Business owners who sell a business, assets held or used in their business, or real estate used in their business operations can face significant capital gain taxes. These capital gain taxes due from the sale of your company, assets or real property can be minimized or even eliminated with the proper tax deferral or tax exclusion planning in conjunction with your legal and tax advisor.
There are numerous tax deferred and/or tax exclusion strategies available for the sale of businesses, assets and real estate. It is critical that careful tax planning be a priority in order to properly deal with the potential capital gain taxes that will be generated by the sale of your property.
The 1031 Tax Deferred Exchange May Not Be Suitable
Owners of real or personal property, such as a business interest, assets used in a business or real property that have been held for rental, lease, investment or used in a trade or business, frequently structure tax-deferred exchanges pursuant to Section 1031 (“Section 1031″) of the Internal Revenue Code (“Code”) in order to defer the payment of their taxable gains.
However, tax-deferred exchanges pursuant to Section 1031 are not always feasible, suitable nor appropriate for taxpayers when they are selling their company, assets used in their company or real property used in their business operation.
Section 1031 Exchange transaction structures require business or property owners to exchange equal or up in net sales value by acquiring one or more replacement properties that are of like-kind. Locating suitable replacement properties to be acquired as part of the Section 1031 Exchange in order to replace the relinquished property (business) can be extremely challenging, very stressful, and virtually impossible in some cases.
The taxpayer may have absolutely no wish to reinvest his or her net sale proceeds into another business operation of like-kind, or any kind, for that matter. Taxpayers may just wish to “cash out” and pay their taxes.
Taxpayers may have reached a point in their life when they merely wish to sell, cash out, pay the taxes, and absolutely not reinvest in another business, assets or real estate. They may not even want to see another business as long as the live. Some taxpayers may opt to sell and pay their capital gain taxes in the current year, but many would prefer to implement some kind of tax deferral or tax exclusion strategy that would allow them to defer the payment of their taxable gains over a period of time of their choosing rather than get hit with them all in the year of sale.
Deferring Capital Gain Taxes Without a 1031 Exchange
There are a number of tax deferred and tax exclusion strategies available that a taxpayer can use to defer the payment of taxable gains, so it is important that the taxpayer meet with his or her tax advisor to review all of their tax strategies. The following are the two most common tax-deferral strategies available for the sale of businesses, assets used in your business or real estate:
Seller Carry Back Note (Seller Financing)
The taxpayer could structure the sale of his or her business operation by carrying back a note, which is often referred to as seller financing or a seller carry back note. Seller financing is merely an installment note or promissory note where the buyer of the business entity or assets/property makes periodic payments to the seller. Depreciation recapture taxes, if any, are due and paid in the year the business, assets or real estate were sold. The capital gain taxes are partially or fully deferred over the term of the note and are taxed as principal loan payments are made to the taxpayer.
The installment note or promissory note strategy has positive and negative features. The obvious positive is that you can sell your business, asset or property and defer the payment of your taxable gains by structuring a seller carry back note.
However, the risk of buyer default on the installment note is a considerable negative. The process to foreclose or otherwise take back the business or asset/property can consume significant amounts of time and money and the business, asset or property may have been irreparably damaged during the buyer’s ownership and management.
Deferred Sales Trusts or DSTs
Deferred Sales Trusts or DSTs are highly effective tax-deferred strategies, similar to the installment sale or seller carry back note, but without the risk of buyer default. The Deferred Sales Trust receives all of the net cash proceeds from the buyer at the closing of the sale transaction, thus removing the buyer from involvement in the Deferred Sales Trust transaction. Deferred Sales Trusts can provide other great tax and estate planning strategies as well.
Deferred Sales Trusts are drafted pursuant to Section 453 of the Internal Revenue Code, just like the installment sale note or promissory note in seller financing. The capital gains tax is realized or triggered, but not recognized or paid, because it is deferred over a period of time selected by the taxpayer.
The capital gains tax liability is partially or fully tax deferred over the term of the installment sale note created within the Deferred Sales Trust account, which you will negotiate in advance directly with the Trustee of the Deferred Sales Trust.
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