The buyer is demanding we accept a seller note with zero interest because they are already paying a premium multiple. How do we explain the IRS imputed interest rules under Section 1274 without derailing the deal?

Question

Tyler Smith · Accepted Answer

If you agree to carry a seller note to help finance the deal, you cannot just offer a zero-interest loan to secure a higher purchase price. The IRS enforces imputed interest rules under Section 1274 and Section 483. If your seller note does not state an interest rate at least equal to the Applicable Federal Rate, the IRS will recharacterize a portion of your principal payments as ordinary interest income. This recharacterization turns your tax-advantaged capital gains into ordinary income, which carries a much higher tax rate. It also recalculates the buyer's tax basis in the acquired assets. You must treat this as a non-negotiable compliance issue rather than a point of horse-trading. Inform the buyer directly that the seller note must carry an interest rate equal to or higher than the current Applicable Federal Rate for the corresponding term. Frame this as a standard regulatory requirement to protect both parties from an audit. If the buyer complains that the interest payments break their cash flow model, restructure the note to allow the interest to accrue and pay out at maturity, or use a pay-in-kind structure. This keeps you in compliance, protects your capital gains tax treatment, and preserves the buyer's near-term operational cash. Use your V/TO to keep your long-term financial goals clear so you do not make emotional concessions on structural tax rules.