We are planning an installment sale under Section 453 to defer our tax liability, but the buyer wants to allocate most of the purchase price to fast-depreciating assets, which would trigger immediate depreciation recapture taxes. How do we structure the asset purchase agreement allocation to maximize our installment tax deferral?

Question

Tyler Smith · Accepted Answer

An installment sale under Section 453 is an excellent strategy to defer capital gains tax, but it can be ruined if you do not pay attention to the purchase price allocation. Buyers want to allocate as much of the purchase price as possible to fast-depreciating assets, like equipment and software, so they can write them off immediately. However, this triggers ordinary income tax on depreciation recapture for you in the year of the sale, regardless of when you receive the cash payments.

To protect your tax deferral, you must negotiate the asset allocation as part of the initial deal terms, not as an afterthought during closing. Work with your tax advisor to allocate the maximum allowable value to goodwill and other non-depreciable intangible assets. Goodwill qualifies for long-term capital gains treatment and can be deferred over the life of the installment note.

Keep the allocation to personal property and depreciable equipment as low as defensible under market standards. If the buyer insists on a high allocation to physical assets, negotiate an increase in the upfront cash portion of the purchase price to cover the immediate depreciation recapture tax liability. This ensures that you are not left paying a massive tax bill out of pocket in year one before the installment note is fully paid.