Asset Purchase vs. Stock Purchase: Some Advantages & Disadvantages

Early in the process of buying or selling an existing business, both Buyer and Seller must come to an agreement about how the transaction will occur – that is, will the transaction be a purchase of the assets of the business or a purchase of the all of the stock (or membership interests in the case of an LLC) of the business? In an asset purchase, the Buyer purchases the selling business’ assets, including facilities, vehicles, equipment and stock or inventory, while in a stock purchase, the Buyer purchases the selling company’s stock so that Buyer will own the business rather than just its assets (and liabilities).

Tax aspects are the main reason that C - corporation Sellers usually prefer to sell their stock, while Buyers prefer to buy the assets (less the liabilities). In a C corporation asset sale, Seller will be taxed twice (1) the corporation will pay tax on any gains realized when the assets are sold, and (2) then the shareholders will pay capital gains tax when the corporation is liquidated. In contrast, if Seller sells the stock, Seller will pay capital gains tax on the profit from the sale, generally at the 15 percent long-term capital gains rate (through the end of 2010).

However from a Buyer's perspective, an asset purchase will usually be preferable. In an asset purchase, a Buyer's tax basis for depreciation is the purchase price allocated to the transferred assets. In a stock sale, the tax basis of the stock is “stepped up” to the purchase price of the stock being purchased. However, the Buyer receives whatever tax basis the Seller had in the assets. If Buyer had already depreciated some of the assets down to zero, Buyer cannot claim any more depreciation deductions on them. It is easy to see why a Buyer would much prefer the stepped-up basis of an asset sale.

One thing Seller should keep in mind when negotiating with Buyer regarding the form of the transaction — whether the deal will be a stock sale or an asset sale — is that Seller’s increased taxes from an asset sale will usually be greater than the savings that Buyer would get from the sale. A stock sale usually results in the lowest total amount of taxes being paid to the IRS, and the most money in the hands of the parties. Seller should be able to take advantage of a stock sale by adjusting the sales price to reflect the future tax burdens. Also, if the parties use a stock sale, the IRS permits Buyer to elect to have the transaction treated as an asset purchase, i.e., Buyer can get a step up in the basis for the assets purchased if Buyer pays tax on the difference between each asset’s current basis and its fair market value.

Generally, if Seller is an S corporation, there is just one tax to shareholders on either an asset or stock sale. If Seller is contemplating the sale of the business several years down the road, Seller may want to consider electing to be taxed as an S corporation now. By doing so Seller can usually eliminate the double taxation on any appreciation after the date of the switch.