Buying or selling a business can be thrilling. But when it’s not a simple cash deal, things get interesting—especially with taxes. One popular way to buy or sell a business is through owner financing. That means the seller acts like a bank, and the buyer pays over time. Sounds simple, right? Well, when the taxman gets involved, things can get a bit more complicated. But don’t worry—we’re going to make it all easy to digest!
What Is an Owner-Financed Acquisition?
Imagine you want to buy a nice little coffee shop. But instead of handing over a big chunk of cash, you promise to pay the owner little by little—like a loan. That’s an owner-financed purchase.
You and the seller agree on the price and terms. The seller gives you the keys, and you give them monthly payments. Sometimes this is also called a seller carry-back.
Why Choose Owner Financing?
Let’s break it down. Here are a few great reasons both buyers and sellers go for this:
- Buyers need less cash up front.
- Sellers can earn interest over time.
- The process is often faster than using a traditional lender.
But with all these benefits, there are some tax responsibilities on both sides. Let’s break it down for each party.
Tax Considerations for Buyers
1. Interest Deductions
Good news! If you’re the buyer and paying interest, you might be able to deduct that interest. It must be classified as business interest, not personal. That means if you’re buying a business asset—like equipment or a building—you could get a deduction.
Just make sure the interest rate is reasonable. The IRS doesn’t want funny business.
2. Asset Allocation Matters
When you buy a business, you’re not just buying one thing. The business usually has:
- Inventory
- Furniture and equipment
- Buildings or property
- Goodwill (basically, the name and reputation)
Each type of asset gets taxed differently. This is where IRS Form 8594 comes in. Both the buyer and the seller fill it out to show how they divided the purchase price across those categories. Get this right, or you might have the IRS knocking on your door!
3. Depreciation and Amortization
When you buy certain assets—like equipment or buildings—you can typically depreciate them over time. That means claiming a bit of the cost each year as a deduction.
For things like goodwill, you amortize it over 15 years. Again, more deductions. Woohoo!
4. Down Payment Isn’t Deductible
If you pay some money up front (called a down payment), keep in mind—it’s not a deduction. It just reduces the total loan amount. But the good news? It increases your ownership stake.
Tax Considerations for Sellers
1. Installment Sale Reporting
Here comes the fun part—breaking up the taxes. The seller doesn’t have to pay all the capital gains tax in the first year. Instead, they can report the sale as an installment sale.
You pay taxes only when you receive the payments. This can be a major relief and may keep some sellers in a lower tax bracket. You’ll use IRS Form 6252 for this.
2. Interest Income
Sellers earn interest just like a bank would. But here’s the catch: interest income is taxable.
This money is taxed as regular income, not capital gains. So it could be taxed at a higher rate. Make sure to report it using the right tax forms—usually a 1099-INT.
3. Depreciation Recapture
If the business included depreciated assets—like equipment—the IRS might want some of that depreciation back. This is called depreciation recapture.
Even if you spread out the payments, you may have to pay taxes on this part in the first year of the sale. Ouch!
4. Matching Asset Allocation
We mentioned earlier that both parties file Form 8594. Well, here’s the kicker—both sides must report the same numbers. If you don’t match, you could get audited. Nobody wants that!
Tips to Make Things Smoother
Here are a few bonus pointers to keep things smooth as butter:
- Work with a tax pro. Seriously. This stuff can get tricky fast.
- Keep good records. Every payment, every check, every form. Save it.
- Use formal agreements. Don’t rely on handshakes. Put it in writing.
- Include a default clause. What happens if the buyer stops paying?
These steps protect both the buyer and the seller. And the IRS loves paperwork!
Example Time!
Let’s say Jenny buys a flower shop from Tom for $300,000. She gives him $50,000 up front and agrees to pay the rest over 5 years at 6% interest.
Tom reports $50,000 in the first year and then reports capital gains and interest on the rest as payments come in. Jenny deducts interest and starts depreciating the shop equipment. They both fill out Form 8594 and keep things aligned. Easy peasy—but only because they planned ahead!
Final Thoughts
Owner-financed acquisitions can be a great option—for both buyers and sellers. They’re flexible, faster, and sometimes even more profitable. But tax rules don’t take a back seat. Be smart, plan early, and work with professionals when needed.
And most importantly—fill out those forms correctly!
Now go buy (or sell) that dream business like a pro.