After a challenging 2023, merger and acquisition activities across various sectors are seeing a resurgence in 2024. If you’re considering purchasing a business, achieving the best post-tax outcomes is paramount. Generally, you can structure the purchase in two main ways:
- Buy the assets of the business, or
- Buy the seller’s entity ownership interest, applicable if the target business operates as a corporation, partnership, or LLC.
Here, we’ll delve into the nuances of buying assets.
Understanding Asset Purchase Tax Basics
When purchasing assets, it’s crucial to allocate the total purchase price to the specific assets acquired. This allocation determines the initial tax basis for each asset.
For depreciable and amortizable assets—such as furniture, fixtures, equipment, buildings, software, and intangibles like customer lists and goodwill—the initial tax basis dictates the post-acquisition depreciation and amortization deductions.
If you eventually sell a purchased asset, a taxable gain arises 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 Outcomes with a Pass-Through Entity
Operating the newly acquired business as a sole proprietorship, a single-member LLC (treated as a sole proprietorship for tax purposes), a partnership, a multi-member LLC (treated as a partnership for tax purposes), or an S corporation means post-acquisition gains, losses, and income are passed through to you and reported on your personal tax return. Various federal income tax rates will apply to income and gains, contingent on the asset type and holding period before sale.
Asset Purchase Outcomes with a C Corporation
If you choose to operate the newly acquired business as a C corporation, the corporation itself handles the tax obligations from post-acquisition operations and asset sales. All taxable income and gains recognized by a C corporation are taxed at the federal income tax rate, currently set at 21%.
Strategizing a Tax-Smart Purchase Price Allocation
A key tax opportunity in an asset purchase deal lies in how you allocate the purchase price to the acquired assets. To optimize your tax outcomes, consider the following allocation strategies:
- Allocate more to assets that generate higher-taxed ordinary income when converted to cash, such as inventory and receivables.
- Allocate more to assets that can be depreciated quickly, like furniture and equipment.
- Allocate more to intangible assets (e.g., customer lists and goodwill) that can be amortized over 15 years.
- Allocate less to assets with longer depreciation periods, such as buildings, and to land, which cannot be depreciated.
To substantiate your allocations, obtaining appraised fair market values for the purchased assets is advisable. This appraisal process can be subjective, with multiple legitimate valuations possible for the same group of assets. The tax outcomes from one appraisal might be more favorable than those from another.
Nothing in the tax rules prevents buyers and sellers from agreeing to use appraisals that result in acceptable tax outcomes for both parties. Agreeing on appraised values becomes a critical part of the purchase/sale negotiation process. However, the final agreed appraisal must be reasonable.
Plan Ahead with Professional Guidance
When buying the assets of a business, precise allocation of the total purchase price to the acquired assets is essential. This process can significantly influence your post-acquisition tax results. Engaging with a tax advisor early, ideally during the negotiation phase, can ensure you achieve the most favorable tax outcomes. At Accavallo & Company, LLC – we’re here to assist you in navigating this complex process effectively.
