- Buy the assets of the business
- Buy the seller’s entity ownership interest if the target business is operated as a corporation, partnership, or LLC.
This article focuses on the asset purchase approach.
Tax Basics of Asset Purchases
When purchasing assets, the total purchase price must be allocated to the specific assets acquired. The amount allocated to each asset becomes its initial tax basis.
For depreciable and amortizable assets—such as furniture, fixtures, equipment, buildings, software, and intangibles like customer lists and goodwill—the initial tax basis determines the depreciation and amortization deductions post-acquisition.
When you eventually sell a purchased asset, you will have a taxable gain if the sale price exceeds the asset’s tax basis (initial purchase price allocation plus any post-acquisition improvements minus any post-acquisition depreciation or amortization).
Asset Purchase Results with a Pass-Through Entity
If you operate the newly acquired business as a sole proprietorship, single-member LLC treated as a sole proprietorship, partnership, multi-member LLC treated as a partnership, or S corporation, post-acquisition gains, losses, and income are passed through to you and reported on your personal tax return. Various federal income tax rates can apply to income and gains, depending on the type of asset and how long it is held before being sold.
Asset Purchase Results with a C Corporation
If you operate the newly acquired business as a C corporation, the corporation pays the taxes on post-acquisition operations and asset sales. All types of taxable income and gains recognized by a C corporation are taxed at the same federal income tax rate, which is currently 21%.
Optimizing Purchase Price Allocation
A key tax planning opportunity in an asset purchase deal lies in how you allocate the purchase price to the acquired assets. To the extent permitted, you should aim to allocate more of the purchase price to:
- Assets that generate higher-taxed ordinary income when converted into cash (such as inventory and receivables)
- Assets that can be depreciated relatively quickly (such as furniture and equipment)
- Intangible assets (such as customer lists and goodwill) that can be amortized over 15 years
Conversely, you should allocate less to assets that must be depreciated over long periods (such as buildings) and to land, which cannot be depreciated.
Obtaining appraised fair market values for the purchased assets can help allocate the total purchase price to specific assets. As noted, you will generally want to allocate more of the price to certain assets and less to others for optimal tax results. Since the appraisal process can be subjective, multiple legitimate appraisals may exist for the same group of assets. The tax results from one appraisal may be more favorable for you than another.
Nothing in the tax rules prevents buyers and sellers from agreeing to use legitimate appraisals that result in acceptable tax outcomes for both parties. Agreeing on appraised values is part of the purchase/sale negotiation process. However, the final agreed-upon appraisal must be reasonable.
Plan Ahead
When buying the assets of a business, remember that the total purchase price must be allocated to the acquired assets. This allocation process can significantly impact your post-acquisition tax results. Engage your advisor early in the negotiation phase to ensure the best tax outcomes. We are here to help you achieve favorable tax results. Contact us for guidance.
