Asset Purchases: Tax Considerations for the Buyer and Seller
Business mergers and acquisitions can be complex when it comes to taxation issues. Whether you are the buyer or seller in the transaction, both parties should be aware of the advantages and disadvantages tied to each decision they make. When purchasing a corporation, both the buyer and seller need to first determine whether the deal will be structured as an asset or stock deal.
THE BUYER SIDE
In an asset deal, specific assets are acquired from the seller based on the buyer’s specific needs. From the buyer’s perspective, the objective is to attain the assets that are beneficial, while typically avoiding the assumption of liabilities. In some cases, however, certain liabilities cannot be avoided (i.e. tax liens), so tax due diligence is a crucial step in the acquisition process.
Asset sales are typically taxable transactions, therefore the buyer gets a stepped-up tax basis in the assets purchased equal to their fair market value (FMV). The buyer’s purchase price is then allocated among the acquired assets and any excess is allocated to goodwill, which the buyer can amortize for tax purposes. This stepped-up tax basis benefits the buyer since the assets can be depreciated. However, the buyer is not entitled to any of the acquired entity’s tax attributes since only the assets are being purchased. Any transfer taxes upon the purchase of the assets also need to be considered.
Obtaining a stepped-up tax basis in the assets can be lucrative for the buyer. It is also possible to obtain this advantage when completing a stock deal if the entity elects to treat the stock purchase as an asset purchase pursuant to IRC Section 338 or 336. These elections, and the circumstances in which they may be utilized, will be discussed further in the second installment of this blog which will present the various business combinations available via a stock deal.
THE SELLER SIDE
The seller is concerned with how much it will have to pay in taxes on the transaction. The seller is taxed on the excess of the purchase price over its tax basis in the assets, which may have a low tax basis due to depreciation deductions already taken, often resulting in a greater gain than if they had sold the stock of the entity. This typically results in the seller demanding a higher sales price of the assets.
It should be noted that the seller’s tax attributes, such as NOL or capital loss carryforwards, can be utilized to offset the company’s taxable gain. For example, if the seller has capital loss carryforwards that are about to expire, it may not necessarily be concerned about the amount of the gain realized. The seller should also consider whether any associated liability of the asset is relinquished upon sale in determining which type of transaction to pursue.
Deciding whether a business transaction is to be structured as an asset versus a stock deal is an important consideration for both the buyer and the seller. In most scenarios, the buyer would typically prefer to purchase business assets for many of the reasons listed above, including limited liability exposure, basis step-up to FMV, the ability to purchase only desired assets, and the opportunity to renegotiate or terminate existing (unfavorable) contracts. That being said, the tax costs for the seller associated with the asset deal are often quite prohibitive, so it’s always important to weigh the full range of costs against the potential benefits before finalizing the prospective deal. If it’s determined that an asset transaction is not a business combination that will work to benefit either party, a stock transaction may be more ideal.
The decision to model a business deal as either an asset or stock purchase comes with a laundry list of potential tax implications, advantages and disadvantages, all dependent on the details of each specific scenario. Our professionals at FF&F are familiar with the questions you should be asking yourself before moving forward with any transaction, and we are well-equipped to assist you throughout each step of the process. For questions about asset purchases, general business transactions, or for information about our services, please contact us at firstname.lastname@example.org or (212) 245-5900.
Kimberly Roque, CPA, MST is a Tax Manager at FF&F with over 9 years of accounting experience, with 6 in private and 3 in public accounting. Her focus is consolidated corporate tax returns and income tax provisions.