Understanding Capital Gains Tax on a Business Sale + How to Avoid
Dylan Gans
May 5, 2025 ⋅ 9 min read
Selling your business is a major financial milestone. Yet, in the rush to prepare listings and negotiate with buyers, it's easy to overlook one of the most important financial considerations: The capital gains tax.
It might not be at the top of your mind, but it can greatly impact how much money you actually keep after the sale. But while you’re focused on getting the right price or finding the right buyer, capital gains tax can dramatically impact your outcome.
Taxes are the most confusing part of the sale for many small business owners. What will you owe? When? And is there anything you can do to reduce it?
This guide breaks down exactly what the capital gains tax on a business sale is, how it’s calculated, and what strategies you can use to minimize capital gains taxes. While avoiding taxes altogether isn’t realistic, smart planning can help you defer paying taxes or reduce your tax liability—sometimes significantly.
What Is Capital Gains Tax in a Business Sale?
The profit is considered a capital gain when you sell your business for more than you originally invested. The Internal Revenue Service treats that gain as taxable income, applying a tax rate based on how long you owned the business and your total income.
The differences are:
Short-term capital gains (held less than a year) are taxed at ordinary income rates.
Long-term capital gains (held longer than a year) enjoy lower preferential capital gains tax rates—usually 0%, 15%, or 20%, depending on your adjusted gross income.
Let’s say you started your business with an investment of $200,000. You sell it for a selling price of $500,000. Your capital gain is $300,000. Depending on your total taxable income, that $300K could be taxed at a lower capital gains rate if it qualifies as long-term gains.
Keep in mind that state-level taxes often apply as well, and they don’t always distinguish between capital gains and regular income.
Understanding these definitions gives you more control when it comes time to negotiate the deal or plan for the next chapter.
How Is Capital Gains Tax Calculated on a Business Sale?
The basic formula is simple: Selling price – Adjusted basis = Capital gain
The adjusted basis includes what you originally paid, plus improvements minus any depreciation deductions you’ve taken over the years. If you’ve depreciated business assets like equipment, that portion may be taxed as ordinary income due to depreciation recapture.
Let’s break it down:
You sell your business for $800,000
Your adjusted basis is $400,000
Your capital gain is $400,000
You fall into the 15% long-term capital gains tax rate bracket
Capital gains tax owed: $60,000 (plus possible state tax and net investment income tax if applicable).
Depending on your business structure, parts of the sale may be taxed differently. That’s why understanding the type of sale—asset vs. stock—is essential, as it directly impacts how much tax you’ll owe and how that tax is treated—which brings us to an important distinction.
Asset Sale vs. Stock Sale: How Structure Impacts Taxes
When it comes to business succession, the structure of your sale is one of the biggest tax considerations you'll face, and it directly impacts your final tax consequences.
Business sales typically fall into one of two categories:
Asset sale: You sell the individual assets of the business (equipment, inventory, and goodwill).
Stock sale: You sell your ownership interest in the company.
Most deals are structured as asset sales for LLCs and S-Corps. C-corporation owners may have the option of a stock sale, which can be more favorable tax-wise.
Here’s the key breakdown:
The IRS requires the purchase price to be allocated across different asset classes in an asset sale. Some allocations—like equipment or non-compete agreements—can be taxed at ordinary income rates, which are much higher than capital gains rates. Others, like goodwill, are taxed at long-term capital gains rates.
On the other hand, stock sales typically result in the entire gain being taxed at the more favorable long-term capital gains rate. But buyers tend to avoid this structure—especially in smaller deals—because it comes with more legal risk and fewer tax benefits.
How your deal is structured plays a major role in your tax bill. Asset sales are common, but potentially more complex from a tax standpoint. Understanding the trade-offs early can save you money. Understanding these trade-offs early in your overall tax consideration can help minimize unexpected consequences and save money.
When Should You Start Tax Planning for a Business Sale?
The short answer: Much earlier than most business owners realize.
Ideally, you should begin tax planning at least one to two years before selling.
That gives you time to:
Clean up your financials and remove personal expenses
Restructure compensation and boost net income
Consider an entity conversion (like from LLC to S-Corp) if it supports a better tax outcome
Explore tax-efficient strategies for retirement contributions, timing, or sale structure
Think you’re too late? Once you’re under LOI (Letter of Intent), most tax decisions are already locked in. It’s nearly impossible to make impactful changes by the time you hit closing.
Key takeaway: Early planning gives you flexibility, better financial optics, and more negotiating power.
Real-World Example: How Early Prep Reduced a Tax Bill
One seller came to Baton after already doing the prep that most owners skip.
They had:
Cleaned up their financials and eliminated personal expenses
Worked with their accountant on whether converting from an LLC to an S-Corp made sense
Timed the sale to qualify for long-term capital gains treatment
The result? Their books were clean, the business was SBA-financing ready, and buyer interest surged. When the deal closed, their tax liability was far lower, and they walked away with more money, less stress, and no last-minute surprises.
Biggest Tax Surprise? It’s Not Always Capital Gains
Most owners assume their sale will be taxed at the favorable long-term capital gains rate. But here’s the surprise: Not all parts of the deal qualify.
In asset sales (the most common structure), allocations to things like equipment or non-compete agreements may be taxed at ordinary income rates—which are much higher. If sellers aren’t involved in allocating the purchase price, they can face unexpected tax burdens.
Another surprise? If you’ve been running personal expenses through the business, it may hurt your valuation and limit SBA financing options.
Smart tax planning isn’t just about paperwork. It’s about knowing how deal structure, purchase price allocations, and financial presentation shape your final tax bill—and getting ahead of those decisions.
4 Legitimate Strategies to Reduce or Defer Capital Gains Tax
Proactive planning can significantly reduce how much you owe after a sale. Here are some of the most common strategies used to minimize capital gains taxes when selling a business. These are Internal Revenue Service-compliant approaches—not loopholes.
1. Installment Sale (Seller Financing)
Instead of receiving the full sale amount upfront, you agree to be paid over time—usually with interest. This spreads your gain across multiple tax years.
Example: You sell your business for $500,000 over 5 years. Instead of owing taxes on the full gain in year one, you pay a portion annually.
Just make sure your agreement includes clear buyer-pay protections and a promissory note. Learn more about the seller's tax implications and how IRS rules and other tax implications apply.
2. Max Out Tax-Deferred Retirement Contributions
Reducing your taxable income in the year of the sale can help reduce your overall tax burden.
You can contribute to a SEP-IRA, Solo 401(k), or other retirement account for business owners. This doesn’t lower your capital gain but lowers how much other income is taxed. This strategy is beneficial for those also collecting retirement income.
Bonus tip: If your business owns real estate, you might consider a 1031 exchange to defer paying taxes on property gains.
3. Qualified Small Business Stock (QSBS) Exclusion
If you own a C-corp and meet certain requirements, you can exclude up to $10 million in capital gains through Section 1202 of the tax code.
You must have:
Held the stock for 5+ years
Acquired it when the company was valued under $50M
This is one of the few true ways to create a tax-free gain, but it only applies in specific situations and may depend on tax purposes.
4. Charitable Contributions or Charitable Trusts
If you’re charitably inclined, consider donating part of your capital assets or setting up a charitable remainder trust (CRT). These options can reduce your tax liability while supporting a cause you care about.
CRT structures are more complex and should be planned well before the sale.
Avoiding Common Mistakes in Business Sale Tax Planning
Even experienced entrepreneurs can fall into these traps. These are simple mistakes but can have costly consequences if you're not paying attention. Avoiding them could save you thousands.
Steer clear of:
Waiting until the deal is done to think about taxes: Many sellers wait until negotiations are nearly complete before thinking about taxes. By then, your options are limited.
Not understanding the tax impact of deal structure: It is risky to assume your entire sale will be taxed at favorable capital gains rates. Some items (like equipment) could trigger ordinary income.
Skipping professional help: One meeting with a tax advisor who understands business sales taxed under IRS rules can help you avoid mistakes and unlock smarter strategies.
Overlooking purchase price allocation: In an asset sale, how the price is split across business assets (goodwill, inventory, equipment) affects how much tax you owe. This should be negotiated and not left to the buyer.
Failing to offset capital gains: Sellers often miss opportunities to offset capital gains using capital losses or reinvestments. This simple tactic can lower your final tax bill.
Being aware of these issues is a key part of smart planning.
How Baton Simplifies Business Sales—and Maximizes Your Outcomes
Taxes aren’t the only complicated part of selling a business. Valuations, buyer outreach, and paperwork are all pressures and are already an emotional process.
That’s why Baton exists: To make it easier, faster, and more transparent.
Here’s how we help sellers take control of their financial future:
Free, accurate business valuations so you know where you stand
Capital gains tax deferral guidance and access to resources
Structured sale process with built-in tools and weekly updates
Pre-qualified buyer network—no cold leads or flaky prospects
50% faster closing times compared to traditional brokers
Clear, transparent fee model with no surprises
You’ve invested everything in your business—now it’s time to maximize it. Baton provides the structure, speed, and support you need to sell on your terms and walk away with confidence.
Don’t Leave Money on the Table
You can’t eliminate taxes, but you can prepare for them. Whether you’re just starting to consider selling or already in talks with a buyer, there are smart moves you can make right now to lower your liability. Whether you’re just starting to consider selling or already in talks with a buyer, there are smart moves you can make right now to lower your liability.
Baton helps small business owners navigate every part of the sale—from valuation to closing to capital gains tax deferral strategies.
Ready to sell your business—or just understand what it could mean for you financially?
Get a free, no-obligation business valuation with Baton and start planning your future today.