Tax Consequences of Selling Your Small Business
Selling a small business is the largest taxable event most entrepreneurs ever experience. The tax consequences depend on the entity type (sole proprietorship, S-Corp, C-Corp, partnership), the sale structure (asset sale vs. stock sale), and how the purchase price is allocated among asset classes. In an asset sale, each asset produces a different tax character: inventory and depreciation recapture are taxed as ordinary income (up to 37%), while goodwill and intangibles are taxed as long-term capital gain (0%, 15%, or 20%, plus the 3.8% NIIT unless the gain comes from a business the owner actively runs). Understanding these distinctions before the letter of intent is signed can save tens of thousands of dollars. The seller’s tax advisor should be involved from the first offer, not after the closing.
Selling a business: tax overview by entity type:
Sole proprietorship / single-member LLC (asset sale only):
- The business IS the owner; no stock/equity to sell
- Each asset is sold individually
- Depreciation recapture (IRC 1245): ordinary income on previously depreciated equipment
- Inventory: ordinary income
- Goodwill: long-term capital gain (favorable rates)
- Real property recapture (IRC 1250): 25% maximum rate
- Self-employment tax does NOT apply to asset sale proceeds (not earned income)
S-Corp (asset sale or stock sale):
- Asset sale: same treatment as sole prop, but gain passes through on K-1
- Stock sale: seller reports gain on personal return as capital gain on the stock
- Section 338(h)(10) election: treats a stock sale as an asset sale for tax purposes (buyer gets stepped-up basis)
- No entity-level tax (pass-through)
C-Corp (double taxation risk):
- Asset sale: C-Corp pays corporate tax on the gain, THEN shareholders pay capital gains on the distribution
- Stock sale: only shareholder-level capital gains tax (avoids double taxation)
- This is why C-Corp sellers strongly prefer stock sales
- Installment sale can spread the shareholder-level tax but not the corporate-level tax
Partnership / multi-member LLC:
- Asset sale: similar to sole prop, gain allocated per partnership agreement
- Interest sale: the selling partner reports gain on sale of partnership interest
- Hot assets (IRC 751): certain assets (inventory, unrealized receivables) produce ordinary income even in an interest sale
- Basis adjustments under IRC 754: the buying partner can elect to step up their share of asset basis
Purchase price allocation (IRC 1060): The purchase price is allocated across seven classes. The allocation determines how much is taxed at ordinary rates vs. capital gain rates.
Key tax rates on sale:
| Component | Tax Rate | Notes |
|---|---|---|
| Inventory | 10-37% (ordinary) | Cost or market value |
| Depreciated equipment (1245) | 10-37% (ordinary) | Up to depreciation claimed |
| Real property (unrecaptured 1250 gain) | 25% maximum | Straight-line depreciation taken (any excess over straight-line is ordinary income) |
| Goodwill | 0-20% (+ 3.8% NIIT if the owner is passive) | Long-term capital gain |
| Covenant not to compete | 10-37% (ordinary) | Ordinary income to seller |
| Accounts receivable (cash basis) | 10-37% (ordinary) | Ordinary income for cash-basis seller |
3.8% Net Investment Income Tax (NIIT):
- Applies if MAGI exceeds $200,000 (single) or $250,000 (MFJ)
- Capital gain from selling a business counts as investment income if the owner is passive in the business (or it’s a trading business); gain on C-Corp stock counts either way
- For a passive owner, a $500,000 gain can trigger up to $19,000 in NIIT alone
- Exception for active owners: gain on property held in a business you actively run is excluded, and a partnership or S-Corp interest sale is tested as if the entity sold its assets
What does the tax look like on a typical business sale?
How does depreciation recapture work when I sell business assets?
When you sell a depreciable business asset for more than its adjusted basis, the IRS recharacterizes a portion of the gain as ordinary income rather than capital gain. For personal property (equipment, vehicles, furniture), IRC 1245 recaptures all prior depreciation as ordinary income up to the amount of gain. For real property, IRC 1250 recaptures only the excess of accelerated depreciation over straight-line as ordinary income, though “unrecaptured Section 1250 gain” is taxed at a maximum 25% rate. This means the first dollars of gain on a business asset sale are often taxed at higher ordinary income rates, not the preferential long-term capital gains rates.
Can I offset capital gains with capital losses from other investments?
Yes. Capital losses first offset capital gains of the same type (short-term losses against short-term gains, long-term against long-term), then any remaining net loss offsets gains of the other type. If net capital losses exceed capital gains, you can deduct up to $3,000 of the excess against ordinary income ($1,500 if married filing separately). Unused losses carry forward indefinitely to future tax years, maintaining their character (short-term or long-term). The wash sale rule (IRC 1091) prevents you from claiming a loss if you repurchase substantially identical securities within 30 days before or after the sale. Tax-loss harvesting before year-end is a common strategy to realize losses that offset gains elsewhere in the portfolio.
Related guides:
Does the 3.8% NIIT apply when I sell my own business?
Not automatically. The net investment income tax excludes gain on property held in an active, non-passive trade or business, so a sole proprietor selling the assets of a business they work in may owe none of the 3.8% on that gain. Where it does apply, it’s figured on the lesser of net investment income or modified AGI over $250,000 joint, $200,000 single or $125,000 married filing separately.
Those thresholds aren’t indexed, so they’re the same for 2025 and 2026. Whether your gain is excluded turns on whether the business was passive for you. Selling S corporation stock or a partnership interest works on a look-through basis: the gain counts only as far as it would if the entity sold all its assets at fair market value. The regular long-term rates still apply either way, 15% up to $600,050 of 2025 joint taxable income and 20% above.
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Yarik Yarosh, CPA. "Tax Consequences of Selling Your Small Business." Blue Cloud CPA, September 5, 2026, updated September 23, 2026. https://bluecloudcpa.com/guides/small-business-selling-a-business-tax-consequences
This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.