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In recent years, the tax law has focused on real estate as a
complex asset to own, but even more complicated to sell. The use of
real estate in an operating business can create many tax benefits,
including the ability to claim depreciation on the business use,
create an investment for tax credits and even reduce some tax rates
for qualified business income. Recent tax legislation has added
some more issues to the sale of the real estate, making the tax
results more dependent on how a sale is structured and whether the
gain on the sale is taxable now or deferred by reinvestment.

Regardless of the reason for the sale and the scope of the
business, be prepared to plan ahead if you are about to structure a
sale of real estate for your business. Your preparation and careful
tax planning may help determine whether the closing of the sale has
significant tax issues.

NEED TO DETERMINE THE TAXABLE GAIN

The gain on real estate is based upon the original purchase
price and related improvements and capitalized costs, and the
original tax basis may need to be adjusted for the depreciation
over the asset life. If the sale is simply for the real estate
alone, then the seller may have a choice whether the proceeds are
all realized and the gain will be taxable at lower tax rates. If
the seller is either a pass-through entity or an individual, a
taxable gain may be eligible for long term capital gain rates (15%
or 20%) if the property was held for longer than a one year period
and some gain created from depreciation deductions may be eligible
for a 25% tax rate as Section 1250 gain. In this example, the tax
rate on the sale may be favorable enough to accept the tax
consequences.

Other transactions may include a sale of a business with
additional assets which include tangible personal property. When
more than one type of asset is involved, there are additional tax
issues with the sale, including how to allocate sales price and
determine if the overall gain is properly related to the real
estate or the other assets of the sale. Many purchase agreements
should try to identify how the purchase price was negotiated and
may need to be supported with a valuation of the business and the
various categories of assets. If so, then the agreement may need to
be explained in more detail since both the buyer and the seller
should agree on the contract terms.

If personal property results in a gain, then the tax rates are
likely to be higher when depreciation is also faster due to shorter
asset life. With tax benefits from bonus depreciation and Section
179 expense elections for these assets, it is important to
understand whether the gain results in ordinary income on any
portion of the proceeds. It is also difficult to defer any of the
taxable gain since many of the tax deferral strategies for Section
1031 (like-kind) exchanges do not apply to them. Beginning January
1, 2018, Section 1031 like-kind exchange tax deferral no longer
applies to exchanges of tangible personal property. Under the Tax
Cuts and Jobs Act, only real property will qualify for tax deferral
in a like-kind exchange, so the amount and allocation of gain may
need to be negotiated carefully between the buyer and seller. 
 

NEED TO DISCLOSE ASSET ALLOCATIONS

Most tax returns have a special form to disclose the allocation
and valuation of asset sales. Both the purchaser and seller of a
group of assets that makes up a trade or business must report an
asset sale, especially if goodwill or going concern value is
involved in the sale and if the purchaser’s basis in the
assets is determined only by the amount paid for the assets.
Generally, both the purchaser and seller must file Form 8594 and
attach it to their income tax returns when there is a transfer of a
group of assets. This applies whether the group of assets
constitutes a trade or business in the hands of the seller, the
purchaser, or both.  By doing so, the IRS expects there is
consistency and support for them to rely on the value of assets
sold in the exchange.

The disclosure of assets includes seven classes of assets. Class
I assets are cash and general deposit accounts (including savings
and checking accounts). Class II assets are actively traded
personal property and include certificates of deposit, foreign
currency, U.S. Government securities and publicly traded
stock.  Class III assets are assets that the taxpayer marks to
market at least annually for federal income tax purposes and debt
instruments (including accounts receivable). Class IV assets are
stock in trade of the taxpayer or other property of a kind that
would properly be included in the inventory of the taxpayer if on
hand at the close of the tax year. Class V assets include furniture
and fixtures, buildings, land, vehicles and equipment that
constitute all or part of a trade or business. Class VI assets are
all Section 197 intangibles, except goodwill and going concern
value, which form a separate Class VII.

An allocation of the purchase price of consideration must be
made to determine the purchaser’s basis in each acquired
asset and the seller’s gain or loss on the transfer of each
asset.  The amount allocated to an asset, other than a Class
VII asset, cannot exceed its fair market value on the purchase
date. The amount you can allocate to an asset is also subject to
any applicable limits under the Internal Revenue Code or general
principles of tax law.  For example, cost segregation studies
have been used to allocate buildings into their separate
components, and the tax benefit of having separate assets is
generally more favorable depreciation on assets with shorter
lives.

NEED TO EVALUATE THE TAX CONSEQUENCES

Many taxpayers assume that the taxable gain from a transaction
is determined as the sum of the parts. If all of the gain is from
real estate, then there can be a decision made to reinvest proceeds
into like-kind real property and defer the gain until a subsequent
sale of the reinvested property. There are time limits for
identifying replacement investments, choosing and closing on your
new properties and protecting the sales proceeds with a qualified
intermediary to avoid taxable funds.

If all of the gain is from capital gain assets, then recent tax
law has allowed Opportunity Funds as a simple way for investors to
contribute money in Opportunity Zones. These funds allow you to
work with professionals and let them manage your reinvestment and
defer the taxable income. Investors will create new capital gains
or defer tax on prior eligible gains to the extent the money is
invested into the Qualified Opportunity Zone.

Certain taxable transactions may be recognized on an installment
method basis to report the gain as the proceeds are received. 
The installment gain is allowed to be deferred to match the timing
of the proceeds. Since the deferral does not apply to ordinary
gains, the tax consequences of the character and timing of gain are
very critical to qualify for any tax deferral and benefits of a
sale.

CONSIDER THE SCENARIOS AND OPTIONS

Of course, choosing the best option is important if you have a
business transaction that requires negotiation for both the sale
and the reinvestment. It is best to determine how much time and
help is needed to work through the process and whether you have
considered all of your options.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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