We are structuring a $6 million asset sale with a 50 percent seller installment note under Section 453, but our CPA warned us that depreciation recapture on our equipment must be paid entirely in the year of sale. How does Section 453 handle depreciation recapture, and how do we negotiate the initial cash down payment to avoid paying taxes out of pocket on cash we have not yet collected?
Section 453 of the Internal Revenue Code allows taxpayers to defer recognition of gain on an installment sale as payments are collected, but Section 453(i) contains a brutal exception: all depreciation recapture under Section 1245 and Section 1250 must be recognized as ordinary income in the tax year of the sale, regardless of how little cash you actually receive at close.
If you sell equipment, machinery, or depreciated technology assets that carried aggressive accelerated depreciation, that phantom tax bill hits you on day one. Carrying a 50 percent seller note without calculating your recapture liability can easily trigger a massive tax bill that exceeds your net cash proceeds at closing.
To solve this, your deal structure must follow three tactical steps. First, calculate your exact recapture liability before agreeing to the consideration mix. Bring your CPA into the deal team early to model out the Form 8594 asset allocation across all seven IRS asset classes. Minimize the allocation to Class VI equipment and furniture to the extent legally defensible, pushing value toward Class VII intangibles and goodwill, which qualify for true installment treatment.
Second, negotiate a hard floor on the closing cash consideration. Your cash at close must cover all transaction legal fees, advisory costs, and 100 percent of your year-one tax liabilities, including state taxes and depreciation recapture, plus an adequate safety reserve.
Never let a buyer defer purchase price into a seller note if the immediate tax burden on the full asset sale falls on your shoulders without sufficient cash at close.
Category: Valuation & Deal Structure