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| Accounting for Your Money Can I trade my restaurant for another? By Michael J. Rasmussen, CPA |
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We are asked from time to time whether there are any tax strategies to use if I wanted to trade my restaurant for another in a different location possibly due to a move or lifestyle change?
As always in tax law the answer is “YES: however,…..”
A strategy that is available with limitations is known as a Like-Kind Exchange. A Like-Kind Exchange (also known as a 1031 Exchange), is a method to temporarily bypass capital gains taxes by investing proceeds from the sale of a property into an asset with the same General Asset Class.
For example, office furniture, fixtures, and equipment have a General Asset Class of 00.11 and information systems (computers and peripheral equipment) 00.12. Thus, Restaurant A may transfer a personal computer (asset class 00.12) to Restaurant B in exchange for a printer (asset class 00.12). With respect to A, the properties exchanged are within the same General Asset Class and therefore are of a like class and qualify for non-recognition of tax and any gain is deferred.
Overall, depreciable tangible personal properties of a like class are considered to be of a “like kind” for purposes of Section 1031. Furniture for furniture or computer for computers qualifies for the deferral of tax treatment.
To be a like kind exchange all six of the following must be met:
- Property traded (not sold) and property received must be held by the taxpayer for business or investment purposes.
- Property must not be inventory.
- There must be an exchange of property.
- Exchanges of intangible property cause problems...more homework is required.
- Property to be received must be identified within 45 days.
- Property must be received within 180 days or the due date (including extensions) of the tax returns.
Therefore, the restaurant owner first needs to break out real property from depreciable tangible personal property.
For restaurant owners who own the land and building the exchange of property for the same kind of property is the most common type of nontaxable exchange. To be a like-kind exchange, the property traded and the property received must be both of the following.
- Qualifying property such as land for land or building for building
- Like-kind property.
Additional requirements apply to exchanges in which the property received is not received immediately upon the transfer of the property given up. If the like-kind exchange involves the receipt of money or unlike property or the assumption of your liabilities, you may have to recognize gain.
Basis of property received. If you acquire property in a like-kind exchange, the basis of that property is the same as the basis of the property you transferred.
Example. You exchanged your restaurant’s building with an adjusted basis of $50,000 for a different restaurant’s building. The fair market value of both properties is $100,000. The basis of your new property is the same as the basis of the old ($50,000).
Money paid. If, in addition to giving up like-kind property, you pay money in a like-kind exchange, you still have no recognized gain or loss. The basis of the property received is the basis of the property given up, increased by the money paid.
Example. Bill Smith trades a freezer for a new one. The new freezer costs $30,000. He is allowed $8,000 for the old freezer and pays $22,000 cash. He has no recognized gain or loss on the transaction regardless of the adjusted basis of his old freezer. If Bill sold the old freezer to a third party for $8,000 and bought a new one, he would have a recognized gain or loss on the sale of his old freezer equal to the difference between the amount realized and the adjusted basis of the old freezer.
We have learned how to separate the restaurant’s assets into real property (building) and depreciable tangible personal property (office furniture, fixtures, machinery and equipment.) What typically happens when a restaurant is exchanged for another is that one party pays a premium for the other and the fair market values of the restaurants are not identical.
TAXABLE TRAP. The excess value of one restaurant over another is termed “Goodwill or going concern value.” Unfortunately this goodwill or going concern value is NOT of a like kind to the goodwill or going concern value of another restaurant. The goodwill calculated in this scenario will be separately treated as taxable and subject to capital gain if the restaurants have been held for greater than one year.
Reporting the exchange. Report the exchange of like-kind property, even though no gain or loss is recognized, on IRS Form 8824 found at www.irs.gov . The instructions for the form explain how to report the details of the exchange.
If you have any recognized gain because you received money or unlike property such as goodwill, report it on IRS Form Schedule D (Form 1040) or Form 4797, whichever applies. You may have to report the recognized gain as ordinary income from depreciation recapture.
Exchange expenses. Exchange expenses are generally the closing costs you pay. They include such items as brokerage commissions, attorney fees, and deed preparation fees. Subtract these expenses from the consideration received to figure the amount realized on the exchange. Also, add them to the basis of the like-kind property received. If you receive cash or unlike property in addition to the like-kind property and realize a gain on the exchange, subtract the expenses from the cash or fair market value of the unlike property. Then, use the net amount to figure the recognized gain.
You can exchange your restaurant for another and defer the entire gain until a later time if you meet certain qualifications set forth above. The assets of the restaurant must be broken out into classes (furniture, fixtures and equipment) and like kind (buildings) to determine the potential like kind exchange treatment. The requirements are stringent and if not followed the deferral of tax is not allowed and the exchange becomes taxable.
Rasmussen Tax Group is a team of industry specialists led by Mike Rasmussen empowering restaurant owners to have more personal time, grow their business and be more profitable through innovative technology and personalized service that simplifies planning, accounting and business solutions. For more information visit www.rasmussentaxgroup.com