We want to structure our exit using an installment sale under Section 453 to defer our tax liability, but our advisor warned us about the depreciation recapture trap. How do we structure the purchase price allocation to minimize immediate tax exposure at close?

Question

Tyler Smith · Accepted Answer

Section 453 of the Internal Revenue Code allows you to defer capital gains tax by recognizing income as payments are received. However, the IRS treats depreciation recapture under Section 1245 as ordinary income that must be fully recognized in the year of the sale, regardless of whether you received any cash at close. If your business is asset-heavy or has written off significant equipment costs through Section 179, this recapture can trigger a massive tax bill with zero cash to pay it.

To solve this, you must negotiate a detailed purchase price allocation during the Letter of Intent phase, rather than leaving it as a post-closing afterthought. Work with your CPA to allocate the bulk of the transaction value to goodwill and customer lists, which qualify for capital gains treatment, rather than to personal property or fast-depreciating equipment. Additionally, structure the deal so that the cash received at closing is at least equal to your total immediate tax liability, including federal, state, and ordinary income recapture taxes.

In our EOS practice, we look at the Accountability Chart to see how your assets are actually managed and utilized. By showing that your true enterprise value lies in your systemized operational workflows and organizational structure rather than physical machinery, you gain the leverage needed to defend a goodwill-heavy allocation. This protects your cash flow and ensures the installment structure works in your favor.