Categories
Business

Understanding Why Recapture Tax is Paid in Full at Closing — Even with a Seller Financing Note

Understanding Why Recapture Tax is Paid in Full at Closing — Even with a Seller Financing Note

When selling a business or investment property, many owners are surprised to learn that recapture tax on depreciation is due in full at closing, even if part of the deal involves seller financing. This detail can have a major impact on your cash flow and tax liability — and ignoring it can lead to expensive surprises come tax season.

What Is Recapture Tax?

Over the course of owning a depreciable asset — such as real estate, equipment, or fixtures — you likely took depreciation deductions each year to reduce your taxable income. While depreciation provides valuable tax savings during ownership, the IRS eventually wants that money back when you sell.

This is where depreciation recapture comes in. When the asset is sold, the IRS “recaptures” the total depreciation taken, taxing it at a higher rate — up to 25% for real estate. It applies to the portion of your gain attributable to depreciation, not the total capital gain.

The Seller Financing Misconception

Many sellers assume that if they finance part of the sale through a seller note (installment sale), they can spread their tax liability — including recapture tax — over time as they receive payments. While that may be true for capital gains, it’s not true for depreciation recapture.

The IRS treats depreciation recapture differently. Under Section 453 of the Internal Revenue Code, recapture income is not eligible for installment sale treatment. That means it must be reported — and taxes paid — in the year of the sale, regardless of how much of the sales price was actually collected at closing.

An Example

Let’s say you sell a commercial property for $1 million. Your adjusted cost basis, after years of depreciation, is $600,000 — including $250,000 in depreciation taken. The gain is $400,000, of which $250,000 is subject to recapture tax, and the remaining $150,000 is a capital gain.

You agree to seller-finance 50% of the deal, receiving only $500,000 at closing. Even though you only pocket half the sale proceeds, you’ll owe taxes on the full $250,000 of depreciation recapture in the year of sale, which could be up to $62,500 in tax (25%).

You’ll pay this recapture tax out-of-pocket, potentially even before collecting all the payments due from the buyer over time. This can create serious cash flow strain, especially if you haven’t planned for it.

Planning Ahead

For sellers considering seller financing, it’s critical to work with your accountant and broker to estimate tax exposure upfront. In many cases, sellers increase the down payment requirement or adjust the terms of the seller note to help cover their immediate tax obligations.

Alternatively, if the asset qualifies, consider using a 1031 exchange (for real estate) to defer the recapture tax entirely — but remember, this strategy only applies if you reinvest in like-kind property and follow strict IRS timelines.

Final Thoughts

Recapture tax is often the most overlooked and misunderstood tax consequence of selling a business or investment property. The fact that it must be paid in full at closing, even if the buyer is paying in installments, can drastically affect your net proceeds and tax liability.

Don’t let depreciation catch you off guard — proper tax planning is essential to maximizing the return on your sale. Would you like this post turned into a branded flyer or web article?

You said:
Write a 500 word blog on 1031 exchange and seller note. What portion can be invested in the 1031
ChatGPT said:

1031 Exchange and Seller Financing: What Portion Can Be Reinvested?

A 1031 exchange is one of the most powerful tools available to real estate investors looking to defer capital gains taxes and depreciation recapture when selling an investment property. However, when a deal involves seller financing (a seller note), many sellers and even professionals are confused about how that affects the exchange and what portion of the proceeds can be reinvested.

The short answer: Only the cash and equity actually received at the time of closing — not the note — can be used to fund a 1031 exchange.

Let’s break this down.


What Is a Seller Note?

A seller note (or seller financing) is when the seller agrees to receive a portion of the sale price over time, acting as the lender. The buyer gives a promissory note and pays back the principal with interest on an agreed schedule. While this can be an effective tool to facilitate deals, it introduces complications for tax planning — especially in a 1031 exchange.


What Is a 1031 Exchange?

A Section 1031 exchange allows an investor to sell a property and reinvest the proceeds into another “like-kind” investment property, deferring both capital gains and depreciation recapture taxes. To qualify, the seller must follow strict timelines and reinvest all net proceeds and debt relief into the replacement property.


How a Seller Note Affects the 1031

In a 1031 exchange, the IRS allows only the proceeds received and held by a qualified intermediary (QI) to be reinvested. If part of the sale proceeds is tied up in a seller-financed note, that portion cannot be used to buy the replacement property, and is not eligible for deferral under Section 1031.

This means the amount of the seller note is treated as “boot” — a portion of the sale that does not qualify for deferral — and is taxable in the year of the sale or as payments are received, depending on how it’s structured.


Example Scenario

Let’s say you sell a commercial building for $1 million:

  • $700,000 is paid at closing and transferred to a qualified intermediary

  • $300,000 is carried by the seller as a note payable over 5 years

Only the $700,000 can be used in the 1031 exchange. The $300,000 seller note is considered boot. Even though you haven’t received that money yet, the IRS treats it differently than cash because it’s not reinvested into the replacement property.

You may be able to structure the note to qualify for installment sale treatment, allowing you to spread the taxes on the boot over time — but this applies only to capital gains, not to depreciation recapture.


Best Practices

If you’re planning a 1031 exchange and want to offer seller financing, consider these tips:

  • Limit the size of the seller note to reduce taxable boot

  • Sell the note to a third party and reinvest those proceeds in the exchange (advanced strategy)

  • Work with an experienced QI and tax advisor to structure the deal properly


Final Thought

A 1031 exchange and seller financing can coexist, but only the cash proceeds transferred to the qualified intermediary can be reinvested tax-deferred. If part of your sale includes a seller note, be prepared for potential tax liability on that portion. Careful planning upfront ensures you maximize the benefits and avoid surprises.

Categories
Business

Understanding Beginning and Ending Inventory in Relation to Cost of Goods Sold.

If you’re running a product-based business, one of the most important financial metrics you’ll encounter is Cost of Goods Sold (COGS). COGS refers to the direct costs of producing the goods that a company sells during a specific period. Accurately calculating COGS is essential not only for determining profitability but also for understanding inventory performance, tax implications, and overall financial health.

At the heart of the COGS calculation are two often-overlooked components: Beginning Inventory and Ending Inventory.

What is Beginning Inventory?

Beginning inventory is the value of the inventory that a business has on hand at the start of a financial period. This inventory includes all goods that are available for sale, whether finished or in-process, and is essentially the leftover stock from the end of the previous accounting period.

For example, if you closed last year with $25,000 worth of inventory still on your shelves, that amount becomes the beginning inventory for the new year.

What is Ending Inventory?

Ending inventory, on the other hand, is the value of goods remaining at the end of the financial period. It is determined through physical counts or inventory management systems and reflects what hasn’t yet been sold.

Ending inventory will become next period’s beginning inventory, and its accuracy is critical because it directly affects both your COGS and your reported profit.

The COGS Formula

The relationship between inventory and COGS can be summarized by the following formula:

COGS = Beginning Inventory + Purchases During the Period – Ending Inventory

Let’s break this down:

  • Beginning Inventory: What you started with.
  • Purchases: New inventory bought or produced during the period.
  • Ending Inventory: What’s left over.

What you’ve sold during the period is everything you had (beginning inventory + new purchases), minus what’s still unsold (ending inventory).

Why It Matters

  1. Accurate Profit Reporting: COGS directly reduces your gross income. If your ending inventory is overstated, your COGS will be understated, and you’ll show an inflated profit. The reverse is also true.
  2. Tax Implications: Since COGS is deductible as a business expense, its accuracy affects your taxable income.
  3. Cash Flow Insight: Monitoring inventory levels helps businesses manage cash tied up in stock. Too much ending inventory may signal overstocking or slow-moving products.
  4. Business Valuation: For business buyers, brokers, or investors, inventory and COGS data provide critical insight into operational efficiency and pricing strategy.

Conclusion

Understanding how beginning and ending inventory impact your cost of goods sold is fundamental for maintaining accurate financial statements and making informed business decisions. Whether you’re preparing for tax season, seeking investment, or just looking to improve margins, take the time to track your inventory correctly—your bottom line depends on it.

Categories
Business

Why a Transition Period is Critical When Selling Your Business.

Why the Transition Period Is Critical When Selling a Business

For many business owners, selling their business is one of the most significant transactions of their life—financially, professionally, and emotionally. Whether it’s a main street business or a lower middle market company, the process doesn’t end at closing. One of the most important, yet often underestimated, elements of a successful business sale is the transition period.

A transition period is the time following the sale during which the previous owner assists the new owner in assuming control of the business. This phase can last anywhere from a few weeks to several months, depending on the complexity of the business and the buyer’s experience.

Why the Transition Period Matters

  1. Ensures Continuity and Stability

Buyers—especially first-time owners—are understandably anxious about running a business they didn’t build. The transition period provides a critical cushion that allows for a smoother handoff. Customers, employees, and vendors all benefit from seeing the outgoing owner actively supporting the transition. This continuity helps maintain operations, staff morale, and client relationships.

  1. Preserves Institutional Knowledge

Most businesses rely on a wealth of “unwritten knowledge” that resides in the seller’s head: supplier relationships, customer preferences, pricing strategies, workflow systems, and more. During the transition, the seller can transfer this knowledge, helping the buyer avoid missteps that could impact performance or profitability.

  1. Builds Buyer Confidence

The presence of the former owner during the transition boosts buyer confidence. It shows commitment to the long-term success of the business and reassures the buyer that the seller stands behind the company’s value. This confidence often translates into a faster learning curve and quicker decision-making.

  1. Protects the Value of the Sale

For sellers, the transition period can protect the sale’s value—especially if there’s a seller-financed note or an earn-out provision tied to future performance. Helping the new owner succeed improves the chances of full payment and post-sale satisfaction.

Tailoring the Transition to Fit

No two businesses—or buyers—are alike. That’s why an experienced business broker will help negotiate a transition period that fits the needs of both parties. For a small service business, a two- to four-week part-time handover might be sufficient. For larger or more technical businesses, a structured, multi-month transition with optional consulting afterward may be more appropriate.

Key Areas to Cover in a Transition Plan

  • Training on daily operations and systems
  • Introduction to key clients, vendors, and employees
  • Transfer of licenses, accounts, and contracts
  • Continued consulting or advisory support, if needed

Final Thoughts

A well-structured transition period can make the difference between a successful ownership change and a bumpy handoff that puts the business at risk. At Suncoast Business Consultants, we ensure our clients understand the strategic value of a thoughtful transition and help structure it to serve everyone’s best interests. When buyers feel prepared and supported, and sellers feel their legacy is preserved, it’s a win-win for all involved.

Ready to sell or buy a business with confidence? Contact us today to learn how our expert guidance can make all the difference.

Categories
Business

Partnering with Crexi.

See attached article about my partnership with Crexi and how it lead to closing a scrap metal recycling facility with real estate for $5,000,000.

Categories
Business

Helping Buyers and sellers from around the world!.

Suncoast Business Consultants has helped people from the following countries buy and sell businesses in South Florida in all industries and price ranges. We can refer you to the appropriate professionals such as attorneys and accountants to assist in areas of immigration, business representation, due diligence, bookkeeping and taxes.

We also provide relocation assistance. Our team of professional real estate agents can assist you in renting or buying a home.

Check out examples of closed transactions to see the variety of industries in which Suncoast Business Consultants successfully completed multiple transactions.

Sign Up

Sign Up For Our Newsletter

We will keep you informed of the best business opportunities.