IBA Blog

  • Categories
  • Authors
  • Archives
  • How to Maximize Net Proceeds in a Business Sale

    Jun 15, 2021

    IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities.  Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog article has been provided by Jack Gruber of Ja-Mar Analytics (www.ja-maranalytics.com):

    How to Maximize Net Proceeds in a Business Sale

    It is not just how much you sell for, the important question is, how much do you get to keep?

    The discussion of increasing Capital Gains Tax (CGT) rates has been a constant drumbeat for months. It is too soon to know what the final resolution of this discussion will be. However, if you are contemplating the sale of highly appreciated assets, such as real estate, a business, a patent, private stock, or a partnership, you must assume that all the talk will ultimately result in some form of CGT increase.

    So, what will that increase look like, and how will it affect the seller of the appreciated asset? The answer to that question, unfortunately, starts with the non-sequitur “it depends”.

    Most of the conversation has focused on two areas. The first is talk coming from the White House to increase the Federal tax from 20% to 28%. There is also discussion coming from some State legislatures to add or increase the rates many states add on to the Federal rate. In Washington State, the Governor has signed into law a 7% State CGT planned to take effect January 1, 2022. This increase is for all appreciated asset sales with the exception of real estate including agricultural property. Washington has been one of only nine states not having a State CGT. As an example, here on the west coast, Oregon has 9.9% CGT, California has 13.3%, and Hawaii 11%. As previously stated, these State-sponsored CGTs are in addition to the Federal rate.

    The second tax adjustment discussion has focused on IRS Code 1031 Exchange. Since the tax and jobs act changes in 2017, the 1031 Exchange is only available as a tax deferral for appreciated real estate. The discussions started with the idea that the ‘stepped-up bases’ features of 1031 could be removed. That discussion has now expanded to include the elimination of the 1031 Exchange in total. Trying to prognosticate the possible actions of the Federal Government is an exercise with little or no merit. However, when you consider the billions of dollars that utilize the 1031 exchange, it seems a stretch to imagine a total elimination of the entire tax deferral option. Elimination of the ‘stepped-up basis’ seems a much more likely scenario.

    To expect consistency in the decisions of government is to fail to understand the basic push and pull of the political process. There are basic principles of the process which we come to rely on, however. In the arena of tax deferral regulations, one of those principles is the idea that the IRS never intended that the deferral of CGT would mean the elimination of the tax. It has been the IRS intent that the tax would always be paid, but at a later date. It is that basic principle that could lead to the elimination of the ‘stepped-up basis’ in the 1031 Exchange. Only time will tell.

    Until we know the final decisions concerning the possible increase in CGT% or the elimination of some aspects of CGT deferral options the best we can do is to be aware. This awareness can include the evaluation of our deferral options under various scenarios.

    Start with possible changes in the 1031 exchange. If the 1031 Exchange were to be eliminated, it could have a domino effect on alternative exchange deferral options. This might include the Delaware Statutory Trust (DST), and IRS Code 721 upREIT. The entwined relationship between exchange deferral options is one reason why the total elimination of the option seems improbable. But again, we are dealing with the governments decisions process which can be unpredictable.

    If the regulation change were the elimination of the ‘stepped-up basis’ of the 1031 Exchange, the change would primarily affect the estate planning aspects of the seller’s consideration. The 1031 Exchange would continue as a viable CGT deferral option, but the beneficiaries of the seller’s estate would no longer benefit from the ‘stepped-up’ appraisal value. This means the beneficiaries might have to sell the inherited asset to pay for the accumulated CGT.

    When we look at possible increases in the Federal or state CGT rates, it is primarily a math exercise. It does, however, increase the value of finding CGT deferral options that could work for a wide range of asset classes. To evaluate the possible effect on the asset seller’s tax obligation we will focus on the State of Washington as an example.

    Currently the sale of an appreciated asset, (real estate, business, patient, private stock, or partnership sale) in Washington, is a CGT rate of 23.8%. (20% Fed, 3.8% NII, 0% WA). For a $1 million net sale of a business this would result in a $238,000. CGT.

    With the proposed increases, the Washington CGT could be 38.8% (28% Fed, 3.8% NII, 7% WA). For that same $1 million business sale, the result would be $388,000. CGT. That is a 63% increase in the CGT bill. Remember that the 7% State CGT will not be included in real estate sales. However, if the sale is for real estate in Washington, there will be an additional 1.1% to 3% graduated excise tax. The proposed increases in CGT would mean a 44.1% CGT in California, 41.7% in Oregon, and 42.8% in Hawaii.

    While there is little you can do about the possible changes in the CGT regulations or possible increases, you have options. The key is to make yourself knowledgeable about the possible alternatives available for the deferral of CGT. As an example, are you familiar with IRS Code 453(A) Installment Sale with Monetization Loan?

    This option can be utilized to defer the CGT for almost every appreciated asset class. This includes real estate, business sales including LLC, C-Corp, S-Corp, and private ownership, private stock sales, partnership sales, intellectual property such as patents, and large personal asset sales such as art, jewelry, and collectibles.

    The basic structure of IRS Code 453(A) Allows you to sell your appreciated asset, receive your sales proceeds in a tax-free form at closing (less fee) and defer your tax obligation for 30 years.                              

    To illustrate the value of this type of deferral, we will use the previously mentioned $1 million net sales of a business in Washington. As we discussed the possible CGT could be 38.8%.

    Sale with NO deferral:

    38.8% CGT X $1 million net sale = $388,000 Tax, leaving the seller with $612,000.

    Sale with a 453(A) deferral:

    5% deferral Fee X $1million net sale $50,000 Fee, leaving the seller with $950,000.

    Deferral Advantage:                                                                                                                        

    $950,000 less $612,000. = An advantage of $338,000. 

    Time Value of Money equation for the 30-year deferral period.                                                    

    Invest the $338,000 deferral advantage X 5% net return X 30-year = $1,460,883.

    Now pay the CGT obligation -$388,000 Tax

    Total Deferral Advantage      $1,072,883

    The million dollars plus advantage is accomplished by investing tax dollars rather than simply paying the tax to the IRS in the year of the sale.

    If you have questions relating to the content of this article, IRS Code 453(A), or the services provided by Ja-Mar Analytics, Jack Gruber would welcome the opportunity to talk with you.  Mr. Gruber can be reached at (425) 365-7160 or jack.gruber@ja-maranalytics.com.

    IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.

    Related Articles


    Leave a Comment

    Your email address will not be published.

    Leave a Reply

    Your email address will not be published.

    More Articles by this Author

    Recent Articles

    Why 2022 is the Year to Buy a Business in the Pacific Northwest?

    Every environment creates business opportunities and challenges.  An unexpected midafternoon summer rain generates umbrella & rain poncho sale opportunities for retailers who previously purchased the now impulsively desired inventory, taxicab & Uber revenue from previously content pedestrians, and unanticipated food & beverage orders between traditional mealtimes for restauranteurs and bar owners from people attempting to…

    The Story of David Shinder (Pedag USA)

    American Dream Achieved IBA, as an approximately fifty-year old business brokerage firm serving the entrepreneurial community of the Pacific Northwest, has been uniquely positioned since before the American Bicentennial celebration of 1976 to witness and hear the stories of thousands of people who have lived the American dream through entrepreneurship creating beloved businesses by employees,…

    Why a Top Tier M&A Professional Should be Hired to Sell Your Business?

    As the President & CEO of the largest business brokerage firm in the Pacific Northwest with a double-digit team of knowledgeable, experienced, highly skilled intermediaries, a frequent conversation held with members of my team relates to the commissions we charge our clients for professional representation.  For the unfamiliar, IBA has operated for 47 years with…

    Contributing Authors

    Sign Up for Our Newsletter

    Popular Articles Delivered Directly to your inbox