Merger and acquisition activity in several sectors is on an incline – bouncing back from a slow turn in 2023. If you’re buying a business, you should want the best results possible after taxes. So, in keeping your goal in mind, it is suggested that you structure your purchase in two ways:
Buy the assets of the business, or
If the targeted business is structured as a corporation, partnership or LLC, you can buy the seller’s entity ownership interest
For the purpose of this article, we’re going to focus on buying assets.
The Tax Basics
The total purchase price must be allocated to the specific acquired assets. The amount allocated to each asset then becomes the tax basis for that asset. Now why does this matter?
For depreciable and amortizable assets like: furniture, fixtures, equipment, buildings, software, and intangibles – the initial tax basis determines the post-acquisition depreciation and amortization deductions.
When selling an asset, the tax basis becomes important in determining if your sale is a gain or a loss. To calculate, add the initial purchase price and any post-acquisition improvements, then deduct the post-acquisition depreciation or amortization value.
Assets Purchased through a Pass-Through Entity
What happens if your newly acquired business is operated a pass-through entity? For tax purposes, any losses or gains are passed through to you and reported on your personal tax returns. In such, the loss or gain from your sell will be treated as income to be reported on your upcoming personal tax returns.
Assets Purchased through a C Corporation
For tax purposes, corporations are held responsible for the payment of tax bills resulted from a post-acquisition sale. All taxable income recognized by a C-Corporation will be taxed at the federal income rate of 21%.
Allocation of the Price
At the time of acquisition, hire an appraiser to assess the total value of assets. Doing so guarantees a fair market value of each asset. Since the appraisal process involves a significant degree of subjectivity, it's possible to have multiple valid appraisals for the same set of assets. Consequently, the tax implications can vary between different appraisals, with one potentially offering more favorable outcomes for you than another. Determining appraised values is a key aspect of the purchase/sale negotiation process. So, the final agreed-upon appraisal must be reasonable.
When purchasing, pay attention to how you allocate the purchase price to the acquired assets. We recommend allocating more to:
Assets that are valued at a higher tax income
Assets that depreciate quickly like furniture and equipment
Intangible assets that can be amortized over 15 years
Assets that depreciate over longer period of times should receive a lower allocation amount.
Remember, when buying the assets of a business, the total purchase price must be allocated among the acquired assets. This allocation process can significantly impact post-acquisition tax outcomes. We can help you achieve more favorable tax results. Therefore, involve your advisor early in the process, ideally during the negotiation phase.
As always, our CPAs are here to advise you during your process. Schedule an appointment before acquiring assets to help guide you through the process.