Tax Tips That Matter in Business Transactions

Imagine you’ve spent the last 30 years building a successful business. It’s your life’s work. Now you’re ready to sell, step away, and transition into retirement. At first glance, it may seem simple—you sell the business, collect the proceeds, and move on to the next chapter. But in reality, there are important tax consequences and planning considerations that can significantly impact how much of your life’s work you actually keep.

For example, remember the tax benefits you received over the years from depreciating furniture, equipment, and real estate? When you sell the business, a portion of those prior deductions can be “recaptured” and taxed as ordinary income, often at higher rates than capital gains.

Without proper planning, these surprises can materially reduce your after-tax proceeds. Thoughtful advance planning can help make the transition smoother, more efficient, and ultimately more rewarding.

What is depreciation recapture?

Depreciation recapture is a tax rule that comes into play when you sell a business asset for more than its adjusted basis—essentially, its original cost minus the depreciation you’ve claimed over time.

When this happens, part of your gain is “recaptured” and taxed at ordinary income rates (as high as 37%) rather than the more favorable long-term capital gains rate (which tops out at 20%). That difference can significantly reduce the net proceeds a business owner keeps after a sale.

Depreciation recapture most often applies to assets such as equipment and machinery, office furniture, vehicles, commercial real estate, leasehold improvements, software, and certain intangible assets.

A key decision: asset sale vs. entity sale

Depreciation recapture can meaningfully affect your tax bill, especially in an asset sale, where individual business assets are sold instead of the business entity. Here’s why:

• In an entity sale, the buyer purchases the company itself, including its existing liabilities. Depreciation recapture may be less direct than in an asset sale, but the tax outcome can still be affected by entity type, pass-through rules, and special elections.
• In an asset sale, the buyer purchases specific assets free and clear, and the seller typically retains prior liabilities. In addition, depreciation recapture is often a more direct tax issue because the underlying depreciated assets are being sold.

If recapture is overlooked, or if the sale price isn’t allocated properly across different types of assets, the result can be a much higher tax burden, greater scrutiny by the IRS, and the potential for penalties and compliance issues.

Understanding how deal structure and recapture interact can help business owners plan more thoughtfully and avoid unwelcome tax surprises.

Capital gains vs. ordinary income: the role of recapture

Not all gains from a business sale are taxed equally:

• Capital gains (up to 20%) apply to the sale of long-term assets like goodwill or business equity.
• Ordinary income (up to 37%) applies to gains stemming from depreciation recapture on equipment, buildings, and other depreciated assets.

This means a portion of your sale proceeds—sometimes a substantial portion—may not qualify for the lower capital gains rate. Knowing which assets trigger recapture and structuring the deal accordingly can help reduce your tax bill.

Many business owners assume that selling a business automatically triggers both the 20% long-term capital gains tax and the additional 3.8% net investment income tax (NIIT). But that isn’t always the case.

If you actively manage your business and sell an interest in an S-Corporation or partnership, the gain is often treated as active business income. In some cases, this means the 3.8% surtax may not apply, and you pay only the standard capital gains rate.

With the right planning, the surtax can often be reduced or avoided entirely by using strategies such as installment sales, the strategic use of trusts, or structuring the sale to reduce income above surtax thresholds.

The key is ensuring that the sale isn’t treated like passive investment income.

Capital gains, estate, and gift taxation

Of course, income tax is only part of the picture. For many owners, the way business interests are transferred before or during a sale can also affect estate and gift tax outcomes. While long-term capital gains generally receive more favorable treatment than short-term gains, estate and gift taxes may also shape how a business owner chooses to transfer wealth.

For 2026, the federal estate tax exemption is $15 million per individual and $30 million per married couple, with amounts above those thresholds generally taxed at 40%. The annual gift tax exclusion is $19,000 per recipient, or $38,000 for married couples who elect to split gifts. Gifts above those amounts generally require a gift tax return and reduce the lifetime exemption, even if no tax is immediately due.

For owners with significant wealth, this makes pre-sale planning especially important, because the structure and timing of a transaction can influence both after-tax proceeds and the efficient transfer of wealth.

Strategies to help minimize income and capital gains taxes

Sophisticated approaches—such as Enhanced Direct Indexing—can intentionally generate tax losses by creating long/short positions around an index. These losses can then be used to offset future capital gains, including gains from the sale of a business.

Owners may also reduce taxes by transferring ownership ahead of a sale using annual exclusion gifts, lifetime exemption gifts, or Intentionally Defective Grantor Trusts (IDGTs). An IDGT allows business interests to be moved out of your taxable estate while still having income taxed to the grantor, making it a powerful wealth-transfer strategy.

The bottom line

Nearly every decision you make when preparing to sell your business carries tax implications. Understanding the rules and applying the right strategies can mean the difference between unnecessarily giving up substantial amounts  in taxes and keeping more of what you’ve spent a lifetime building.

Before moving forward with a sale, work closely with your Corient Wealth Advisor to identify strategies aligned with your business, personal goals, and long-term financial plan.

Sources:

• https://www.heritagelawwi.com/depreciation-recapture-in-business-sales
• https://flextcg.com/asset-sale-or-entity-sale/

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