We are structuring our transaction as an asset sale with a large installment note, but our accountant warned us about immediate depreciation recapture taxes under Section 453. How do we negotiate the purchase price allocation to minimize this upfront cash tax bill?

Question

Tyler Smith · Accepted Answer

When you structure an asset sale with an installment note, Section 453 of the internal revenue code allows you to defer taxes on your capital gains. However, there is a dangerous tax trap. Section 453(i) dictates that any depreciation recapture under Section 1245 or Section 1250 is fully taxable in the year of the sale, regardless of how much cash you actually receive at closing. This means if you have heavily depreciated your equipment, vehicles, or software assets, you could face a massive upfront tax bill with zero cash from your installment note to pay it. To prevent this cash-flow disaster, you must aggressively negotiate the purchase price allocation before signing the definitive agreements. Work with your CPA to draft a purchase price allocation that prioritizes intangible assets, such as goodwill, which are not subject to depreciation recapture rules. Minimize the allocation to tangible personal property that carries high historical depreciation. Additionally, structure your closing payment terms so that the cash received at closing is, at a bare minimum, sufficient to cover one hundred percent of your immediate tax liabilities, including the recaptured depreciation. Use your dedicated Thinking Time to model these tax outcomes. Never assume that an installment sale automatically defers all your tax obligations, or you will pay a painful tax penalty.