Can a Section 453 installment sale be used to sell a business owning depreciable property to a related party?

Question

Tyler Smith · Accepted Answer

Using a Section 453 installment sale to sell a business that owns depreciable property to a related party presents specific challenges and limitations. Under Internal Revenue Code Section 453(g), installment sale treatment is generally not allowed for the sale of depreciable property between related persons. The purpose of this rule is to prevent related parties from achieving a 'basis step-up' for depreciation deductions for the buyer, while the seller defers gain, essentially creating a tax advantage for the related group as a whole. In such transactions, all payments to be received are treated as received in the year of the disposition, meaning the seller must recognize all gain in the year of sale, even if they haven't received cash.

'Related persons' for this purpose are broadly defined and include, but are not limited to, an individual and a corporation in which the individual owns more than 50% of the stock, two corporations that are members of the same controlled group, or a partnership and a person owning more than 50% of the capital or profits interest in the partnership. There is a limited exception if the seller can establish to the satisfaction of the Secretary that the avoidance of federal income tax is not one of the principal purposes of the disposition. However, this exception is difficult to meet and rarely applies. Therefore, sellers considering such a transaction must be aware that traditional Section 453 deferral benefits will likely not apply to the portion of the sale attributable to depreciable property when dealing with a related party. Careful planning and professional advice are crucial to navigate these complex rules.