Sometimes you just want or need to walk away from your business assets…they aren’t productive anymore, you can’t sell them, or you can’t continue making payments on loans used to finance their purchase. What does this mean from a tax perspective? It depends on the property and your actions.
Obsolete inventory
If items have been sitting on your shelf and you just can’t move them, even with substantial markdowns, maybe it’s time to get rid of them. There are three issues:
- What to do with them physically. Depending on what the items are, you may be able to sell them in bulk to a remainder company or donate them to a charity. Otherwise you can simply throw them out.
- What to do with your financial statements. You’ll need to remove them from your balance sheet. And you should adjust your income statement.
- What to do for taxes. You can take an immediate tax deduction for a write-down of inventory that’s become obsolete. You don’t even have to scrap the item but you must offer it for sale at the write-down price for at least 30 days after the inventory date. (This write-down option doesn’t apply if you use LIFO to value your inventory.) Note: If you donate food inventory that’s still wholesome to a qualified tax-exempt organization, there’s a special deduction rule that may give you a tax break. For C corporations, donations of any inventory for the care of the ill, the needy, or infants, are also eligible for a special write-off rule. Find information in IRS Publication 526.
Obsolete equipment
Old computers and other machinery and equipment may become outdated. Even if equipment is still functional, replacing it with a newer item may perform better and perhaps save on utility costs. As in the case of obsolete inventory, you can try to sell obsolete equipment or give it away. In some cases, you may just have to junk it (be sure to dispose of computers, tablets, and smartphones properly to comply with environmental rules and wipe out personal information).
For tax purposes, your actions dictate the tax results:
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If you sell the item, you may have a gain even though you receive very little. The reason: it’s likely that you wrote-off the cost through the Section 179 deduction (first-year expensing), bonus depreciation, and/or regular depreciation.
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If you donate the item, you may not receive any charitable contribution deduction, but check the IRS publication listed earlier.
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If you throw away the item, you still may have to “recapture” (report some income) from the Section 179 deduction you claimed when you bought it (see IRS Publication 946.
Abandoned real property
If you want to walk away from realty, understand what it means from a tax perspective. An abandonment means voluntarily and permanently giving up property. To do this, you need to show that you intended to abandon the property and that you took affirmative action to do so. If there’s a mortgage on the property, things get more complicated. Here are some of the rules simplified as much as possible (but they may not be the whole story):
- If you voluntarily convey the property in lieu of a foreclosure, this isn’t treated as an abandonment. Instead it’s treated as an exchange of the property to satisfy the debt; gain or loss results.
- If you abandon property that’s secured by a debt for which you’re personally liable, no gain or loss results until a foreclosure is completed. You’ll also have cancellation of debt income equal to the canceled debt.
- If you abandon property with non-resource debt (you aren’t personally liable for it), the abandonment is treated as a sale or exchange.
For more information, see IRS Publication 544.
Conclusion
The tax rules for dealing with obsolete inventory and equipment as well as abandoned property are very complicated. Be sure to work with your CPA or other tax advisor who can advise you on the best strategy for your tax situation.
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