Updated 2026
Are you a small business owner considering selling a business? There are a few key items involved with capital gains tax that you鈥檒l want to understand as you embark on this decision.
What are Capital Gains?
A capital gain occurs when you sell or exchange a capital asset for more than your adjusted basis in that asset. In simple terms, basis often starts with what you paid for the asset, then may be adjusted over time by factors such as capital improvements, depreciation, and other tax adjustments.
For example, if you purchased an asset for $300,000, made $100,000 in qualifying capital improvements, and later sold it for $450,000, your gain may be $50,000 before considering other adjustments or transaction costs.
Business sales are more complex than that simple example. When a business is sold, the IRS generally treats the transaction as the sale of individual assets, not one single asset. Different parts of the sale may be taxed differently depending on whether the buyer is acquiring inventory, accounts receivable, equipment, real estate, goodwill, or other assets.
That means a business sale may involve capital gains, ordinary income, depreciation recapture, or some combination of tax treatments. Owners should work with a CPA before going to market so they understand the likely tax impact and what they may actually keep after closing.
What is Ordinary Income?
Ordinary income generally includes items such as wages, interest income, and business operating income. In a business sale, certain assets or portions of the transaction may also be treated as ordinary income rather than capital gain. For example, inventory, accounts receivable, and gain related to certain depreciated business assets may receive ordinary income treatment.
Capital Gains Tax vs. Ordinary Income Tax
When a business is sold, the tax result is not always one simple capital gains calculation. Some portions of the sale may qualify for capital gains treatment, while other portions may be taxed as ordinary income.
Capital gains are generally divided into two categories: short-term and long-term.
For business owners, the important point is that purchase price, asset allocation, entity structure, holding period, basis, and depreciation history can all affect the final tax outcome.
Short-Term Capital Gains
Short-term capital gains tax may apply when an ownership interest, capital asset, or certain assets sold as part of a business sale have been held for one year or less. A net short-term capital gain is generally taxed as ordinary income at the owner鈥檚 applicable federal income tax rate, which can be as high as 37%.
Long-Term Capital Gains
Long-term capital gains treatment may apply when an ownership interest, capital asset, or certain assets sold as part of a business sale have been held for more than one year. A net long-term capital gain is generally taxed at preferential federal rates, often no higher than 15% for many taxpayers, though higher-income taxpayers may be subject to a 20% rate and, in some cases, the 3.8% Net Investment Income Tax.
Because a business sale may involve different types of assets and tax treatment, owners should work with a CPA to understand which portions of the sale may qualify for capital gains treatment and which may be taxed differently.
The as the amount by which net long-term capital gain exceeds net short-term capital loss, and notes that a lower tax rate may apply to net capital gain than to ordinary income.
Asset Allocation: Why the Purchase Price is Not Taxed as One Lump Sum
What does this mean for a small business owner?
It means the tax impact of selling a business is not calculated by taking one lump-sum sale price and applying one tax rate to the entire amount. In many business sales, the purchase price must be allocated among the different assets being sold, and different types of assets may receive different tax treatment. Inventory, equipment, real estate, goodwill, accounts receivable, and other assets may not all be taxed the same way.
That is why asset allocation matters. The way the purchase price is allocated can affect how much of the sale is treated as capital gain, ordinary income, depreciation recapture, or another tax category. Business owners should work with a CPA and experienced M&A advisor before going to market so they understand how allocation may affect net proceeds, deal structure, and negotiations with a buyer.
Other Planning Considerations When Selling a Small Business
As discussed above, business owners should begin working with an advisory team well before they plan to sell, ideally one to two years in advance when possible. That team may include an M&A advisor, CPA, attorney, and financial advisor. Starting early gives the owner time to understand valuation, tax exposure, deal structure, entity considerations, retirement needs, and planning opportunities before a buyer is already at the table.
Some owners may also consider selling the business to employees. Depending on the company, this could involve an Employee Stock Ownership Plan (ESOP) or another form of employee or management buyout. These structures can help preserve jobs and continuity, but they are complex and should be evaluated carefully with qualified tax, legal, and transaction advisors.
Family succession may be another option. Selling or transferring a business to family can support legacy and continuity goals, but it can also raise valuation, tax, estate planning, governance, and fairness issues among family members. Owners considering this path should work closely with advisors who understand both business sale transactions and family business succession planning.
Owners may also consider deal structures in which not all proceeds are received at closing. That could include seller financing, an installment sale, an earnout, rollover equity, or a consulting agreement during the transition period. Each structure has different implications for risk, control, payment timing, tax recognition, and net proceeds. For example, an installment sale generally involves receiving at least one payment after the tax year of the sale, but the tax treatment depends on the facts of the transaction and applicable IRS rules.
The larger point is that there is rarely one 鈥渂est鈥� structure for every seller. The right approach depends on the owner鈥檚 goals, the buyer鈥檚 needs, the company鈥檚 readiness, tax consequences, financing realities, and the likelihood of closing. That is why planning should begin before the sale process is already underway.
With so many details to consider, make every effort to surround yourself with the best possible team to mitigate any unnecessary expenses, taxes, or headaches. With decades of experience buying and selling businesses, our 91探花 team of advisors is also here to help. If you are thinking about your future exit, reach out to us today for a no-obligation, complimentary consultation.
Editor鈥檚 note/disclaimer: This article is for educational purposes only and should not be considered tax, legal, or financial advice. Business owners should consult their CPA, attorney, and financial advisor before making decisions related to a business sale.