When making a sale, the buyer usually wants an asset sale and the seller wants a stock sale. The reason for this is because an asset sale provides an immediate write off for some of the assets acquired, providing the buyer with an opportunity to recoup some of the purchase price quickly.
A seller prefers a stock sale because it generally means the gain is taxed at the favorable long-term capital gain (LTCG) tax rate, which can be a difference of 7 percent (.37-.20) or more if the rate is 15 percent. With a stock sale, the buyer loses the opportunity for the potential immediate write-offs available with accelerated depreciation under an asset sale.
For example, a buyer and seller agree to an asset sale with a price of $1.5 million. Each hires a qualified valuation professional to provide an appraisal of the assets being sold. Neither the buyer nor the seller are C corporations. The results are as follows:
|
Asset
|
Seller’s Appraisal
|
Buyer’s Appraisal
|
|
Accounts receivable
|
$250,000
|
$275,000
|
|
Fixed Assets
|
$100,000
|
$175,000
|
|
Building
|
$250,000
|
$250,000
|
|
Land
|
$500,000
|
$350,000
|
|
Intangibles
|
$175,000
|
$200,000
|
|
Total
|
$1,275,000
|
$1,250,000
|
Additional factors:
- The fixed assets are fully depreciated equipment, furniture and fixtures.
- The building has an adjusted cost basis of $100,000.
- The land has a cost basis of $200,000.
- The intangibles include covenants not to compete (ordinary income) and a customer list (capital gain) 50/50.
- The sales price minus the total appraisal value is allocated to goodwill.
- Both intangibles and the goodwill are amortized over 15 years.
- The building is nonresidential and depreciated over 39 years.
Results for the Seller
Using the seller’s appraisal and federal tax rates of 20 percent LTCG, 25 percent for the gain on the building, 37 percent for the top bracket and 9 percent for New Jersey, the approximate tax paid is $430,000, leaving the seller with approximately $1,070,000 after tax.
Using the buyer’s appraisal and the same tax rates mentioned above, the approximate tax paid is $449,000 leaving the seller with approximately $1,051,000 after tax.
Results for the Buyer
In the year of purchase, using the seller’s appraisal, the depreciation and amortization deduction for a full year is approximately $133,000. Using the 37-percent federal tax rate and 9 percent New Jersey tax rate, the approximate tax savings is $54,000.
Using the buyer’s appraisal, the depreciation and amortization deduction for a full year is approximately $211,000. Using the same tax rates as above, the approximate tax savings is $84,000.
While a $19,000 tax savings for the seller and a $30,000 savings for the buyer should not be a deal breaker, if the amounts are considered material, then negotiations begin. Once a compromise is reached, the breakdown is reported on Form 8594, Asset Acquisition Statement, Under Section 1060.
Tax Planning Opportunities
For buyers, if a deal can be finalized in either 2022 or 2023, it is better to close the deal in 2022 as bonus depreciation is dropping from 100 percent in 2022 to 80 percent in 2023. Keep in mind that if the deal is structured as an installment sale, the gain from inventory and/or depreciation recapture is not eligible for installment reporting. Only capital gain income qualifies. A cost segregation study can help to accelerate the building depreciation from 39 years to assets with a useful life of 20 years or fewer that are eligible for bonus depreciation.
If the seller insists on a stock sale, a compromise could be a Section 338(h)(10) or Section 336€ election, which treat the transaction for federal income tax purposes as if it had been structured as an asset sale. New Jersey conforms to both code sections.
For sellers, the tax on the gain can be deferred by investing in a Qualified Opportunity Zone. If the gain is not deferred, it should not be subject to the net investment income tax. For New Jersey purposes, if a final-year S corporation or partnership tax return is filed in the year of the sale, the gain can be allocated to the disposition of assets line on the tax return, which would move the gain out of the partnership/S corporation buckets on the personal tax return and into the net income from disposition of property bucket. The advantage is that this gain can be decreased if the seller has current-year losses realized from the sale of securities.
While the price is important in an asset sale, also important is the allocation of the sales price among the assets, the basis, and the depreciation and amortization available for the assets to calculate the remaining cash that remains for the seller after paying taxes and the immediate tax savings for the buyer.