TAX PLANNING | 09/25/2024
Mergers and acquisitions are on the rise in 2024 after a slower 2023. If you’re planning to buy a business, structuring the purchase correctly can lead to significant tax advantages. There are two primary ways to structure a purchase:
- Buy the assets of the business, or
- Buy the seller’s ownership interest (if the business is a corporation, partnership, or LLC).
This article focuses on the tax considerations when purchasing business assets.
The Basics of Asset Purchases
When buying a business’s assets, the total purchase price must be allocated to specific assets. This allocation determines the initial tax basis of each asset, which is crucial for calculating depreciation, amortization, and eventual taxable gains.
- Depreciable and Amortizable Assets: Assets like furniture, fixtures, equipment, software, buildings, customer lists, and goodwill allow for post-acquisition depreciation and amortization deductions.
- Taxable Gain: When selling an asset later, the taxable gain is the difference between the sale price and the asset’s adjusted tax basis (purchase price plus improvements minus depreciation or amortization).
Tax Implications by Entity Type
- Pass-Through Entities
If the acquired business is operated as a sole proprietorship, single-member LLC, partnership, multi-member LLC, or S corporation, the business’s gains, losses, and income flow directly to your personal tax return. The applicable tax rates depend on the type of asset and the holding period before sale. - C Corporations
When the business operates as a C corporation, the corporation itself pays tax on post-acquisition income and gains at a flat federal rate of 21%.
Maximizing Tax Benefits with Purchase Price Allocation
A critical tax-planning opportunity in an asset purchase is the allocation of the purchase price.
You generally want to allocate:
- More to assets that:
- Generate ordinary income when sold (e.g., inventory and receivables).
- Can be depreciated quickly (e.g., furniture and equipment).
- Are intangible (e.g., customer lists and goodwill, which are amortized over 15 years).
- Less to:
- Assets with longer depreciation periods (e.g., buildings).
- Land, which cannot be depreciated.
Obtaining appraised fair market values for the purchased assets can support a favorable allocation. Appraisals often vary, so negotiating a reasonable allocation with the seller can help both parties achieve acceptable tax outcomes.
Plan Ahead for Better Tax Results
When buying the assets of a business, the allocation of the purchase price is critical to achieving optimal tax outcomes. This process should ideally begin during the negotiation phase to maximize post-acquisition benefits.
At Chartered Consulting, our experienced tax advisors can guide you through this complex process, ensuring you make informed decisions that align with your business goals. Contact us early to get the best possible results.