Written by Evgenia V. Sheaffer, CPA, Senior Manager at Trout CPA
Business owners considering selling their business as a stock or asset sale at a gain often wonder if there is a way to minimize the tax impact in the year of sale. The good news is that if you receive at least one payment after the tax year of the sale, then the gain will be recognized when you receive each payment, therefore allowing the business owner the option to defer the gain. This method of reporting gain is called the installment method.
Note: Funds held in escrow are only considered a payment once they are released to you.
Example: The sales price for an asset sold is $30,000, and the adjusted basis of the asset is $24,000. The sales agreement is for 15 monthly installment payments.
Step 1: Calculate deferred gain (gross profit).
$30,000-$24,000=$6,000
Gross Profit = Sales Price – Adjusted Basis
Step 2: Calculate deferred gain percentage (gross profit percentage).
$6,000 / $30,000=20%
Gross Profit Percentage = Gross Profit/Sales Price
Step 3: Calculate the amount for each installment payment.
$30,000 / 15=$2,000
Installment Payment Amount = Sales Price/Number of Payments (without consideration for interest for example simplicity)
Step 4: Calculate the gain realized at the time the installment payment was received.
20% x $2,000=$400
Realized Gross Profit = Gross Profit Percentage x Installment Payment Amount