We are structured as an S-Corp and want to use a Section 453 installment sale to spread out our tax liability, but the buyer is proposing an asset sale rather than a stock sale. How does this combination affect our depreciation recapture and the actual tax deferral benefits?

Question

Tyler Smith · Accepted Answer

When you combine an asset sale with a Section 453 installment sale in an S-Corporation, you face a major tax trap. Buyers prefer asset sales because they get a stepped-up tax basis in your physical equipment and inventory. However, under Section 453, depreciation recapture on personal property and real estate cannot be deferred. This means you must pay ordinary income tax on all accumulated depreciation in the tax year of the sale, even if you have not received a single dollar of cash from the buyer. This can lead to a massive, immediate tax bill that drains your upfront liquidity. To prevent this cash-flow mismatch, you must negotiate the purchase price allocation before signing the definitive agreement. Work to allocate more of the purchase price to goodwill and intangibles rather than fast-depreciating equipment. Goodwill qualifies for long-term capital gains and can be deferred over the life of the installment note. Additionally, you should demand that the upfront cash payment at closing is large enough to cover your entire tax liability, including the depreciation recapture. Do not let the buyer push all the cash into the future while you carry the tax burden today. Use your V/TO® to clarify your target net proceeds. Keep your CPA and deal team aligned on this allocation early in the process so you do not get blindsided by a tax bill that exceeds your year-one cash proceeds.