Section 453 Installment Sale and 1042 Tax Free Rollover

[Guest Babs]

Selling Shareholder wants to sell a large block (45%) of stock to a brand new ESOP and utilize section 1042 tax free rollover treatment. Management would like to set up the ESOP and cause it to purchase the stock on a promissory to be issued by the ESOP. The acquisition would be financed over ten years. However, this is an installment sale so how can the shareholder obtain the benefits of 1042??

[RLL]

The seller has to purchase qualified replacement property ("QRP") within 12 months after the sale to completely avoid current taxation. There is no requirement that the seller use the actual proceeds received from the ESOP. If the seller does not have other assets available for purchasing QRP, he/she should borrow the necessary funds.

In addition, the 1042 election does not require a 100% reinvestment.....so the seller can do a partial reinvestment in QRP and recognize some capital gain. The computation of taxation in an installment sale combined with a 1042 election is a bit complicated....as there is current taxation based on the amount "realized" (not "recognized") in the sale (including the installment note) to the extent it exceeds the cost of QRP.