CAPITAL GAINS DEFERRAL IN A BUSINESS SALE

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When selling a business, a major challenge a business owner will face is what to do with the proceeds of the sale.  After building a successful business for years, a great offer is accepted and a closing date is set.  This is not the time to learn from your accountant and attorney that loss of capital is a serious risk that should have been considered.  This article will help you look for ways to maximize your transaction proceeds when selling your business while keeping as much as possible through the use of intelligent tax planning and deal structure.  Selling the business is a good thing, but being prepared and knowing what to expect are important.

Capital gains, depreciation recapture and even income taxes may be levied against the proceeds of the sale of the business. Depending on the initial amount invested and how much the business has grown, these taxes can consume much of the sale price.  When a business is sold, the owner’s cash flow also stops, eliminating the regular income.  Without this regular income, former business owners are left with a significant gap in what they receive each month and must alter any plans or budgets accordingly.  Therefore, the amount of money that was been produced needs to be replaced.  There are many ways to put the money to work for you, but this often means accepting significant risk and investing in markets without much experience.  Inadequate returns and potential loss of capital are serious risk factors that must be considered.

The traditional business sale is a cash transaction.  It is pretty simple, as the seller is paid cash from the buyer.  Loans and other debts are paid at closing, and the remainder of the funds is given to the seller.  At this point, the seller must pay federal and state taxes on the proceeds, leaving the remainder to invest.  This drastically reduces the principle and lowers any future returns.  The stock market and other liquid investments carry very significant market risk, and the seller could lose some or all of the money.  The investments could, however, increase and earn additional money.  The greater the risk, the greater the loss or increase.  On the other hand, the seller could place the money into a guaranteed investment, such as a certificate of deposit; but the returns will drastically lag other possible alternatives.

Investing on your own requires some planning and active management of the portfolio; but more importantly, it may provide for unpredictable future income necessary to manage and care for an investor and his or her family.  Many individuals prefer to work with a financial planner to handle their investments and consider it worth the fee to have a professional with knowledge and experience.

There is a way to defer taxes on a cash sale.  The seller will accept a down payment at closing and carry a note for the balance. Payments are set up to be paid through a bank monthly or sometimes annually, depending on the size and type of business.  The seller receives financial statements and a resume from the buyer and usually requires monthly or quarterly financial statements from the business after closing.  An advantage of this type of sale is it can provide a quick closing, but the big advantage is the tax deferral.  The seller only pays taxes on the money as it is received rather than on the entire amount received from the sale of the business!  The problem can be that the buyer doesn’t make the payments promised.  Often times the business is run poorly and is no longer producing enough revenue to make the promised payments.  There is recourse in the note so that if the buyer doesn’t live up to his/her obligation, the seller can foreclose and reclaim ownership of the business.  Sometimes the business has not been run properly or the value lowers for other reasons, causing the seller to reclaim a much less valuable business.  For that reason, the seller should require a large down payment when accepting a note on a business.

The sale of a business can be challenging and difficult with several complicated aspects.  One of the most troubling issues is the manner in which capital gains and other taxes are addressed.  Be sure to work with your business broker, your attorney, and your accountant in preparation of listing your business for sale.  Remember, in a business sale the important number is how much you get to keep.

  • Author: Pat Jones
  • Title: President/Owner - Business Broker
  • Company: Pat Jones Business Brokers
  • Company Website: http://www.patjones.biz/
  • Date: January 12, 2017
  • Category: Buying a Franchise or Business
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