Remaining Inventory When Bus Is Closed

[GTS1101]

Hi,

I have a client who owned a retail store. He closed the business in March of 2007. He has about 25,000 of inventory left after selling everything he could for 50% off or less. What happens to the inventory if he never sells it? Can he still write it off as a business loss? Or what if he decides to give the inventory away? Or what if he keeps it for his family. Or if he holds onto the inventory can he invest it into a new business in the future? And finally what if he keeps the inventory and sells it two or three years later. Do you we just file a tax return to show the inventory sold?

Thanks!

GTS1101

[JG EA]

If he keeps it, it is like the line " less cost of items withdrawn for personal use". No deduction.

If he gives it away it is personal use, unless donated to a charity then he could claim lesser of FMV or cost as a deduction. (If he has a receipt, etc.)

Or if he holds onto the inventory can he invest it into a new business in the future?

Yes, because he has not counted any cost for the inventory yet. He could use it in the new business.

I am not sure if inventory is always inventory and always SE income, but I think If he sells it a couple of years down the road and in not in the business of... then it is ordinary income but not SE income. Hopefully someone else knows this.

[Bees Knees]

TTB, Page 20-11 says:

Distribution of Inventory
If a partner receives a distribution of unrealized receivables or
inventory, gain or loss on subsequent sale by the partner is ordinary
gain or loss. Exception: If the partner sells inventory items
held for more than five years after the distribution, the type of
gain or loss depends on how the items are being used on the date
of sale. The gain or loss is capital gain or loss if the property is a
capital asset in the partner’s hands at the time sold.

I know, of course, that this applies to a partnership that liquidates and distributes its assets to the partners. There is this 5 year period where the inventory is still inventory in the hands of the partner. But after the 5 year period, depending on how the asset is used by the partner, it can turn into a capital asset.

The term capital asset basically means it turns into personal use property. This is not like depreciation recapture. Once depreciated, gain attributed to depreciation is always recaptured at ordinary rates. Inventory was never deducted. So it is possible that although it was once going to be sold in a business, after so many years of personal use, it no longer is considered business property and therefore any gain upon sale is capital gain rather than ordinary gain.

Partnerships put this 5 year period on it. There is no similar time period for sole proprietors. So in a sole proprietor, it is a facts and circumstances thing. You could probably say that after 2 years, for example, it could qualify as capital gain property.

The SE tax issue is another issue. The sale of inventory for an operating business is subject to SE tax. SE tax applies to business profits. If the business is no longer a business, the sale is no longer SE taxable. Again, there is no time limit set for this. It is a facts and circumstances thing. I would treat it as SE taxable if sold in the same year the business was in operation, and any future year if business issues are still being wound down. After that, if it was sitting on a garage shelf for a couple of years and you sold some inventory to a friend, it’s not going to be SE taxable if it is no longer your business.