Selling your business is one of the largest financial events of your life, and how the deal is structured determines whether the IRS takes a modest or very large share of the proceeds. Buyers and sellers often have opposite tax interests, making deal structure as important as purchase price.
What Is an Asset Sale?
In an asset sale, the buyer purchases individual business assets. The seller's ownership interest stays out of the transaction. The parties agree on a purchase price and allocate it among seven asset classes under Section 1060, which determines the tax character of each piece of the seller's gain.
Not all gain is treated equally:
- Inventory and accounts receivable produce ordinary income, taxed at rates up to 37%.
- Equipment and machinery (Section 1245 property): depreciation previously claimed is recaptured as ordinary income; any additional gain above original cost is capital gain.
- Real estate: depreciation recapture up to the prior amount is taxed at 25% (unrecaptured Section 1250); remaining appreciation is long-term capital gain.
- Goodwill and going-concern value: if held more than one year, this is long-term capital gain taxed at 0%, 15%, or 20%, plus the 3.8% net investment income tax (NIIT) if income exceeds $200,000 (single) or $250,000 (MFJ).
Because most asset sales concentrate significant gain in ordinary-income categories, sellers often pay more tax in an asset deal than in a stock deal.
What Is a Stock Sale?
In a stock sale, the buyer acquires the seller's ownership stake directly. The seller's gain equals proceeds minus the original basis in the stock or membership interest. If held more than one year, that gain is taxed at long-term capital gain rates, with no depreciation recapture and no need to allocate price among asset classes.
Buyers dislike stock sales because they inherit the company's full tax history. The basis in the acquired assets does not step up, and any historical tax liabilities remain inside the entity.
The 338(h)(10) and 336(e) elections: For S-corporations and certain subsidiaries, the parties can jointly elect to treat a stock purchase as an asset purchase for tax purposes. The buyer gets a step-up in the assets while the seller may still report a stock sale. Both parties must agree, and the economics need to reflect the buyer's benefit (usually a higher purchase price).
How the Rates Compare
For 2026, long-term capital gain rates are 0%, 15%, or 20% depending on taxable income. Add 3.8% NIIT on amounts above the thresholds noted above. Ordinary income rates run up to 37%.
The difference is often 20 to 30 percentage points. On a $2 million gain, routing half of it through ordinary-income categories (recaptured depreciation, inventory, non-competes) versus treating it all as capital gain can cost $200,000 or more in additional federal tax.
Spreading Gain with an Installment Sale
If the buyer cannot pay cash upfront, Section 453 lets sellers report gain proportionally as payments arrive, spreading the recognition across the payment period and avoiding the lump-sum hit at closing. This can keep each year's recognized gain in a lower rate bracket.
Two limits apply: ordinary income from recaptured depreciation cannot be deferred under the installment method (it is recognized in the year of sale), and selling or assigning the installment obligation after closing accelerates recognition of the remaining deferred gain.
The Section 1202 QSBS Exclusion
If you hold qualified small business stock (QSBS) in a C-corporation, Section 1202 can exclude all or part of the gain from federal tax.
For stock issued before July 5, 2025, a five-year hold produces a 100% exclusion, up to the greater of $10 million or 10 times your original basis per issuer.
The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, enhanced these rules for stock issued after July 4, 2025. The exclusion is now tiered: 50% after three years, 75% after four years, and 100% after five or more years. The per-issuer cap increased from $10 million to $15 million and is inflation-indexed going forward.
QSBS applies only to original-issuance C-corporation stock acquired in exchange for money, property, or services. S-corporations, partnerships, and LLCs do not qualify.
Earn-Outs and Non-Compete Agreements
Earn-outs paid contingent on post-closing performance are generally ordinary income when received. The IRS treats them as compensation for future services, outside the category of capital asset sale proceeds.
Amounts allocated to non-compete covenants also produce ordinary income to the seller under Section 1245. Where possible, sellers should negotiate to allocate more price toward goodwill and other capital assets and less toward non-competes.
Plan Before You Sign
Tax structure is easiest to change before the letter of intent is signed. Once a purchase agreement is drafted, renegotiating structure is far harder. Working with a CPA before going to market lets you model net after-tax proceeds under each structure, evaluate an installment sale, assess QSBS eligibility, and negotiate from an informed position.
For more on the capital gains rates that apply to business sale proceeds, see our guide to capital gains tax rates for 2026. If you hold QSBS, our detailed Section 1202 QSBS exclusion guide covers the full eligibility rules.
Have questions about selling your business or planning for the tax impact? Contact TS CPA for a free consultation. We respond within the same day.