We are structuring our transaction as an installment sale under Section 453 to defer taxes, but our accountant says our heavy asset depreciation recapture must be paid in the year of sale regardless of when we receive the cash. How do we structure the initial cash payment at close to prevent a negative cash flow situation?

Question

Tyler Smith · Accepted Answer

When you sell your business using an installment sale under Section 453, you defer capital gains tax, but Section 453 does not defer tax on depreciation recapture. Any historical depreciation you claimed on equipment, software development, or real estate is recaptured as ordinary income and taxed fully in the tax year of the sale. If you take a minimal cash payment at close and a massive seller note, you could easily face a cash crunch where your tax bill exceeds your cash proceeds.

To solve this, your leadership team must run this issue through the IDS process before signing any Letter of Intent. You must calculate your depreciation recapture liability and structure the deal mechanics to mandate that the cash down payment at close is at least large enough to cover your total estimated tax bill, including federal, state, and recapture taxes.

Another strategy is to negotiate the purchase price allocation using IRS Form 8594. Buyers want to allocate as much of the purchase price as possible to depreciable assets like equipment to maximize their future tax write-offs. You want to allocate as much as possible to goodwill, which is treated as a capital asset and eligible for installment sale treatment. Balance this trade-off during negotiations. Use your weekly Level 10 Meeting to keep your financial team focused on model projections so you do not get blindsided by tax bills.