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PDtax, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 4291
Experience:  35 years tax experience, including four years at a Big 4 firm.
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I am selling my practice, and there is an allocation in the

Customer Question

I am selling my practice, and there is an allocation in the sales agreement (not a separate agreement) for a covenant not not compete. I'm getting a lot down, but I will still elect the installment method of reporting the sale. How do I report the covenant income? Normally it is ordinary income, but now under the law it is a Section 197 asset. Some sources say to report it on a separate 6252 and have it still as ordinary income. Is that correct?
JA: The Accountant will know how to help. Is there anything else the Accountant should be aware of?
Customer: No
Submitted: 5 months ago.
Category: Tax
Expert:  PDtax replied 5 months ago.

Hi from Just Answer. I'mCustomer and can assist.

Expert:  PDtax replied 5 months ago.

The answer is between the two extremes you mention.

Since covenant payments are ordinary income OVER THE LIFE OF THE AGREEMENT, it is neither when paid or over 15 years as 197. It is over the life of the agreement.

If you agreed not to compete for two tax years, then the payment of that portion would be ordinary income over the years of receipt.

We take covenant payments out of the payment stream for the installment gain reporting, and report it separately as other income, 1040, line 21.

Thanks for asking at Just Answer. Positive feedback is appreciated. I'mCustomer

Customer: replied 5 months ago.
This is an installment sale. Do I have to report the entire covenant in the year of sale or can I recognize the income as the note is collected?
Expert:  PDtax replied 5 months ago.

You recognize the covenant income over the life of the agreement.

Let's say you receive $100,000 in year 1 and 2 of your note. A two year covenant that you value at $55,000 would be allocated $55,000 of your note payments. The $45,000 remainder would be considered note payments of your installment sale. Report the income as it is paid to you over the life of the COVENANT.