Business dispositions may be structured as a stock sale or an asset sale. In a stock sale, a buyer purchases the ownership rights for a business from the seller directly and takes possession of both the company and its assets. In an asset sale, on the other hand, a buyer purchases the assets from the business, which in turn distributes the proceeds to the owners. Structure is often an important aspect of negotiations because the form chosen for the transaction can have significant tax ramifications for the buyer and seller.
Accounting for an Asset Buyout
In an asset buyout, the purchase price must be allocated to the assets being transferred. Allocation is important because it determines the rate at which assets are depreciated. A buyer would prefer to take depreciation deductions as soon as possible, but it also must follow procedures outlined by the IRS. Section 1060 of the Internal Revenue Code specifies that the purchase price should be allocated to assets according to their liquidity. For instance, Section 1060 requires that the purchase price be first allocated to cash, then to publicly traded securities, then to furniture and equipment.
Buyers will almost always prefer an asset purchase over a stock purchase. This is because a company can depreciate assets. Depreciation and amortization expenses can begin to offset future income and reduce tax liabilities immediately. In a stock sale, the basis must be carried until the stock is sold.
If a buyer purchases stock, it may inherit liabilities created by the previous owners. Assume the previous owners have a lease obligation that lasts for two more years. If the buyer purchases stock, it will inherit this obligation. In an asset buyout, on the other hand, the buyer does not inherit liabilities of the company.
Sellers will almost always prefer a stock sale to an asset sale. There are a couple of reasons for this. First, in an asset sale, the seller has to recapture depreciation as ordinary income, which is taxed at a higher rate than capital gains. Second, in a stock sale, the seller can reduce its gain by its basis in the stock. If the buyer purchases assets, the seller generally forfeits any basis it has in the stock.
Companies that have operated as C corporations may have to pay taxes twice when selling assets. In an asset sale, the corporation sells the assets and pays tax on depreciation recapture and any gain above the original purchase price. If the corporation distributes the remaining proceeds as a dividend, the shareholders will need to pay tax again at the individual level.
Benjamin Podraza holds a Bachelor of Science in accounting and a Master of Science in taxation from Arizona State University. He is a financial consultant that has provided advice to thousands of individuals and business owners for more than 15 years.