Can Section 453 be used for the sale of a controlling interest in a private company with retained equity?

Question

Tyler Smith · Accepted Answer

Yes, Section 453 can often be used for the sale of a controlling interest in a private company, even when the seller retains a minority equity stake. This scenario is common in M&A transactions where a founder or owner sells a majority of their shares but wishes to remain involved or participate in future upside through retained equity. The key is that the transaction involves the sale of property, typically corporate stock, where at least one payment is to be received after the close of the taxable year in which the sale occurs.

The gain associated with the sold portion of the controlling interest can be deferred under Section 453. The retained equity, by definition, is not sold, so no gain or loss is recognized on that portion until it is eventually disposed of. However, structuring such a deal requires careful attention to the specific terms. The payments received for the controlling interest, if structured as an installment note, would qualify for deferral. Any immediate cash received at closing would reduce the deferred gain accordingly.

It's important to differentiate this from an 'earnout' structure, which is a contingent payment based on future performance and has its own rules, though often still compatible with Section 453. A retained equity interest, however, typically implies a continued ownership stake, not a future payment for the initial sale. Complexities can arise with valuation of the retained interest, potential recharacterization issues by the IRS if the retained interest looks more like an earnout, or if there are related party issues. Professional tax and legal advice is essential to ensure compliance and optimize the tax outcome.