If your business has a piece of equipment that it no longer needs, selling it could be a smart move. Not only will you free up space and reduce maintenance costs, but you’ll also bring in some extra cash.
However, before you go and celebrate the sale, it’s important to consider the tax implications. The IRS may see the sale of business assets as taxable. Whether or not you owe taxes depends on a few different factors like depreciation or if the sale resulted in profits.
Situation 1 – The Loss of a Depreciation Deduction
One of the most valuable tax benefits for small business owners is the Section 179 deduction. When you claim this deduction, your business can deduct the entire cost of buying equipment in the first year, rather than spreading it out over the life of an asset.
For example, let’s say you buy a bulldozer for $100,000, and the IRS expects it to last five years. Instead of taking $20,000 off your taxes each year, you can deduct the full $100,000 in the first year. This can be a huge benefit in terms of cash flow.
However, there’s a catch when it comes to selling that equipment or using it personally. If you sell the equipment before the end of its expected useful life, you might have to pay back part of the tax savings you claimed through the Section 179 deduction. This process is known as “recapture.” Essentially, the IRS wants to ensure the equipment was actually used for business for its entire life.
The sale of business assets isn’t the only way to lose the 179 deductions. Another situation is when you start using a business asset for personal use, like driving a company car to go grocery shopping. For example, if you’ve claimed 100% of a vehicle’s cost for business but start using it for personal errands more than 50% of the time, the IRS may tax you on the percentage that you use personally. The more you use personally, the more you’ll lose from the initial deduction.
The Tax Cost of Losing Depreciation
Let’s continue with the example above.
Imagine you purchased a bulldozer for $100,000 and it depreciated at $20,000 per year over five years. After three years, you decide to sell it for its fair market value of $40,000. By this time, you would have already deducted $60,000 in depreciation ($20,000 per year for 3 years), but you still have $40,000 of depreciation left to claim for the remaining two years of its useful life. By selling the bulldozer, you are forfeiting the ability to claim that additional $40,000 in depreciation deductions.
Since deprecation reduces your taxable income, losing the deductions for the remaining $40,000 will increase your taxable income. It’s as if you have suddenly earned an additional $40,000 for that tax year, even though you may have only broken even on the sale of the equipment. This increase in taxable income could push you to a higher tax bracket, resulting in a significantly higher tax bill than you may have anticipated.
Situation 2 – Selling for a Gain
When you sell business equipment for more than its current market value, you’re making a profit, or a “gain. The IRS will tax that gain under the capital gain rules. These situations usually arise when a buyer is willing to pay more than the equipment is worth due to high demand or scarcity.
Profiting off the sale of a business asset is considered taxable income, and the IRS applies the capital gain taxes depending on how long you’ve owned the equipment. If you’ve owned this asset for one year or less, then the gain is treated as a short-term capital gain, which means it will be taxed at your regular income tax rates.
However, if you’ve owned the equipment for more than a year, the IRS will consider it a long-term capital gain, and it will be taxed at a lower rate. Long-term capital gains are taxed at 0%, 15%, or 20%, depending on your income tax bracket. This can significantly reduce the tax liability compared to the short-term rate, making it more beneficial to hold onto equipment for over a year before selling it.
Planning for the Sale of Business Assets
Many business owners are surprised by the taxes they may owe, especially when they’ve claimed depreciation deductions on the equipment over the years. Selling for gains can trigger capital gains tax and depreciation recapture, which can increase your overall tax bill.
If you sell equipment for more than its adjusted tax value (original cost minus accumulated depreciation), the profit is considered a capital gain. For example, if you purchased equipment for $50,000 and have depreciated it down to $20,000, selling it for $30,000 creates a $10,000 gain. This gain is subject to capital tax gains, which can vary depending on how long you’ve owned the asset and your income bracket.
Additionally, the IRS may require you to “recapture” any depreciation you have claimed, which means previously deducted amounts are taxes at ordinary income tax rates. This could result in a higher tax burden than the capital gains tax rate. For example, if you’ve claimed $30,000 in depreciation and sell the equipment for gain, the IRS could recapture that $30,000 and tax it at your regular income tax rate.
Like with any major financial decision, it’s wise to speak with your tax consultant before finalizing the sale of any business assets. They can help you calculate the tax liability you would face, advise on how depreciation recapture applies to your specific situation and suggest any strategies or other deductions that may lower your tax burden.
Frequently Asked Questions
1. Will I owe taxes if I sell used business equipment?
Yes, you may owe taxes when selling used business equipment, depending on the sale price and how the asset was depreciated. If you sell the equipment for more than its adjusted value (original cost minus depreciation), you’ll likely owe taxes on the gain. Depreciation recapture may also apply.
2. What is depreciation recapture and how does it affect my bill?
Depreciation recapture happens when the IRS taxes you on the depreciation deductions you claimed on the equipment before you sold it. When you sell a business equipment, the IRS may “recapture” the deprecation by taxing you at your ordinary income tax rate, which can be significantly higher than the capital gains tax rate,
3. What if I sell the equipment for less than its adjusted price?
If you sell your business equipment for less than the adjusted value, you won’t owe any taxes on the sale. In some cases, you may even be able to claim a capital loss, which could reduce your overall tax liability for the year. However, capital losses on personal property aren’t deductible so be sure the equipment was strictly used for business purposes.
4. Can I reinvest the profits gained from the business equipment sale to avoid taxes?
No, simply reinvesting the proceeds from selling used equipment won’t exempt you from taxes. Under certain circumstances, like using the like-kind exchange (Section 1031), you may be able to defer the taxes. This is a complex process, so it’s best to consult a tax professional to see if this applies to your situation.
5. Do I need to report the sale of equipment even if I didn’t make profits or owe any taxes?
Yes, you must still report the sale of any business asset to the IRS, regardless of whether you’ve profited or not or owe taxes. You are typically required to fill out Form 4797 (Sales of Business Property), which determines if the sale results in a gain or loss and calculates tax liability.
