Deciding to sell your business is a major milestone, but structuring the sale can quickly become complex. One of the most important considerations is whether to structure the transaction as an asset sale or a stock sale.
And this choice isn’t just about paperwork. It affects your tax obligations, how liabilities transfer, and the proceeds you ultimately walk away with.
In this video, we’ll provide a high-level look at both options and key factors to consider. While every deal is unique, understanding these fundamentals will help you navigate the process with greater confidence.
Asset sale vs. stock sale: the basics
Asset sale
In an asset sale, the buyer purchases specific business assets rather than acquiring the entire legal entity. These assets may include tangible items like equipment, inventory, or real estate, as well as intangible assets like intellectual property or goodwill.
Asset sales typically leave liabilities, like unpaid tax obligations, with the seller. Buyers often prefer an asset sale because they can pick and choose which parts of the business to acquire, avoiding unwanted liabilities and getting a “step-up” in the tax basis of assets. This can create future tax benefits, as higher basis values can translate into larger depreciation or amortization deductions down the road.
Stock sale
In a stock sale, the buyer acquires ownership in the company itself – whether in the form of corporate stock (for C or S corporations) or membership interests (for LLCs taxed as partnerships). This means the buyer generally assumes ownership of all business assets and liabilities.
Sellers typically prefer stock sales because they often qualify for capital gains treatment, which is generally more favorable than ordinary income tax rates.
The main drawback for buyers is the possibility of inheriting unknown or contingent liabilities, from outstanding lawsuits to unresolved tax issues. Because of that, buyers may negotiate price adjustments to account for potential risks.
Also, stock sales generally don’t provide buyers with a step-up in basis unless certain tax elections are made, allowing the buyer to treat the transaction more like an asset sale. However, these elections must be carefully structured and agreed upon by both parties, as they can have tax consequences for the seller as well.
Key tax implications
In an asset sale, the type of asset dictates how you’ll be taxed. Proceeds allocated to intangible assets are usually taxed at the capital gains rate. However, proceeds from tangible assets like machinery may be subject to depreciation recapture, which is taxed at ordinary income rates.
Allocation of purchase price in asset sales
In an asset sale, both parties must agree on how to allocate the total purchase price across different asset classes, as this affects taxation for both the buyer and seller. The IRS has specific guidelines for allocation, and both parties must report the same figures to avoid red flags.
Since sellers prefer allocations toward intangible assets taxed at the capital gains rate, and buyers prefer allocations toward depreciable assets like equipment or machinery, negotiation is key.
Hybrid structures
It is possible – and sometimes beneficial – to structure a hybrid transaction blending elements of both asset and stock sales. In such a deal, the buyer may purchase certain assets directly while simultaneously buying some or all of the seller’s equity interests. This may allow each party to optimize specific tax or legal outcomes.
For instance, let’s say your company operates as an S corporation. Its assets include equipment, intellectual property, and real estate. The buyer wants to acquire certain high-value assets, like real estate, to receive a step-up in basis for depreciation. The buyer also wants to purchase a controlling stake in the company’s stock to streamline the transfer of contracts, customer accounts, and licenses – which will help them avoid the need to re-negotiate under a new entity.
Under this hybrid structure, the sale of stock would generally qualify for capital gains treatment.
The real estate would be treated as a direct asset sale, and the seller would likely be taxed at capital gains rates if the property has appreciated in value. However, if the real estate had been depreciated, you could also face depreciation recapture, which is taxed at ordinary income rates up to the amount of previously claimed depreciation.
Most hybrid deals are taxed as asset sales
It’s worth noting that many hybrid deals are taxed as asset sales for federal tax purposes through special elections or reorganizations.
A Section 338(h)(10) election allows a stock sale of a C or S corporation to be treated as an asset sale for tax purposes. This provides the buyer with a step-up in basis, but the transaction remains a stock sale for legal purposes. While this election offers “the best of both worlds” from a tax standpoint, it doesn’t shield the buyer from legal risks tied to the corporate entity.
Implementing this election is complex and may require a corporate restructuring known as an “F re-organization.” Given the potential pitfalls and technicalities, it’s important to collaborate with tax and legal professionals to navigate the process effectively and avoid unintended consequences.
Considerations Based on Entity Type
C corporations
C corporations often face double taxation when selling their business through an asset sale. Gain on the sale of assets is first taxed at the corporate level, and the remaining proceeds are taxed again when distributed to shareholders.
This double taxation is a key reason why C corporation owners often prefer stock sales over asset sales. In a pure stock sale, generally, only the C corporation shareholders are taxed on the proceeds. The corporation itself remains intact, simply under new ownership.
S corporations
S corporations typically avoid the corporate-level tax in an asset sale. However, if a business was originally formed as a C corporation and converted to an S corporation later, the built-in gains tax may apply if the asset sale happens during the recognition period – which is generally five years.
Partnerships and LLCs
When selling a partnership interest, the transaction is generally treated as the sale of a capital asset, resulting in a capital gain or loss. However, a portion of the gain may be recharacterized as ordinary income if it is attributable to certain assets. These include unrealized receivables and inventory items, which can trigger ordinary income upon sale.
Consequently, both buyers and sellers should carefully consider the allocation of the purchase price and the fair market value of the partnership’s assets to understand the potential tax implications.
Engaging professional advisors
Selling a business comes with plenty of complexities, and no two deals are the same. But having the right team of professionals on your side can make all the difference. An experienced CPA can help you understand how different tax structures impact your bottom line, crunch the numbers on potential scenarios, and ensure you’re fully prepared for negotiations. Even in a straightforward sale, the details can make a big difference in your final payout and tax liability. That’s why expert guidance is key to getting the best outcome.
For more personalized advice, please contact our office.
