Thinking about selling your business and worried about capital gains tax? There are several strategies that you can implement to potentially avoid or lower these taxes. Here are some options to keep in mind:
Installment Sales Agreement
Under IRS Publication 537, taxpayers can defer capital gains on the sale of property with an installment sales agreement. Instead of paying tax on the entire gain, which also increases your adjusted gross income (AGI) and could potentially place you in a higher tax bracket, taxpayers can use an installment sales agreement to report a prorated portion of the gain over several years. Because the seller is paid in installments over the course of many years, interest is added to the buyer’s cost. This is additional income for the property seller, which is subject to ordinary income tax rates.
You still have to pay taxes, but spreading out the payments from the business sale means you won’t be hit with one large tax bill.
Reinvest Gain in a Qualified Opportunity Zone
Opportunity zones offer many tax benefits. Created by the Tax Cuts and Jobs Act of 2017, reinvesting capital gains from the sale of a business or investment property into a Qualified Opportunity Zone (QOZ), you can defer hefty taxes on that reinvested gain. A QOZ is a low-income and economically disadvantaged community in the United States that could benefit from new investments that may qualify for special tax treatment. This deferral of capital gains tax is extended until December 31, 2026, and must be recognized before that date.
If the taxpayer holds funds in the investment for at least five years before the end of 2026, there is a 10% reduction on the original capital gains tax liability. When it’s held for 10 years, the tax basis on the QOZ investment increases to its fair market value, thereby eliminating capital gains tax experienced in the QOZ.
Allocation of Purchase Price
The allocation of the purchase price is a negotiation between the buyer and the seller, and it can impact what you pay in taxes on the sale of your business. It’s the process of applying fair value to acquired assets and assumed liabilities from the target company in the transaction. Allocation determines gain and loss on each asset and determines the taxpayer’s basis on each asset. The IRS provides instructions on how taxpayers should allocate the purchase price as well as the seven classes of assets.
An investor can defer capital gains tax by selling a business or investment property and replacing it with a like-kind property within a specific time period.
Capital gains tax on the sale of a business can be significant, but the good thing is that there are ways to avoid paying this hefty price. Understanding the tax consequences of a business sale can be tricky, but it needs to be part of your investment strategy. Working with a specialist can help you reduce or even avoid the amount that you owe.
The Investor's Cap Gains Guidebook
Re-invest your capital gains. Defer or Eliminate Taxable Income.