How Is a $700,000 Business Sale Taxed? Basis, Allocation, and Planning
Why basis, improvements, depreciation, and purchase-price allocation matter more than the headline price
A business owner who sells for $700,000 does not automatically have $700,000 of long-term capital gain. The result depends on when and how the business was acquired, post-acquisition capital improvements, depreciation already claimed, selling costs, deal structure, and how the price is allocated among inventory, equipment, goodwill, and other assets.
Why “$700,000 × 20%” is not a reliable estimate
For a federal asset sale, the IRS generally treats the business as a group of separately sold assets. A useful starting formula is:
Taxable gain = amount allocated to an asset − selling costs − that asset’s adjusted basis.
Adjusted basis starts with acquisition cost, may increase for qualifying capital improvements, and generally decreases for depreciation already allowed or allowable. Even a founder may have basis in equipment, improvements, and certain capitalized costs.
When and for how much did you acquire the business?
If you bought an existing business, locate the purchase agreement, closing statement, and Form 8594 from that acquisition. The original allocation among inventory, furniture, equipment, contracts, customer-based intangibles, and goodwill is often the starting point for today’s asset basis.
Also identify whether the current deal is an asset sale or a sale of corporate stock or LLC interests. Those structures can produce very different tax results.
Do later investments increase basis?
Some do, but not every dollar spent on the business can be counted again at sale.
| Record | Potential effect | Useful support |
|---|---|---|
| Original acquisition | Initial asset basis | Agreement, closing statement, Form 8594 |
| Major remodel or new system | May be capitalized and depreciated | Contracts, invoices, permits, payments |
| Equipment purchases | Asset basis reduced by depreciation | Fixed-asset ledger and tax returns |
| Routine repairs, payroll, advertising | Usually current operating deductions | Books and returns; no double counting |
Depreciation can change the character of gain
Depreciation deductions generally reduce basis. At sale, part of the gain on depreciable property may be recaptured and taxed as ordinary income. This is why an equipment schedule and prior depreciation reports are essential. A seller cannot simply shift value from equipment to goodwill without support; the allocation must reflect economic reality and fair market value.
Purchase-price allocation drives the analysis
| Asset category | Typical federal treatment to review |
|---|---|
| Inventory | Ordinary income |
| Furniture and equipment | Gain plus possible depreciation recapture |
| Goodwill and going-concern value | Potential long-term capital gain when requirements are met |
| Noncompete or consulting payments | May produce ordinary income depending on facts and drafting |
Buyer and seller generally report an applicable asset acquisition on Form 8594. Their reporting should be consistent. Allocation should be addressed with the CPA and transaction attorney before the purchase agreement is final.
What information is needed for a $700,000 illustration?
- Original acquisition date and price
- Original asset allocation
- Capital improvements and later equipment purchases
- Cumulative depreciation and Section 179 deductions
- Tax basis of inventory
- Broker, legal, accounting, and closing costs
- Proposed allocation in the new sale
- Installment, earnout, or seller-financing terms
- Filing status, other income, and capital-loss carryovers
With meaningful adjusted basis and selling costs, total gain may be well below $700,000. With extensive prior depreciation, basis may be lower and recapture may be significant. Without these inputs, a claim of exactly $140,000 in federal tax and $93,100 in California tax is not dependable.
Federal capital-gain rates and NIIT
Federal long-term capital gain can fall into 0%, 15%, and 20% brackets. The entire gain does not necessarily receive one rate because taxable income fills the brackets. Higher-income taxpayers should also test the 3.8% Net Investment Income Tax and the rules governing whether a particular business interest is included.
California does not offer a separate capital-gain rate
California taxes capital gains through its regular income-tax system. But multiplying the entire $700,000 price by 13.3% is also misleading. California uses progressive rates, and the result depends on taxable gain, filing status, other income, deductions, and residency or sourcing rules.
Documents to organize before going to market
- Original acquisition agreement and closing statement
- Prior Form 8594 and allocation schedules
- Fixed-asset ledger and annual depreciation schedules
- Invoices and payment evidence for remodels and equipment
- Recent business returns and financial statements
- Current inventory and cost records
- Estimated transaction expenses
- Entity and ownership records
- Capital-loss carryover schedules
If documents are missing, a CPA may be able to evaluate bank records, tax returns, depreciation schedules, and vendor records. Reconstruction should be evidence-based; invented estimates create audit and negotiation risk.
Planning strategies worth discussing
Reconstruct basis early
Organize acquisition, improvement, and depreciation records 12 to 24 months before a possible sale, not during the final week of escrow.
Negotiate a defensible allocation
Buyer and seller often have different tax preferences. Allocation must still match business facts, valuation, financing, and the contract.
Evaluate an installment sale
An eligible installment structure can spread recognition of some gain, but inventory and depreciation recapture have limitations, and the seller assumes collection risk.
Review capital losses
Available capital losses can offset capital gains. The familiar $3,000 annual limitation applies to excess net capital loss used against ordinary income—not to capital-loss offsets against capital gain.
Treat QSBS as a narrow exception
Qualified Small Business Stock generally requires qualifying original-issue C-corporation stock and a required holding period. It does not automatically apply to a sole proprietorship, LLC asset sale, or ordinary small-business sale. California does not conform to the federal QSBS exclusion.
Do not assume an IRA or 401(k) erases sale tax
Retirement-plan contributions have eligibility rules and annual limits. Moving sale proceeds into a retirement account does not, by itself, defer gain already realized on the business sale.
Bottom line
The best business-sale tax plan usually begins with records, not a shortcut. A seller should be able to explain what was acquired, what was improved, what was already deducted, and how the current deal value is divided among assets.
Before the LOI or purchase agreement locks in structure and allocation, ask a CPA experienced in business sales and a transaction attorney to model after-tax proceeds. That is more useful than applying a single percentage to the headline price.
Frequently asked questions
Is the full business sale price capital gain?
No. Selling costs and adjusted basis matter, and inventory, equipment, goodwill, and other items may have different tax treatment.
Can remodel and equipment spending reduce gain?
Capitalized costs may affect basis, but amounts already deducted or depreciated cannot be counted twice.
What if some receipts are missing?
Other reliable records may help reconstruct basis, including bank records, old returns, contracts, and depreciation schedules. Review the evidence with a CPA.
Can sale proceeds be rolled into an IRA or 401(k)?
Not as a general rollover of business-sale gain. Contribution limits and eligibility rules still apply, and a transfer does not automatically defer the sale tax.
When should allocation be negotiated?
Ideally before the LOI or purchase agreement is finalized, while the parties can still align tax reporting with the economics of the deal.
Authoritative resources
- IRS: Sale of a Business
- IRS: Instructions for Form 8594
- IRS Publication 544
- IRS Topic 705: Installment Sales
- California FTB: Capital Gains and Losses
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