An installment sale is another option where you receive payments for your business over time, instead of in one lump sum. This allows you to defer some of the tax on the gain to later tax years, potentially taking advantage of lower tax brackets. It could also help avoid some state taxes if you stay below a certain income threshold. On the other hand, there's a risk that you might not receive the full payment, and you are exposed to liquidity and market risks. Also, as a seller you can generate additional interest income from the principal valuation amount and possibly attract more buyers.
An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. Section 453 lets you report eligible gain as you collect the principal. Each payment has three pieces: return of basis, taxable gain, and interest.
The installment method does not cover everything. Inventory of personal property does not qualify. You report that gain in the year of sale, even if the buyer pays later. Depreciation recapture under sections 1245 and 1250 is ordinary income in the year of sale, whether or not you received cash. Only the gain above recapture can be deferred. Sales of publicly traded securities do not qualify. You can elect out and report all eligible gain in the year of sale.
The tax benefit is timing. Spreading gain can keep you in a lower federal bracket in any one year. It can also keep California taxable income under the $1 million Behavioral Health Services Tax line, or under another state's cliff, if the numbers work. Interest on the note is ordinary income as you receive it.
The commercial tradeoff is credit risk. If the buyer defaults, you may have already paid tax on recapture and inventory in year one, and you still have to collect. A pledge of the installment note as security for your own borrowing can accelerate remaining gain. Related-party sales of depreciable property have tighter limits.
A seller note in an M&A deal is often an installment obligation. Price it with interest, security, and a clear allocation between inventory, recapture property, and capital assets. File Form 6252 for the years you receive payments.