How do we handle the tax recapture of depreciation under Section 1245 when structuring an installment sale under Section 453, without eating a massive day-one tax bill before receiving the cash?

Question

Tyler Smith · Accepted Answer

When you structure an installment sale under Section 453, you must pay attention to depreciation recapture under Section 1245 or Section 1250. The IRS does not allow you to defer taxes on recaptured depreciation. All of it is taxed as ordinary income in the year of the sale, regardless of how much cash you actually receive from the buyer on day one. If you have heavily depreciated machinery, equipment, or custom software, you could face a massive tax bill with no cash to pay it. To protect your cash flow, you must negotiate the asset purchase price allocation before signing the definitive agreement. Work with your CPA to minimize the allocation to assets subject to high depreciation recapture. Instead, allocate more value to goodwill, which qualifies for capital gains treatment and can be deferred under Section 453. Alternatively, require the buyer to pay an upfront cash down payment that is at least equal to your total first-year tax liability, including the recapture tax. Use your weekly Level 10 Meeting to keep your leadership team aligned on this target so your negotiating team has a clear, non-negotiable threshold. Never let a buyer push you into a deferred payment structure that leaves you writing a check to the IRS from your personal savings before you see their cash.