Business Liquidation
Model a tax-optimized business sale through one-time or installment structure, capturing depreciation recapture (ordinary), capital gain (LTCG), and interest income, with proceeds reinvested in the owner's taxable account.
How it works
Business Liquidation models the sale of a business in a specified year. The strategy decomposes the transaction into three taxable components — depreciation recapture (ordinary income), capital gain (long-term), and interest income (installment only) — and routes net proceeds into the owner's taxable account at 100% cost basis. Two sale structures are supported: a one-time sale (all events in the sale year) and an installment sale (capital gain and interest spread across multiple years using the gross profit percentage method).
1. Choose Sale Structure (One-Time vs. Installment)
One-time sale recognizes all gain in the sale year. Installment sale spreads capital gain over the payment period using a gross profit percentage; interest accrues on the declining balance. Depreciation recapture is always recognized in year 1 — even in installment sales — because IRC §453(i) and Sec. 1245/1250 require ordinary recapture in the year of sale.
Gross Profit % = (Business Value − Basis) ÷ Business Value Taxable Gain per Installment Payment = Annual Payment × Gross Profit %
Example: $1M sale price, $300k basis, 5-year installment: Gross Profit % = 70%. Each $200k annual payment recognizes $140k LTCG. Plus interest on declining principal.2. Recognize Depreciation Recapture (Year 1)
If the business has accumulated depreciation, the recapture amount is taxed as ordinary income in the sale year — regardless of whether the sale is one-time or installment. Cannot be deferred.
Recapture = min(Accumulated Depreciation, Total Gain)
Example: $50k accumulated depreciation on equipment → $50k ordinary income in year 1, taxed at marginal rate (e.g., 24% MFJ = $12,000).3. Recognize Capital Gain
Capital gain equals total gain minus depreciation recapture. One-time sale: full gain in year 1 at LTCG rates (0% / 15% / 20% + NIIT 3.8% if applicable). Installment sale: gain recognized proportionally with each payment.
Total Gain = Sale Price − Basis LTCG = Total Gain − Depreciation Recapture
Example: $1M sale, $300k basis, $50k recapture: $700k total gain → $50k ordinary + $650k LTCG. At 15% LTCG = $97,500.4. Recognize Interest Income (Installment Only)
Installment sales accrue simple interest on the declining principal balance. Interest is ordinary income in the year received. Stratum applies a fixed interest rate entered in the strategy editor.
Year N Interest = Outstanding Balance × Interest Rate Outstanding Balance decreases as principal payments are received
Example: $1M sale, 5-year installment, 5% interest: Year 1 interest ≈ $50k; Year 2 ≈ $40k; Year 5 ≈ $10k.5. Route Proceeds to Owner's Taxable Account
Net cash proceeds (after-tax) are added to the owner's taxable account at 100% cost basis (no embedded gain). This improves the account's overall basis ratio. The Owner field (client / co-client / joint) directs proceeds to the correct account; for single clients it defaults to 'client'.
Example: $1M one-time sale, $200k total tax → $800k contributed to taxable account at 100% basis. The new contribution dilutes any embedded gain in the existing balance.
Real-world context
Why Depreciation Recapture Cannot Be Deferred
IRC §453(i) carves out depreciation recapture from installment sale treatment — it must be recognized in full in the sale year. The rationale is that depreciation deductions previously offset ordinary income at marginal rates; allowing recapture to spread over years would let the seller permanently shelter ordinary income at lower future rates. This rule often surprises clients who expect installment sales to defer ALL tax — Stratum's report makes this explicit on the year-1 line.
IRS reference: IRC §453(i); §1245(a); §1250(a)
Installment Sale vs. One-Time Sale Trade-off
Installment sales spread capital gain recognition, often keeping the seller below the 20% LTCG bracket and the 3.8% NIIT threshold in any single year. Trade-offs: (1) buyer credit risk, (2) interest rate may not keep pace with inflation, (3) §453A interest charge if the deferred amount exceeds $5M, (4) accelerated recognition if the note is pledged as collateral. For sellers in the 15% LTCG bracket already, the deferral benefit is smaller — focus on whether installment payments improve cash-flow planning.
Owner Field for Married Couples
When both spouses have taxable accounts, the Owner field (client / co-client / joint) directs proceeds to the correct account. This matters for basis-ratio calculations, future RMD calculations on inherited accounts, and survivor account-balance projections. For single clients, the field defaults to 'client' and is hidden in the editor.
Basis Ratio Improvement
Sale proceeds enter the taxable account at 100% cost basis (newly contributed dollars). This dilutes any embedded gain in the existing balance, lowering the effective basis ratio. Combined with the proceeds-driven balance increase, this often produces years of improved tax efficiency on subsequent withdrawals — visible in the Strategic case's effective tax rate trend in the Summary Tab.
What drives the result
Determines when the depreciation recapture and (for one-time sales) capital gain are recognized. Choose a year with bracket headroom to avoid pushing into 32%+ ordinary or 20% LTCG / 3.8% NIIT brackets.
$700k LTCG in a year with $200k other income: total $900k pushes MFJ into 20% LTCG + 3.8% NIIT. Same sale in a year with $50k other income: stays in 15% LTCG.
Higher basis reduces total gain dollar-for-dollar. Includes original purchase price, improvements, and any non-deducted contributions to the business.
$1M sale: basis $200k → $800k gain. Basis $400k → $600k gain. $200k more basis saves ~$30k LTCG tax.
Recharacterizes that portion of the gain as ordinary income (year 1). Higher accumulated depreciation means more ordinary recognition and less LTCG.
$700k gain, $50k depreciation: $50k ordinary + $650k LTCG. $200k depreciation: $200k ordinary + $500k LTCG — at 24% ordinary vs. 15% LTCG, the recharacterization costs ~$13.5k more.
Installment spreads capital gain across the payment period; recapture stays in year 1. Useful for clients who would otherwise breach LTCG bracket boundaries or NIIT thresholds.
$700k LTCG one-time: 20% bracket + NIIT = ~$166k. Same gain spread over 5 years (~$140k/year): stays in 15% bracket = ~$105k total — saves $61k.
Routes net proceeds to the correct taxable account (client / co-client / joint). Affects basis-ratio calculations and future withdrawal planning. Field is hidden for single clients.
Married couple: Spouse-owned business sale routes $800k proceeds to spouse's taxable account, not the joint account. Affects survivor planning if joint life expectancies differ.
Assumptions
- Owner has held the business long enough to qualify for long-term capital gain treatment (>1 year)
- Depreciation recapture rate equals the owner's marginal ordinary tax rate in the sale year
- Installment sale interest accrues at the rate entered in the strategy editor — Stratum does not enforce the IRS Applicable Federal Rate (AFR) minimum
- Buyer is creditworthy — Stratum does not model default risk or interest forgiveness
- Sale price represents fair market value; no related-party adjustment under IRC §453(g)
Limitations
- Does not model §1202 Qualified Small Business Stock (QSBS) gain exclusion
- Does not model §1031 like-kind exchange or §1045 rollover treatment
- Does not model §453A interest charge on large installment receivables (over $5M)
- Does not model state-specific business sale tax treatment beyond the flat state rate
- Does not model goodwill amortization recapture separately from §1245/1250 recapture
- Does not model installment sale acceleration (e.g., pledging the note as collateral)
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Related
This page explains how Stratum models this calculation. It is educational material for financial professionals, not tax or legal advice, and tax law changes. Verify current figures against primary IRS sources before relying on them with a client.