Where to report Sales Proceeds - Non-Compete and Lease Transfer - Sold by a Dual Member LLC

[XJS]

At the end of 2022 a dual member LLC (Husband and Wife) sold business fixtures and received money for signing a non-compete agreement and also for transferring an existing lease over to the buyer. The business closed before 12/31 so the couple are filing their last 1065.

The LLC was not sold and neither was the business itself. Purely fixtures plus the lease and of course the entering into of a non compete agreement.

The closing/paperwork was done correctly by lawyers and the proceeds have been apportioned by mutual agreement on the 8594 under class V (Fixtures), and Class VI & VII (Non Compete and Transfer of Lease).

I understand the round sum amount for the sale of the fixtures needs to be apportioned across the individual assets on the 1065. 

My question is where are the proceeds for the other 2 classes of sale reported on the 1065 as the 8594 does not feed anything. The business has no balance sheet. The business reports on a cash basis and of course the K1 figures are duly entered on their joint 1040.

Appreciate any guidance.

[tagteam]

Class VI is for the non-compete and that could be considered capital gain or compensatory, depending.

I'm not at all certain what your attorney (tax professional) did with the lease transfer since Class VII is goodwill and going concern value. 

I will page Champ @Rick19744 for input on this scenario.

[XJS]

The lawyer performed a "closing" and the a "purchase price allocation" document signed by the buyers and sellers reflected the apportionment of the sale price as agreed between the parties. The parties are completing their own respective matching 8594s as required. The only place for the value received for transferring the lease (valuable retail location) is the Class VI & Class VII " "bucket".

The question is how are those 2 pieces of revenue (non-compete and Lease transfer proceeds) treated and where are they entered on the 1065/1040? I suspect 4797 but I cannot see how and where.  Neither one of course has a cost basis.

I corrected the title of the post as I had inadvertently listed Goodwill instead of Non-Compete.

[tagteam]

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@XJS wrote:

Neither one of course has a cost basis.

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Then they are both compensatory and are entered as Other income (Line 7).

[tagteam]

I hasten to add that I would have thought you would have basis in the lease.

After all, a lease is an estate in land (a leasehold estate) and the transfer would appear to be a wash unless the transferee paid more than that estate's basis (which would be unusual in the event of an assumption).

[Rick19744]

I am somewhat confused on how this was handled based on my experience, but as in most cases, there can be different ways to handle the presentation, even if not technically correct.

• Based on the facts, essentially the business was sold if you sold all the assets; regardless of what assets there were.  Additionally, you indicate you are filing a final LLC tax return, so the business is no longer a business and you are making liquidating distributions.
• Typically a noncompete is between a buyer and the owner(s) or key individuals; not the business.  This noncompete is generally a separate agreement; but not always.  Regardless, noncompete proceeds are ordinary income when received.
• I'm not sure that I understand the lease transfer.  Not sure why there were purchase proceeds allocated to that.  There are cases when a lease is transferred and there is some type of a premium received as a result of a change in lease payment, and those would most likely be reported in Class VI.  That premium would be reported as ordinary income as well.  But I'm not sure I have a good understanding of this component of the purchase.
• Without much more to go on, I would say both bullets 2 and 3 would be reported on form 4797 in Part II as ordinary income; just label them as described.

[XJS]

"Typically a noncompete is between a buyer and the owner(s) or key individuals; not the business.  This noncompete is generally a separate agreement; but not always.  Regardless, noncompete proceeds are ordinary income when received."

If this is "ordinary income" should it be reported on 4794 Part II Line 10?

"I'm not sure that I understand the lease transfer.  Not sure why there were purchase proceeds allocated to that.  There are cases when a lease is transferred and there is some type of a premium received as a result of a change in lease payment, and those would most likely be reported in Class VI.  That premium would be reported as ordinary income as well.  But I'm not sure I have a good understanding of this component of the purchase."

The LLC had a property rental lease with several years remaining. The buyer took  over the lease in exchange for a $ payment. Standard retail practice.  So the seller got out of the remaining lease obligation and the buyer took over a valuable location.

If this is "ordinary income" should it be reported on 4794 Part II Line 10?

In summation it looks as though both revenue items are ordinary income and 4797 Line 10 is the  place to put them with an acquisition date the same as the disposal date and zero cost.

Instructions for form 4797 Line 10 says:

"Report on line 10 ordinary gains and losses, not included in line 11 through 16, including gains and losses from property held 1 year or less".

I'm wondering whether the 4797 is in fact the correct place to put these 2 items.  It seems that's really for regular assets. I'm also not sure how to get them into TT H&B - i.e. what feeds line 10, either.  An alternative seems to be to enter them on the K1s directly on line 11 "Other Income /Loss)". I need to read the K1 instructions on that.

Any thoughts? 

BINGO (at least on the Non-Compete).  I believe the Lease Proceeds should go here too.

1065 K1 Instructions re Line 11 say:

1. 1. Income from intangible property if the partner is an individual whose personal efforts significantly contributed to the creation of the property;

   2. Income from state, local, or foreign income tax refunds; and

   3. Income from a covenant not to compete if the partner is an individual who contributed the covenant to the partnership.

[XJS]

So I added the income for Non-Compete and Lease Transfer to line 11 "Other income (loss)"  on the K1s.

Now over to TTD 1040. 

I've entered the K1 information but the dollar amounts for field 11 do not seem to feed through anywhere to the 1040. 

Any ideas please?

[tagteam]

Which code did you use for Line 11?

You may have to enter this manually in Forms Mode, depending.

[Rick19744]

Your K-1 instructions must be different than what I am seeing.

• https://www.irs.gov/instructions/i1065sk1
• Regardless, as stated previously, if you want to put them on box 11 as ordinary income, go ahead.  The end result is the same. 
• Form 4797 is used to report the disposition of assets used in a trade or business.  That's what you sold.
• As noted previously, I typically see the noncompete as a separate agreement between the buyer and the seller (not the business).
• The instructions for form 4797 Part II state: If a transaction is not reportable in Part I or Part III and the property is not a capital asset reportable on Schedule D, report the transaction in Part II.
• As a result of bullet 5, I would put the items / assets on form 4797.  If you can't figure out how to get them there, as stated previously, as long as the end result is correct, should you be audited, there will not be any implications.

[tagteam]

I agree with @Rick19744; get them there any way you can. This income is going to be treated as ordinary income, regardless, so there's little chance of anything changing in the event of an IRS examination.

[XJS]

 @Rick19744 @tagteam 

Your K-1 instructions must be different than what I am seeing.

• https://www.irs.gov/instructions/i1065sk1
• Regardless, as stated previously, if you want to put them on box 11 as ordinary income, go ahead.  The end result is the same.  Understood
• Form 4797 is used to report the disposition of assets used in a trade or business.  That's what you sold. Agreed. But I think that the 4797 is just for "normal" assets that you would capitalize as acquired. I could certainly add the items on the 4797. As pointed out the tax impact would be the same as putting them on the K1. 
• As noted previously, I typically see the noncompete as a separate agreement between the buyer and the seller (not the business). The IRS specifically mentions Non-Compete in its description of income to go onto Line 11 of the K1 so I believe the sale of the leasing rights also belongs there. 
• The instructions for form 4797 Part II state: If a transaction is not reportable in Part I or Part III and the property is not a capital asset reportable on Schedule D, report the transaction in Part II.
• As a result of bullet 5, I would put the items / assets on form 4797.  If you can't figure out how to get them there, as stated previously, as long as the end result is correct, should you be audited, there will not be any implications. I looked at that and then switched over to the K1 Line 11 for the reasons stated.

I went back to the 1040 interview and after entering line 11 as Code "I" I got a screen asking me to select the type of income. I selected" Other Non-Passive income to be reported on Schedule E, Page 2" and entered the description and amount. (I had originally chosen "Other Income and I have a description", or something similarly worded, but TT did not know what to do with those amounts).  I did this for each K1. The income fed into Sch E Part II  Line 28. There are 2 additional line entries, 1 for each K1 in addition to the line entries for the "normal" business income. The description "Non-Compete.....  " shows under column "Name" and the amount shows under column (k) "Income K-1".

I think this is the solution but I will thoroughly review.