As a tax advisor, you will need to employ different strategies when you are representing a buyer vs. seller in the sale of a company. Buyers and sellers tend to have diametrically opposed preferences, since what is advantageous for one is often disadvantageous for the other from a tax perspective. In this article, we’ll zero in on things to look out for when your client is the buyer of a business.
When you represent the buyer, you need to focus on the consequences of the transfer of assets to your client. The tax basis of the assets is calculated by the capital investment made, or the amount paid, to purchase the business. This will differ if you are dealing with a stock sale. The basis of stock is generally the purchase price plus the costs incurred through making that purchase, such as commissions and recording or transfer fees.
For the buyer, you want to look at how fast you can depreciate that purchase to help mitigate tax consequences. One option for businesses with real property is to use a cost segregation study. You will have to enlist the help of an engineer for this. Cost segregation does not increase the amount you can depreciate, but it can accelerate the time when the buyer will be able to take those deductions.
This strategy allows you to assign shorter lives―the number of years the asset is likely to remain in use and contribute to revenue―to personal property. You may then be able to utilize benefits like Section 179, which lets business owners deduct a set dollar amount of their new business assets, or bonus depreciation, which lets them deduct a percentage of the cost of those assets.
In a cost segregation study, the purchase price is generally allocated to four components. This reclassification separates items that can be depreciated over a shorter period of time from the depreciation timeline of the building as a whole. The four components are:
- Five- or seven-year personal property lives
- 15-year land improvements
- Nondepreciable land
- 27.5 years (residential) or 39 years (commercial) building
For example, let’s say your client is selling a business and buying a business in the same year. Cost segregation can help you, as their tax advisor, to create more deductions to offset the capital gain from selling their business. By identifying what counts as fixtures, you can depreciate those aspects of the building in a much shorter time period.
Another consideration when representing the buyer is whether your client is purchasing an S corporation. In this scenario, remember that an S corporation itself can own stock in the company as a subsidiary. If the acquired company is an S corporation, the company’s S election will terminate when it is acquired. To remedy this, you can do an immediate liquidation to give you carryover basis, so all of the assets that are distributed carry over to the new entity.
The buyer might also be able to take a 338(h)(10) election, which allows the sale of stock to be treated as if it was an asset sale for tax purposes. To qualify for the 338 election, the buyer must be a corporation that is purchasing the stock of another corporation. The buyer must also purchase 80% or more of that company’s stock within a 12-month period.
Essentially, the buyer creates a new corporation, which buys all of the assets from the target company (the business being acquired). So the target company is liquidating in the hands of the seller, resulting in only one level of tax on the deemed asset sale. The caveat here is that all affected shareholders have to approve the transaction, which is not always possible to negotiate.
The buyer in a business sale may have a myriad of options to maximize their tax savings depending on the specifics for that business. Learn to anticipate the possible pathways your client can take by becoming a Certified Tax Planner.
