Overview
Selling a family business is both an emotional and financial milestone. Beyond negotiating price and transition details, taxes determine the net cash you receive and can influence how you structure the deal. In my practice advising family-owned businesses, early coordination between the owner, a CPA, and a transaction attorney consistently produces the best tax outcomes.
This article explains the common federal tax issues to evaluate, practical strategies you can consider, and pitfalls to avoid. It also links to related FinHelp resources and IRS guidance so you can dig deeper.
Key tax concepts that matter
- Adjusted basis and capital gain: Your taxable gain generally equals the sale price minus your adjusted tax basis (what you invested plus improvements, minus allowable depreciation). Capital gain rules determine whether that gain is taxed as long-term (preferable) or short-term.
- Asset sale vs. stock sale: Buyers often prefer asset purchases; sellers often prefer stock sales. The tax consequences for each party differ materially—asset sales can trigger depreciation recapture taxed at ordinary rates, while stock sales usually produce capital gains for the seller but can bring tax issues to the buyer.
- Depreciation recapture: Equipment and real-property depreciation that reduced your basis can be “recaptured” and taxed as ordinary income or at special rates (see IRS guidance). This can materially increase tax on part of the gain.
- Entity type: C corporation, S corporation, partnership/LLC, and sole proprietorships each produce different tax results on sale. For example, selling a C corporation’s assets, then distributing proceeds, can create double taxation (corporate level + shareholder level).
- Timing and income stacking: The year you recognize gain affects tax brackets, Medicare surtaxes (Net Investment Income Tax of 3.8%), and state taxes.
(For a primer on capital gains mechanics, see our Capital Gains glossary.)
How sale structure changes taxes
- Asset sale
- What it is: Buyer purchases identified business assets (equipment, goodwill, inventory, real estate).
- Seller tax result: Gain or loss reported at the entity or owner level depending on structure. Depreciation recapture under sections like 1245/1250 may convert part of a capital gain into ordinary income, increasing tax now.
- Buyer benefit: Step-up in basis for purchased assets, which creates larger deductible depreciation for the buyer.
- Stock or ownership interest sale
- What it is: Buyer purchases owners’ equity (stock, partnership interests, LLC units).
- Seller tax result: Typically taxed as capital gain on the sale of the ownership interest (if held long-term), often at preferential long-term capital gains rates.
- Buyer downside: Buyer may inherit the seller’s tax basis (no step-up for the underlying assets), affecting future depreciation and tax planning.
- Hybrid deals and allocated purchase price
- Parties often negotiate how the purchase price is allocated among asset classes—this allocation affects who pays more tax and how much tax is deferred.
Special tax rules and opportunities
- Installment sales (IRC §453): You can report gain as payments are received, spreading tax liability across years. This can reduce top-bracket exposure in a single high-income year. It is not available for certain types of gain and has limits—work with a CPA to model cash flow and tax results.
- Qualified Small Business Stock (QSBS) — Section 1202: If your business is a C corporation that issued qualified stock and you satisfy the holding period and other rules, you may exclude up to 100% of gain on sale of QSBS (subject to limitations). QSBS planning is highly technical—verify eligibility with counsel and the IRS guidance.
- Like-kind exchanges (IRC §1031): Real property used in a trade or business may qualify for deferral if reinvested in similar property; since 2018, 1031 exchanges are limited to real property. This is only relevant when the business sale includes real estate you can swap into replacement property.
- Opportunity Zones (IRC §1400Z-2): Investing capital gains in qualified Opportunity Funds can defer and potentially exclude some gains, subject to strict timelines and rules.
Authoritative IRS guidance: Selling your business (https://www.irs.gov/businesses/small-businesses-self-employed/selling-your-business) and Capital Gains and Losses (https://www.irs.gov/taxtopics/tc409) are good starting points.
Practical examples (simplified)
Example A — Asset sale with depreciation recapture
- Sale price for equipment: $300,000
- Adjusted tax basis in equipment: $50,000 (after depreciation)
- Taxable gain on equipment: $250,000
- Recapture: Much or all of that $250,000 may be recaptured as ordinary income (higher tax) rather than long-term capital gain.
Example B — Stock sale of an S-corp owner
- Sale price for owner’s shares: $1,000,000
- Owner’s basis in shares: $400,000
- Long-term capital gain: $600,000 taxed at favorable capital gains rates (subject to NIIT and state tax).
Example C — Installment sale
- Sale price: $1,000,000 paid in five equal annual payments of $200,000
- Recognize a proportional share of gain each year, potentially keeping the seller in a lower bracket and reducing overall present-value tax cost.
Who is affected and eligibility issues
- Owners and selling shareholders: Their individual tax rates, basis, and timing determine tax owed.
- Partners and minority owners: Sales of partnership interests have special rules (unrealized receivables and inventory can generate ordinary income).
- Heirs: A sale followed by estate planning can change how much heirs pay—gifting or selling to family can trigger gift tax/estate tax considerations.
- Buyers: Transaction structure changes the buyer’s future tax deductions.
Entity-specific notes
- C corporations: Watch for double taxation if assets are sold at the corporate level then distributed as dividends. Consider whether an asset sale followed by a section 336 liquidation (or other strategies) is appropriate.
- S corporations and partnerships: Sales may pass gain through to owners; careful allocation and adjustment of basis matter.
Strategies I commonly recommend (professional insight)
- Start planning 12–24 months before a planned sale. Early structuring often saves taxes and preserves value.
- Run side-by-side models: asset sale vs. stock sale, include state tax and NIIT, and model cash-flow differences.
- Consider installment sales when you want to manage tax bracket creep. Remember to model interest and present-value tradeoffs.
- Preserve and organize basis documentation: capital improvements, prior purchases, and depreciation schedules directly change taxable gain.
- Evaluate QSBS and 1031 potential early. If you might qualify for QSBS, maintain corporate formalities and document capital raises carefully.
- Use estate planning: gifting strategies, grantor-retained annuity trusts (GRATs), or step-up planning at death can reduce taxes for the family long term.
Internal resources: For background on capital gains mechanics and timing, see our Capital Gains glossary and our guide on Timing Capital Gains Around Low-Income Years.
- Capital gains primer: https://finhelp.io/glossary/capital-gains/
- Timing capital gains: https://finhelp.io/glossary/timing-capital-gains-around-low-income-years-a-practical-calendar/
Common mistakes and misconceptions
- Treating sale price as the only number that matters: After-tax proceeds are what counts. Failing to subtract future tax exposure leads to bad decisions.
- Ignoring depreciation recapture: Sellers often underestimate how much gain will be taxed at ordinary rates.
- Waiting too late to plan: Many tax-saving strategies require actions well before the closing date.
- Overlooking state taxes and the Net Investment Income Tax (3.8%): State rates can be material—consult your state tax advisor.
Frequently asked questions
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How does depreciation affect my tax bill when I sell? Depreciation lowers your basis, increasing gain. Portions describable as depreciation recapture can be taxed as ordinary income—check IRS rules on recapture.
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Is it better to sell assets or shares? It depends. Sellers often prefer stock sales for capital gains treatment; buyers prefer asset sales for the basis step-up. The right choice depends on tax modeling, buyer expectations, and negotiation leverage.
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Can I defer all taxes by using a 1031 or Opportunity Zone? 1031 exchanges apply only to real property used in business; they do not apply to stock or goodwill. Opportunity Zone investments allow deferral of eligible capital gains if reinvested properly; each program has strict requirements.
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What about family transfers instead of a sale? Gifting or intra-family sales introduce gift/estate tax and basis issues. A transfer to heirs often uses the step-up in basis at death (which can reduce future capital gains), but estate taxes may apply.
Next steps and practical checklist
- Hire a CPA with transaction experience and a business transaction attorney.
- Gather and reconcile basis and depreciation records for each asset class.
- Run side-by-side tax models for the buyer’s proposed structure.
- Consider timing, installment alternatives, and estate/gift planning.
- Negotiate allocation language in the purchase agreement—allocation affects both parties’ taxes.
Professional disclaimer
This article is educational and not personalized tax advice. Tax law is complex and changes frequently. Consult a qualified CPA and tax attorney to apply these ideas to your situation. For federal guidance, see the IRS’s Selling Your Business page (https://www.irs.gov/businesses/small-businesses-self-employed/selling-your-business) and Capital Gains and Losses (https://www.irs.gov/taxtopics/tc409).
Sources and further reading
- IRS, Selling Your Business: https://www.irs.gov/businesses/small-businesses-self-employed/selling-your-business
- IRS, Capital Gains and Losses: https://www.irs.gov/taxtopics/tc409
- IRS, Like-Kind Exchanges (Section 1031): https://www.irs.gov/likekindexchanges
- IRS, Qualified Opportunity Zones: https://www.irs.gov/credits-deductions/qualified-opportunity-zones
If you’d like a checklist tailored to your business type (C corp, S corp, or partnership), I can draft one you can share with your CPA before you begin talks with buyers.
