We want to accept a $7 million seller note over five years to defer our capital gains tax under Section 453, but our advisors warned us about Section 453A interest charges and immediate tax recapture on our equipment. How do we structure the note and purchase price allocation to protect our net tax deferral?

Question

Tyler Smith · Accepted Answer

Section 453 installment sales offer powerful tax deferral, but business owners frequently stumble over two statutory traps: ordinary income depreciation recapture and Section 453A interest charges. Navigating these rules requires proactive transaction structuring before executing the asset purchase agreement.

Under Section 453(i), any depreciation recapture under Section 1245 on equipment, machinery, or custom technology is recognized immediately as ordinary income in the year of sale. You cannot defer this tax, even if you receive zero cash at closing. To prevent an unexpected tax bill without closing cash, negotiate your purchase price allocation aggressively. Direct all cash received at closing to pay for the high-recapture assets, while allocating the Section 453 seller installment note to unrecaptured capital assets, such as enterprise goodwill and intellectual property.

Second, manage the Section 453A threshold. If the total face value of installment obligations arising during the tax year exceeds $5 million, the IRS charges an annual interest penalty on the deferred tax liability attributable to the excess over $5 million. If you are selling a business owned across multiple shareholders or through separate holding structures, evaluate whether individual partners hold separate installment notes below the $5 million statutory threshold.

Finally, make sure the seller note does not contain equity conversion features or contingent earnout terms that could jeopardize its classification as a fixed installment obligation under the Internal Revenue Code. Align your tax structure directly with the exit targets outlined in your V/TO so you do not surrender operational gains to immediate tax liabilities.