Selling a Franchise: How Your Franchise Fee, Equipment and Goodwill Are Taxed

What you own when you own a franchise

A franchisee owns three things a buyer pays for: the operating assets (equipment, signage, fixtures, sometimes real estate), the remaining rights under the franchise agreement, and the goodwill of a location that already has customers and staff. The brand belongs to the franchisor. For tax, the agreement is a Section 197 intangible: IRC 197(d)(1)(F) lists any franchise, trademark or trade name. You amortized the initial franchise fee over 15 years, and renewal fees start their own 15 years when paid. Running royalties based on sales are different: they were deducted as paid under IRC 1253(d)(1) and add nothing to your basis.

Why the franchise fee comes back as ordinary income

Most owners expect the franchise portion of the price to be capital gain. Much of it is not. IRC 197(f)(7) treats an amortizable Section 197 intangible as property subject to depreciation, which makes the franchise agreement Section 1245 property. Under IRC 1245(a), gain up to the amortization you claimed is ordinary income. Only gain above your original fee is Section 1231 gain.

Example: you paid a $40,000 fee per unit, have amortized $26,667 of it after ten years, and the purchase agreement allocates $40,000 to that unit's agreement. The full $26,667 of gain on the agreement is ordinary. The same logic applies with more force to equipment: kitchens, coolers, point-of-sale systems and build-outs written off under bonus depreciation or Section 179 often come back almost entirely as ordinary income. The depreciation recapture page shows the general rule.

The allocation, the remaining term and the transfer fee

The buyer and you report the same allocation on Form 8594 under the residual method of IRC 1060, so negotiate it with the price. Three franchise-specific points drive it:

• Remaining term. An agreement with two years left is worth less than one with twelve. Many franchisors do not assign the old agreement at all; they require the buyer to sign the current form agreement for a new term. In that case little or nothing of the price is for your agreement, and more falls to goodwill and the going concern, which is capital gain to you. Ask your CPA how your remaining unamortized fee is handled when the agreement ends rather than transfers.
• Transfer fee. Franchisors charge a fee on resale, set in the franchise agreement. If the contract makes you pay it, it is a selling expense that reduces your amount realized; in our example the $15,000 fee comes off the goodwill gain.
• Equipment upgrades. Franchisors commonly condition approval on a remodel or equipment refresh. If the price is cut to cover it, the cut usually reduces the value you can allocate to equipment, which reduces recapture.

See purchase price allocation for the seven asset classes.

Franchisor approval, right of first refusal and buybacks

Nearly every franchise agreement requires the franchisor's consent before you sell, and many give the franchisor a right of first refusal to buy on the same terms as your best offer. Build those steps into your calendar, because approval timing decides which tax year the closing lands in. If the franchisor exercises its right or buys the units back, your tax treatment is the same as in a sale to another franchisee: recapture on equipment and the agreement, capital gain on goodwill. The practical difference is that a franchisor usually pays cash and rarely takes a seller note, so you lose the option to spread the gain.

The franchisor's own tax position is the reverse of yours. Under IRC 1253(a), a transfer of a franchise is not a sale of a capital asset if the transferor keeps any significant power, right or continuing interest, such as the right to approve assignments, set quality standards or terminate. A franchisee selling outright keeps none of those rights, which is why your goodwill can qualify for capital gain even though the franchisor's fees cannot.

Worked example: three units in Ohio, cash or a note

Our Ohio owners sell three units for $1,500,000. Of the $1,345,000 gain, $280,000 is recapture on equipment and franchise fees. Paid all at closing, the sale adds $330,625 of tax, an effective 24.6%. With 25% down and four equal annual principal payments, the same gain adds $202,423, or $128,202 less. The recapture is still taxed in 2026, because IRC 453(i) requires all recapture income in the year of sale even when little cash arrives. The savings come from keeping goodwill gain in the 15% federal bracket instead of 20% (20% applies above $613,700 of taxable income for joint filers, Rev. Proc. 2025-32, 2026) and from Ohio.

Ohio treats gain from selling a business's goodwill or operating assets as business income, deducts the first $250,000 each year for joint filers and taxes the rest at 3% (ORC 5747.01(B) and (A)(28); ORC 5747.02, 2026). Because that deduction resets every year, a payout lets you use it five times instead of once. Net investment income tax does not apply here because the owners were active. Details are on the Ohio page.

Carrying a note for a franchise buyer

Many franchise buyers use bank or SBA financing and ask the seller to carry part of the price. Protect the note the way a lender would: a meaningful down payment, a UCC lien on equipment and inventory, a personal guarantee from the buyer's owners, interest at or above the applicable federal rate, and a cross-default clause so the note accelerates if the buyer loses the franchise or defaults on the lease. If a bank is senior, read the subordination terms closely, since they may block payments to you. The seller financing and installment sale of a business pages cover the terms.

Get the Big Sale Tax Analysis to compare cash, a note and a franchisor buyback for your units.

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Frequently asked questions