How do we manage the tax drag of depreciation recapture under Section 453 when structuring a multiyear installment sale for our physical assets?

Question

Tyler Smith · Accepted Answer

When structuring an installment sale under Section 453 of the Internal Revenue Code, many owners do not realize that depreciation recapture under Section 1245 or 1250 cannot be deferred. All depreciation recapture is taxed as ordinary income in the year of the sale, regardless of how much cash you actually receive upfront. If your deal includes a massive amount of equipment, machinery, or custom-built physical infrastructure that you have already fully depreciated, this creates a major phantom tax liability. You could easily end up writing a tax check that exceeds the cash you walked away with at the closing table.

To defend against this cash squeeze, you must negotiate a specific allocation of the purchase price in the asset purchase agreement. Work with your tax advisor to shift the purchase price allocation away from high-recapture tangible assets and toward capital gains assets like goodwill or customer lists.

Additionally, you should demand that the buyer structure the payment schedule so that the initial cash payment at least covers your entire year-one tax liability, including the fully accelerated depreciation recapture tax. If the buyer refuses, they are essentially asking you to fund their acquisition out of your own pocket. Keep your leadership team focused on your quarterly Rocks to keep the business performing, ensuring the buyer remains motivated to agree to these terms.