We are using an installment sale under Section 453 to defer taxes, but our CPA warns that if the buyer defaults, we face massive tax recapture rules on depreciable property. How do we structure the asset allocation and default remedies in the purchase agreement to minimize this tax risk?

Question

Tyler Smith · Accepted Answer

Under Section 453, you cannot defer depreciation recapture. It must be recognized as income in the year of the sale, regardless of when you receive the cash. If the buyer defaults on their installment payments, you are left with a massive tax bill and no cash to pay it. To mitigate this risk, you must negotiate the asset purchase price allocation. Work with your CPA to allocate as much value as possible to assets that do not trigger immediate recapture, such as goodwill, rather than machinery, equipment, or software with heavy prior depreciation. Use your Value Growth Audit and Business Integration Rating data to defend a high valuation of your operational systems and intellectual property, which support a goodwill allocation. Additionally, structure your default remedies aggressively. The promissory note must contain a clause that accelerates the entire unpaid balance upon any missed payment. Secure the installment note with a first-priority lien on the company shares and its intellectual property, not just physical assets. If a default occurs, you must have the immediate right to step back into the business. Keep your V/TO and operational Scorecards updated during the payment period. If leading indicators drop below agreed-upon thresholds, it should trigger an operational audit or a technical default, allowing you to regain control before the business is ruined and your tax liability is stranded.