How to account for selling shares in private company with 'earn-out' payments?

I am a shareholder for a company going through an acquisition and am unsure how the sale of my shares should be accounted for to the IRS and my personal tax consequences.

I originally bought the shares for $1 five years ago. I am selling the shares and will be paid cash amounting to $2/share upon purchase. However, as part of the purchase agreement for the next two years I will be given a $1/share at the end of each successive calendar year - for a total of $4/share.

My understanding is I would have a capital gains of $1/share ($2 minus $1) this year. Each of the following years I would have a capital gain of $1/share ($1 minus $0). Is my logic correct here? Can you have a basis of $0 or is that going to start setting off (audit) flags. I would sincerely hope to not have to show a capital gain for the full amount as I perceive a non-trivial amount of risk to the future payments as it is predicated on company's positive cash flow. Any help would be appreciated.

Just divide your original purchase price to have in the current year a cost of .50 cents per share and a cost of .25 cents per share for each of the next two years. That way your cost %'s will match your sale payment %'s. As far as a basis of $0 setting off red flags with the IRS that isn't the case at all. Insurance companies have gone from mutual insurance companies to stock insurance companies, and have given shares to insurance policy holders (I have shares of Prudential and my wife has shares of Met Life because of this, and neither of us paid anything for those shares, so our basis in the stocks is $0).

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