandy