By If you plan to sell a business or an intangible asset, you need to understand a critical tax rule that can significantly increase your tax bill.
Tax law treats many self-created intangible assets as non-capital assets. This treatment means you must report the gain as ordinary income instead of lower-taxed long-term capital gain.
This rule applies to assets you create through your own efforts, including patents, inventions, designs, copyrights, and creative works. When you sell these assets, the IRS taxes your gain at ordinary income rates.
But don’t assume that all intangibles receive unfavorable treatment. Many valuable business assets still qualify for capital gains treatment. These include client lists, goodwill, supplier relationships, and similar items. These assets usually produce favorable tax results when you sell them or your business.
Ownership structure also plays an important role. If a corporation or partnership creates an intangible asset through its employees, it may qualify for capital gains treatment. In contrast, if you create the asset personally through a sole proprietorship, the IRS will likely treat the gain as ordinary income.
You can also find planning opportunities in specific situations. For example, tax law allows favorable treatment for certain transferred patents and permits an election for musical compositions.
You should evaluate your situation before you sell. You can often reduce taxes by properly structuring ownership, documenting how the asset was created, and allocating the purchase price among assets in a tax-efficient manner.
If you want to discuss intangible assets, please call me directly at 408-778-9651