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Bartering goes high-tech: Know the tax rules

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in Small Business Tax,Small Business Tax Deduction Strategies

An old-fashioned idea, bartering, is making a comeback among small business owners. And since no cash passes hands, you don’t have to pay any tax on the deal ... right? Wrong.

Advice: Barter profits are generally subject to current income tax although, in some cases, you may be able to postpone the tax. It doesn’t matter if you belong to a barter club.

Here’s a brief look at different types of barter:
  • Bartering goods for goods: If you exchange one business product for another, you must pay tax on the value of the product received minus the cost basis of the product you gave up. The transaction qualifies as a like-kind exchange. Treat the swap as a sale for tax purposes.

    Example: Alan owns a furniture store and Bill operates a sporting goods business. Bill gives Alan a $1,000 set of golf clubs in exchange for a leather chair selling for $1,000. The IRS taxes both Alan and Bill on the $1,000 value received minus the cost basis of the product given up.

  • Bartering services for services: The tax rules are the same if you swap one business service for another. You pay tax on the value of the service provided to the other person.

    Example: Carla is a dentist and Dave owns an auto repair shop. When Carla damages her car, Dave offers to fix it for free if she does his wife’s root canal. Carla charges $950 for a root canal, and it would have cost her $1,000 to repair the car. Dave is taxed on $950 and Carla pays tax on $1,000.

    The IRS will generally accept the fair market value you attach to the service you provide.

  • Bartering services for goods: No difference in the rules here, but you can gain a tax advantage if you provide a service in exchange for property that usually appreciates in value.

    Example: Ed is a building contractor who has been hired to renovate Fay’s office building. The building is currently worth $200,000. Instead of paying Ed $20,000 for the renovations, Fay agrees to give him a 10 percent interest in the building. When Ed completes the work, the building is appraised at $250,000. Although his interest is now worth $25,000, Ed only has to pay tax on $20,000. Plus, he can claim depreciation deductions on his building interest (using a basis of $20,000).

    The key: Handle the transfer first. If Ed and Fay had consummated the deal after the work was done, Ed would have paid tax on $25,000. Get all the paperwork in order before you begin any work.
Similarly, you can postpone the tax on a barter transaction by arranging to receive a non-negotiable promissory note in exchange for goods or a service you currently provide. So long as you operate your business on a cash basis, you’re not taxed until the year the promisor makes good on the note. However, for an accrual-basis company, the value of the note is currently taxable.

Tip: While the Internet makes it easier to barter, it doesn’t eliminate the tax consequences.

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