Quick checklist: tax steps to plan before you sign
- Get a professional business valuation and a written allocation schedule.
- Decide whether to structure the deal as an asset sale or a stock sale (tax consequences differ).
- Calculate your adjusted tax basis and projected gain or loss.
- Identify selling expenses and deductible closing costs.
- Consider timing, installment sales, and any deferral or exclusion opportunities.
- Coordinate with your CPA and tax attorney on required IRS forms and state filings.
Why valuation matters early
A defensible valuation drives everything that follows: the listing price, buyer negotiations, tax-basis calculations, allocation among asset classes, and potential audit support. Valuations that rely on standardized methods (market, income, asset) are more credible if you’re audited. If your sale is an asset sale, the buyer will want an allocation of purchase price among assets (tangible, intangible, goodwill) — this allocation determines whether proceeds are taxed as ordinary income or capital gain (IRS guidance: Sale of a Business) (IRS.gov).
Step 1 — Choose deal structure: asset sale vs. stock sale
- Asset sale: Buyer purchases the company’s assets (inventory, equipment, customer lists, goodwill). Sellers (or selling entities) recognize gain on each asset sold. Ordinary income rates can apply to depreciation recapture, while goodwill and other intangible assets typically generate capital gains. Buyers usually prefer asset sales for stepped-up basis, but sellers often prefer stock sales for capital gain treatment.
- Stock (or membership interest) sale: Buyer purchases ownership units. The sale is generally taxed to the seller as capital gain on the stock, subject to exceptions and adjustments. For corporations, stock sales may avoid recognition of ordinary income tied to assets but can trigger different corporate tax consequences (for C corporations, remaining corporate-level tax matters may remain).
Practical note: In my practice I recommend modelling both structures early — even if the buyer prefers one — so you can quantify the tax difference and negotiate allocation and price adjustments.
Step 2 — Calculate adjusted tax basis and taxable gain
Your taxable gain equals the amount realized minus your adjusted tax basis. Adjusted basis generally equals what you paid for the asset or your original investment, plus capitalized improvements, minus allowable depreciation and previous dispositions. Keep detailed records of capital expenditures and depreciation schedules to support basis calculations.
Example: Sale price $600,000, adjusted basis $400,000. Gross gain = $200,000. If selling expenses (commissions, legal fees) are $30,000 and deductible against the amount realized, taxable gain reduces to $170,000 (assuming applicable rules for allocation and characterization).
Step 3 — Allocate the purchase price and understand character of each component
For asset sales the purchase price should be allocated among classes (inventory, equipment, real estate, intangible assets, goodwill). The allocation matters because:
- Ordinary income items: inventory and depreciation recapture on depreciable property can be taxed at ordinary rates.
- Capital gain items: goodwill and certain capital assets typically qualify for long-term capital gain if held more than one year.
The IRS treats allocation seriously: many buyers and sellers execute IRS Section 1060 allocation statements for asset sales (often called an 8594 allocation for asset acquisition by buyer filing Form 8594). Matching allocations between buyer and seller makes audits less likely.
Step 4 — Recognize special rules and exceptions
- Depreciation recapture (Sections 1245 and 1250): When you sell depreciable business property for more than its adjusted basis, some of that gain may be taxed as ordinary income to the extent of prior depreciation claimed (IRS Pub. 544; Form 4797 instructions).
- Qualified Small Business Stock (QSBS) — Section 1202: If you’re selling C corporation stock and qualify, you may exclude up to $10 million (or 10x basis) of gain if stock meets QSBS rules and you held it >5 years. QSBS rules are technical; confirm eligibility with counsel.
- Like-kind exchanges (Section 1031): Since 2018, 1031 exchanges are generally limited to real property. Personal or intangible business assets no longer qualify for non-real-estate like-kind deferral. (See IRS guidance on like-kind exchanges.)
Step 5 — Consider deal mechanics that affect tax timing
- Installment sale (Form 6252): Spreading payments over time can defer some tax into future years under an installment sale, but interest and depreciation recapture rules can limit benefits.
- Qualified stock sale vs. asset sale timing: A closing date late in the year versus early next year can shift income between tax years and affect marginal rates and AMT/NIIT exposure.
Step 6 — Claim selling expenses and closing costs correctly
Typical deductible selling expenses include broker commissions, legal/accounting fees directly linked to the sale, advertising, and due diligence costs. For asset sales, many closing expenses reduce the amount realized rather than being deductible separately; for stock sales, direct selling expenses typically reduce amount realized. Keep itemized invoices — auditors look for contemporaneous documentation.
Step 7 — Reporting the sale to the IRS and state tax authorities
Common IRS forms used in business sales:
- Form 4797, Sales of Business Property — used to report gains from the sale of business property and to handle depreciation recapture. (See Form 4797 instructions and IRS guidance.)
- Schedule D (Form 1040) and Form 8949 — for reporting capital gains and losses for individuals; some sales of business assets that qualify as capital assets will flow to Schedule D/8949.
- Form 6252 — for reporting installment sales and calculating taxable portions in each year.
- Form 8594 — Asset Acquisition Statement (used by buyer and seller to report allocation in an asset sale).
- Business tax returns: the entity’s final returns (Form 1120, 1120-S, or Form 1065) must reflect the sale as well, including adjustments to income and basis.
File state tax returns as required; state tax treatment of gains and depreciation may differ significantly from federal rules. Many states follow federal definitions but watch for state-specific rates, exclusions, and filing deadlines.
Reporting workflow and audit readiness
- Prepare a sale folder: valuation report, purchase agreement, allocation schedules, closing statements, invoices for selling expenses, depreciation schedules, and bank statements showing escrow and disbursements.
- Coordinate buyer/seller allocations: use Form 8594 where applicable so buyer and seller reports align.
- Make estimated tax payments if you expect significant gain to avoid underpayment penalties; consult Form 1040-ES guidance for individuals and estimated tax rules for entities.
Common mistakes I see and how to avoid them
- Underestimating the tax bite by ignoring depreciation recapture. Solution: separate recapture estimates from capital gain projections.
- Failing to model both asset and stock sale outcomes. Solution: run both scenarios early and use allocation leverage in negotiations.
- Weak documentation for basis or selling expenses. Solution: collect invoices, contracts, and depreciation schedules before closing.
Practical planning strategies
- Engage a transaction CPA and a business attorney before signing the LOI. Early involvement preserves options.
- Consider payment structure: an earnout or installment sale can bridge valuation gaps and spread tax.
- Look for tax-efficient reinvestment options. If you’re selling to fund retirement or a new enterprise, plan estimated taxes and cash flow for post-sale obligations.
Where to get authoritative guidance and next steps
- IRS — Sale of a Business (overview) and forms pages (Form 4797, Form 6252, Form 8949). See IRS.gov’s Sale of a Business resources for federal rules (IRS).
- SBA — practical steps for selling a business (Small Business Administration) for non-tax transaction planning (SBA.gov).
Further reading on FinHelp:
- Tax Checklist When Selling a Side Hustle or Microbusiness — a compact checklist for smaller sellers (FinHelp).
- Capital Gains — detailed coverage of capital gain rates, thresholds, and planning techniques (FinHelp).
- Transferring Business Ownership Smoothly: Buy-Sell and Gifting Options — estate and succession considerations when transferring or selling (FinHelp).
(Internal links: Tax Checklist When Selling a Side Hustle or Microbusiness: https://finhelp.io/glossary/tax-checklist-when-selling-a-side-hustle-or-microbusiness/; Capital Gains: https://finhelp.io/glossary/capital-gains/; Transferring Business Ownership Smoothly: https://finhelp.io/glossary/transferring-business-ownership-smoothly-buy-sell-and-gifting-options/)
Final reminders and professional disclaimer
This article outlines common tax steps for selling a business and cites federal guidance, but every transaction is unique. In my practice over 15 years I’ve seen thoughtful pre-sale planning materially reduce tax cost and post-closing risk. Consult a qualified CPA and tax attorney who can review your entity type, valuation, and contract language before you close. This content is educational and does not replace individualized tax or legal advice.
Authoritative sources: IRS — Sale of a Business (https://www.irs.gov/businesses/small-businesses-self-employed/sale-of-a-business); IRS forms pages (Form 4797, Form 6252, Form 8949); SBA — 10 Steps to Selling Your Business (https://www.sba.gov/article/2020/mar/10-steps-selling-your-business).
