Selling your construction business is a significant decision—one that requires careful planning and consideration of various factors. While the price of the sale is often the focal point, tax implications are equally important in shaping the final terms of the deal. The taxes you’ll face upon selling your business can have a substantial impact on your financial outcomes, so it’s crucial to understand how different tax factors can influence the structure of the sale.
In this blog, we’ll explore how tax considerations can affect the terms of your business sale, the different types of taxes involved, and strategies to minimize your tax burden. Whether you’re selling a family-owned general contracting company or a specialized trade business, understanding these elements is key to a successful exit strategy.
1. Understanding the Types of Taxes Involved in a Business Sale
When you sell a business, several types of taxes may apply. These taxes vary depending on how the sale is structured, your role in the company, and the location of the business. The two main categories to focus on are capital gains taxes and income taxes, but there are also other potential taxes to consider.
Capital Gains Tax
This is one of the most significant taxes you’ll encounter when selling your business. Capital gains tax is levied on the profit you make from the sale of your assets (the difference between the selling price and the original purchase price). In the case of selling a business, the assets might include property, equipment, inventory, or intellectual property.
- Short-term capital gains: If you’ve held the business for less than a year, the gains from the sale are taxed at your ordinary income tax rate.
- Long-term capital gains: If the business has been held for more than a year, the gains are taxed at a lower rate, often significantly lower than ordinary income tax rates.
Income Tax
Income tax on business sales can apply in a few scenarios, particularly if you’re selling shares in a corporation. When you sell the stock of your business, the proceeds are typically taxed as income, meaning the sale proceeds are added to your overall income for the year.
Depreciation Recapture
If your business owns depreciable assets (such as property or machinery), depreciation recapture might come into play. Depreciation is the process of allocating the cost of an asset over its useful life. However, when you sell an asset for more than its depreciated value, the IRS will “recapture” the depreciation you’ve taken over the years and tax the gain at ordinary income tax rates.
For construction businesses, this can be especially relevant if you’ve invested in heavy equipment, machinery, or buildings. You might face a larger-than-expected tax bill if you sell those assets at a gain.
Sales Tax
In certain jurisdictions, the sale of tangible assets such as property or equipment may trigger sales tax. Depending on the specifics of your sale, this could be a significant consideration when negotiating terms.
Also read How Deferred Maintenance Issues Affect the Sale of Your Business
2. How Sale Structure Can Influence Tax Implications
The way you structure the sale of your construction business will have a direct impact on the taxes you pay. Generally, there are two primary ways to sell a business: asset sales and stock or share sales. The structure you choose will determine which taxes apply and how much you’ll ultimately owe.
Asset Sale
In an asset sale, the buyer purchases individual assets of the business, such as equipment, inventory, real estate, and intellectual property. As the seller, you may face a combination of taxes, including:
- Capital gains tax on the sale of assets
- Depreciation recapture on certain assets
- Sales tax on tangible property
While the buyer typically prefers an asset sale because they can “step up” the value of the assets (leading to higher depreciation deductions in the future), an asset sale can be less advantageous for the seller. This is because you may be subject to higher taxes on the sale of individual assets, especially if those assets have appreciated significantly in value.
Stock or Share Sale
In a stock or share sale, the buyer purchases your shares or ownership interests in the business, and the business itself continues to operate as a legal entity. The tax implications for the seller in this type of transaction can be more favorable. Here’s why:
- The seller may pay long-term capital gains taxes on the sale of shares, which are generally taxed at a lower rate than ordinary income.
- There is typically no depreciation recapture in a stock sale.
- Any liabilities tied to the business remain with the company, not the seller personally.
However, a stock sale can be less attractive to the buyer because they inherit all the business’s liabilities and risks, including legal and financial obligations.
3. Tax Deferral Strategies for Sellers
While taxes are inevitable, there are strategies that can help reduce the immediate tax burden when selling your business. Here are some methods that can allow you to defer taxes or minimize their impact.
Installment Sales
An installment sale allows the seller to receive the proceeds from the sale over several years rather than in a lump sum. By spreading out the payments, you may be able to defer capital gains taxes over time. This can be particularly beneficial if the sale is large and you’re concerned about the impact of taxes in the year of sale.
For example, if you sell your construction business for $3 million, you could structure the deal to receive payments over several years, paying taxes only on the amounts you actually receive each year. However, installment sales are not suitable for every transaction and require careful planning.
Like-Kind Exchange
A like-kind exchange (also known as a 1031 exchange) allows you to defer taxes on the sale of certain business assets, such as real estate or heavy equipment, by reinvesting the proceeds into similar properties. This strategy is more applicable to businesses that own a significant amount of real estate or equipment, common in the construction industry.
Under a like-kind exchange, you would swap your business property for similar property, deferring taxes on the capital gains until you sell the new property. Note that a like-kind exchange only applies to real property and requires compliance with specific IRS rules.
Tax-Deferred Retirement Accounts
Another strategy involves selling part of the business or the entire company through tax-deferred retirement accounts, such as a 401(k) or IRA. If you sell assets to fund your retirement account, you may be able to defer taxes on the sale until you begin taking distributions from the account.
4. Consulting with Tax Professionals and Financial Advisors
Given the complexity of taxes in business sales, it’s essential to work closely with a tax professional, financial advisor, or business broker who understands the construction industry and its nuances. These experts can help you structure the sale to minimize tax exposure and maximize your post-sale earnings.
Tax laws can change frequently, and a professional advisor can help you navigate the intricacies of business sales and identify opportunities to reduce your tax burden. Working with an advisor can also ensure that you comply with all applicable tax laws and regulations, preventing any unexpected tax liabilities after the sale.
5. Conclusion: Plan Ahead to Minimize Tax Impact
The tax implications of selling your construction business can significantly impact the terms of your sale and the net proceeds you receive. Whether you’re selling through an asset sale or a stock sale, understanding the tax landscape is key to structuring the deal in a way that maximizes your financial outcome.
By considering tax deferral strategies, working with professionals, and carefully planning the timing and structure of the sale, you can minimize the tax impact and ensure a successful exit from your business. Take the time to plan ahead, and you’ll be in a stronger position when it’s time to sell.
Also read The Importance of Normalizing Owner Earnings Before Selling
Disclaimer:
Any information provided here is for informational purposes only. It should not be considered as legal, accounting, or tax advice. Prior to making any decisions, it’s the responsibility of the reader to consult their accountant and lawyer. N3 Business Advisors and its representatives disclaim any responsibilities for actions taken by the reader without appropriate professional consultation.
