Deferring capital gains taxes under Section 1042 requires purchasing Qualified Replacement Property (QRP) equal to 100% of the taxable gain within 12 months after the transaction closes.
The Challenge of Purchasing QRP Within One Year
ESOP sales are not all-cash transactions. Typically, sellers receive ~25% of the purchase price in cash at closing, with the remainder structured as a seller note. This makes it difficult—if not impossible—to reinvest the full sale price within the required 12-month period.
Floating Rate Notes (FRN): A Costly QRP Financing Solution
To finance the purchase of QRP under Section 1042, banks will typically lend up to 90% of the face value of a Floating Rate Note (FRN). Using leverage enables the purchase of FRN equal to 100% of the taxable gain.
The FRN loan requires the seller to pay annual interest on the borrowed 90%, and the interest expense remains for the rest of the seller’s life. To secure the loan, banks will require a personal guarantee from the seller.
Lazear’s 1042 strategy eliminates interest expense and personal guarantee of debt.
Planning is Essential
Because QRP selection and timing are so critical, selling shareholders should work closely with advisors who understand the technical, tax, and investment aspects of the 1042 election. A thoughtful strategy helps ensure compliance, tax deferral, and financial security.
Learn more about the power of Section 1042 and why it was created to support both economic impact and retirement security.
Explore Lazear’s proprietary 1042 tax solution by clicking here.
