When are taxes due on the sale of qualified replacement property after a sale to an ESOP that qualifies for a tax-deferral under Section 1042?. ?

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Accepted Answer

Taxes are due when the qualified replacement property is sold. The taxpayer’s basis is the basis at the time of the sale to the ESOP. If the replacement property is held until death, there is a step-up in basis, so no capital gains taxes are due.To understand this better, take an example. Assume that John sells his company to an ESOP for $10 million. John started the company and his basis in the $10 million is zero. John then takes the $10 million and reinvests in a portfolio of qualified replacement investments, stocks and bonds of US operating companies. Five years later, John sells 20% of the replacement property. Capital gains taxes are now due on 20% of the $10 million plus or minus whatever gains or losses are attributable to the stocks and bonds that were sold. Any portion of the securities that are not sold at the time of John's death would have a step-up in basis and no capital gains taxes would be due. John could also make a contribution of some of the qualified replacement property. For instance, say that John contributed $2,000,000 of the qualified replacement property to a charity immediately after purchasing it. John would get a $2,000,000 deduction, pay no capital gains tax, and the charity would get the $2,000,000. If John had not sold to the ESOP, taxes would be paid first on the $2,000,000 and the charity would get the remaining amount with John getting a smaller deduction.For more details, see Selling to an ESOP and Financing the Deal.