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Thread: Selling Websites - Income Tax or Capital Gains Tax?

  1. #1

    Default Selling Websites - Income Tax or Capital Gains Tax?

    My main business activity is building websites and then selling advertising on those websites. Occasionally I will sell a website.

    My question is should I pay income tax or capital gains tax on the proceeds of the sale of websites?

    I consider my websites to be an asset of the business since they generate revenue. I also occasionally buy other peoples websites.

    Also, if I am selling an asset of the business how do I calculate the basis?

    The domain name costs around $10 and then I obviously spend my time building it up.

    There are also some other costs like web hosting but they tend to be for multiple websites and not just one the one I am selling.

  2. #2

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    The answer to whether the profit you make from selling a website is ordinary income or capital gain depends on the facts. From what you described, your gain is probably capital gain (whether it is long term or short term depends on your holding period). If someone builds websites primarily to sell them (even if you hold them for a short while so that the ad revenue kicks in and makes them more salable) or who buys websites to tweak them and flip them, the profit is going to be taxed as ordinary income. It's a question of facts and intent, so it is hard to give a solid answer in many cases.

    As for computing your profit, it is the difference between the sales price and your tax basis. You tax basis will include whatever cash you actually invested in the website and did not write off as an expense. If you deducted the domain name registration fee as an expense when you bought the site, you cannot also deduct it from the sales price. If you deducted the domain hosting expense, same thing. The time you spent building up the website doesn't count as a cost in the equation at all. That is part of why you are making a profit in the first place.

  3. #3
    Mr. Tax Man
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    I agree with David that it could be either a capital gain or ordinary income depending on your intent, etc.

    If I just register blahblahblahxyz.com and there is nothing unique about it, and I sell it to you -- that's more ordinary income. But if I held the domain (the cost wasn't expensed) and I put my time into building it into something generating revenue (all costs associated with building it up would be capitalized, not expensed) -- then you can sell it for a $1 million... well then you can consider it a capital gain.

    But if I decided to transfer to you my website above for a few bucks, and it's not really a domain of value -- probably not.
    Small Business CPA
    "A tax loophole is something that benefits the other guy. If it benefits you, it's tax reform."

  4. #4

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    I think you're right when you say it's a question of intent. But how do you prove intent to the IRS? I consider my business to sell online advertising on the websites I build.

    However, last year I actually made about 40% of my income from advertising and 60% from website sales. Does that mean my main business last year was selling websites?

    I build sites so that I can sell advertising. That is my principal method of generating income. Selling off websites is something I am reluctant to do.

    When I do sell a site it causes my income to drop which I don't like even though there is a lump sum generated from the sale. I only sell a site if there is a good reason for it such as a better business opportunity or if I need a lump sum of cash for some other reason.

  5. #5
    Mr. Tax Man
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    You don't have to prove intent when you're filing the return, but you need to have this support in the event of an audit...

    Selling online advertising is not a capital gains event. Building websites is not a capital gains event. (If I hire you to build me a website, this is ordinary income to you.) I'd even question if you made an ordinary website, and then put it out to market with the hope someone would buy it that it'd be a capital gain. How is that different from just changing the ownership? GoDaddy, while not really "selling" domains per se, doesn't have capital gains on each sale it makes.

    Keep in mind that if this is a capital gain, everything needs to be capitalized -- not expensed. So you bought web hosting to get the site going, that needs to be included in your basis... Renewal fees, etc. If you expense these ordinarily and try to just take a capital gain on whatever amount you sell it for, with no basis -- you will probably trigger an audit sooner rather than later.
    Small Business CPA
    "A tax loophole is something that benefits the other guy. If it benefits you, it's tax reform."

  6. #6

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    I am in the same situation as the OP. I primarily earn my income by selling advertising space on websites that I own. However, I may sell one of my websites this year for significantly more than my adjusted gross income.

    I previously deducted all business expenses (relating to the domain I'm selling) over the past 3 years of income tax filings. Since I have previously deducted the expenses to build this particular domain, I'm assuming I will be taxed for the gross amount of the sale.

    Question1: Am I able to claim the income on the sale of the website as Capital Gains even though I deducted its registration/hosting/R&D expenses over the prior three years? It was my initial intent to sell monthly advertising space on the website but it looks like the website will be sold without ever receiving ad revenue.

    Question2: Does it matter if my adjusted gross income is considerably less than the sale of the website? Is there a ratio of earned income/capital gains income that must be maintained? Example: If my business income is $100,000 for the year and I sell the website for $300,000 - will that affect my ability to claim the $300,000 as capital gains income?

    Any input would be appreciated. Thanks in advance.

  7. #7

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    Question 1: Whether you deducted the registration/hosting/R&D expenses has little or no effect on whether the gain is from the sale of a capital asset. If you sell the site without ever having received ad revenue, that doesn't change your intent, but it may raise a question as to whether that was really your intent.

    Let me give you an example. A person has built several dozen apartment buildings over the years and continues to own and manage them as rentals. Before his latest apartment building is completed, he receives an offer to buy the building for an attractive price. Although he has not received any rental income from the property, he has an established history which bolsters his position that the building was a capital asset.

    If, on the other hand, the building was his very first, while his intent may have been to hold the property for the rental income, it may be much more difficult to prove that he was not simply developing the property to sell.

    Question 2: No, in fact it would be expected that you would sell a productive asset used in your trade or business for a multiple of its annual income. Using the example of the apartment building, the fact that the annual net income of a property was only $100,000 would certainly not prevent the owner who held the property for several years as a rental property from claiming the entire sales price as a capital gain.

    ---

    The best evidence of your intent is to show that you actually operated the website as a business for an extended period of time prior to the sale.

    Intent needs to be determined on the facts and circumstances of each case. Subtle differences in facts may result in different outcomes for two seemingly similar fact patterns. The best idea is to consult a tax professional who is familiar with the requirements for characterizing an asset as a capital asset.

  8. #8
    Mr. Tax Man
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    Quote Originally Posted by Business Attorney View Post
    Question 1: Whether you deducted the registration/hosting/R&D expenses has little or no effect on whether the gain is from the sale of a capital asset. If you sell the site without ever having received ad revenue, that doesn't change your intent, but it may raise a question as to whether that was really your intent.

    Question 2: No, in fact it would be expected that you would sell a productive asset used in your trade or business for a multiple of its annual income. Using the example of the apartment building, the fact that the annual net income of a property was only $100,000 would certainly not prevent the owner who held the property for several years as a rental property from claiming the entire sales price as a capital gain.

    The best evidence of your intent is to show that you actually operated the website as a business for an extended period of time prior to the sale.

    Intent needs to be determined on the facts and circumstances of each case. Subtle differences in facts may result in different outcomes for two seemingly similar fact patterns. The best idea is to consult a tax professional who is familiar with the requirements for characterizing an asset as a capital asset.
    Though admittedly the "domain" can never really be owned, it's merely an annual registration. The sale is really of the "goodwill" and the use of the domain name (and the transfer), which they have the right to do whatever with (including let the registration lapse and someone else to snatch it up).

    I do think though that expensing the costs in building the "basis" of this domain creates a unique proposition of what the intent was from the beginning. If the intent is to build up sites and to turn them around regularly, the costs should be capitalized and added to your basis to offset the capital gain. If the sale is just incidentally occurring, I still think the domain can be an asset and have a value. For example, I may have bought the domain "nbc.com" way back when with the intent of keeping it for my own use, but it may have a lot of value. I think it's possible to classify this one-time incidental sale to be a capital gain.

    Though if I was just "pumping and dumping" domains, I don't think you can have your cake and eat it too.
    Small Business CPA
    "A tax loophole is something that benefits the other guy. If it benefits you, it's tax reform."

  9. #9

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    Quote Originally Posted by Evan View Post
    Though admittedly the "domain" can never really be owned, it's merely an annual registration. The sale is really of the "goodwill" and the use of the domain name (and the transfer), which they have the right to do whatever with (including let the registration lapse and someone else to snatch it up).

    I do think though that expensing the costs in building the "basis" of this domain creates a unique proposition of what the intent was from the beginning. If the intent is to build up sites and to turn them around regularly, the costs should be capitalized and added to your basis to offset the capital gain. If the sale is just incidentally occurring, I still think the domain can be an asset and have a value. For example, I may have bought the domain "nbc.com" way back when with the intent of keeping it for my own use, but it may have a lot of value. I think it's possible to classify this one-time incidental sale to be a capital gain.

    Though if I was just "pumping and dumping" domains, I don't think you can have your cake and eat it too.
    Very well put. There are a lot of people who think they can get through transferring and selling domains, but it's almost never the case.
    _______________________________________
    Alexandra from https://transferpricing.global/en/

  10. #10

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    Selling your website or web business can bring in a lot of profit and with profit comes taxes. Unlike regular income though, the sale of a website can be classified as a capital gain, which means it's subject to capital gains tax instead of federal income tax – this means you ONLY pay the capitals gains tax.

    Regards,
    Lewis

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