How does Section 453 interact with the sale of a business owning depreciable property to a related party?

Question

Tyler Smith · Accepted Answer

Section 453 contains specific anti-abuse rules designed to prevent sellers from deferring gain on the sale of depreciable property to a related party. Generally, if a seller sells depreciable property to a related person on an installment basis, the seller cannot defer the gain. Instead, all payments received or deemed received are treated as received in the year of sale, meaning the entire gain is recognized upfront, even if actual cash payments are spread over time.

A related person for these purposes is broadly defined and includes a spouse, siblings, ancestors, lineal descendants, and entities where there is more than 50% common ownership. The rationale behind this rule is to prevent taxpayers from using installment sales to related parties to get a depreciation step-up in basis for the buyer, while the seller defers their gain.

There is an exception if the seller can establish to the satisfaction of the IRS that the avoidance of federal income tax was not one of the principal purposes of the sale. However, meeting this exception is often challenging. Therefore, when contemplating a business sale involving depreciable assets to a related party, it is critical to consult with a tax advisor to understand the immediate tax recognition implications and explore any potential alternative strategies or exceptions, as the deferral benefits of Section 453 are usually unavailable in these scenarios.