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Possible Tax Consequences of Seller Financing

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You have sold your business and elected to do some seller financing to maximize the sale price. But, before you start to spend those payments, be sure to check with your accountant. In general, the gain or profit from the sale of property can be reported under the “installment method” of accounting for tax purposes.

This rule was put in place under the theory of tax law that taxpayers should not be required to pay taxes when they have not received enough cash to cover the tax bill. It started out as a good rule, but Congress has put so many restrictions on the use of this rule that, without careful analysis, you can face a bigger tax bill than any amount of cash you’ve received!

Some of the most common exceptions are:

1) Depreciation Recapture: You’ve been claiming accelerated depreciation on your business assets and you are now disposing of the business before the assets are fully depreciated. Now you have to go back and “recapture” any excess depreciation claimed over the straight-line method of depreciation. This “recapture” amount must be taxed in the year of sale and is not allowed in installment sale calculations. Again, for the sale of a partnership interest, you must “look through” to the assets of the partnership, and this rule could apply.

2) Sale of Publicly Traded Property: Congress determined that if you are selling assets that are readily traded in a market (i.e., an established securities market), the asset is liquid enough that you can sell it in order to pay tax on the gain. Therefore, we have this exception to the installment sales rule.

3) Sale of Inventory: The term “installment sale” does not include disposition of personal property that is included as inventory of a taxpayer. This includes the sale of a partnership interest to the extent that the sale is attributable to the partnership’s inventory.

4) Sale of Depreciable Property to Related Persons: Selling your business to a relative? Don’t expect installment sale treatment to apply to the depreciable assets. Note that this only applies to depreciable assets – if your building is included in the sale, you can still get installment sale treatment on the land under the building. “Related persons” includes selling any property to another company in which you, or a related person, owns 50 percent or more of the stock.

In short, if you have lots of inventory or depreciable equipment, you may find that the installment sale rules are not going to help you come tax time. Therefore, be sure to have your CPA review all terms before entering into an agreement to sell.

Good selling.

-Steve Sink


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