Tax Implications of an Acquisition from the Buyer Side: How Structured Asset Purchase Agreements Benefit New Owners Through Depreciation and Amortization

When businesses change hands, the structure of the acquisition has profound tax consequences for both buyer and seller. From the buyer’s perspective, the choice between an asset purchase and a stock purchase is not merely a technical distinction-it can dramatically affect the after-tax value of the deal. In the world of business acquisitions, asset purchase agreements are often favored by buyers for their unique ability to unlock substantial tax benefits, particularly through the mechanisms of depreciation and amortization.

Asset Purchases vs. Stock Purchases: The Tax Landscape

In a typical business acquisition, buyers and sellers must decide whether the transaction will be structured as a purchase of the company’s equity (stock purchase) or as a purchase of its individual assets (asset purchase). While a stock purchase involves acquiring the ownership interests in the target entity, an asset purchase involves the direct acquisition of selected business assets and, sometimes, certain liabilities. This distinction is critical for tax purposes.

From the buyer’s viewpoint, asset purchase agreements offer a compelling advantage: the opportunity to “step up” the tax basis of the acquired assets to their current fair market value. This step-up is not available in a standard stock purchase, where the buyer inherits the seller’s historical basis in the assets. The stepped-up basis is the foundation for enhanced depreciation and amortization deductions, which serve to reduce the buyer’s taxable income in the years following the acquisition.

The Power of the Stepped-Up Basis

The concept of a stepped-up basis is central to the tax benefits of asset acquisitions. When a buyer acquires business assets, the Internal Revenue Code allows the buyer to set the tax basis of those assets at the price paid for them, allocated among the various assets according to their fair market values. This is a marked departure from a stock purchase, where the assets retain their original basis, often much lower due to years of depreciation or amortization taken by the seller.

This reset in basis has immediate and long-term implications. The buyer can now depreciate or amortize the full value of the assets, rather than being limited to the seller’s remaining undepreciated basis. For example, if the seller’s machinery was nearly fully depreciated, a stock purchase would leave the buyer with little to no depreciation deductions. In contrast, an asset purchase allows the buyer to begin depreciating the machinery anew, based on its fair market value at the time of acquisition. This can translate into significant annual tax deductions, directly reducing the buyer’s taxable income and improving post-acquisition cash flow.

Purchase Price Allocation: The Art and Science

The Internal Revenue Service requires that the total purchase price in an asset acquisition be allocated among the acquired assets according to their fair market values. This allocation is not merely a formality; it is a critical negotiation point between buyer and seller, with significant tax consequences for both parties. The allocation must be reported to the IRS (typically on Form 8594, as required by IRC Section 1060), and both parties must use consistent values.

Buyers generally seek to allocate as much of the purchase price as possible to assets with shorter tax lives, such as equipment, vehicles, or software, because these assets can be depreciated more quickly, accelerating the tax benefits. Intangible assets like customer lists, patents, and, most notably, goodwill, are also important. Under IRC Section 197, most acquired intangibles-including goodwill-can be amortized over 15 years. While this is a longer period than for many tangible assets, it still provides a steady stream of annual deductions that would not be available in a stock purchase.

The negotiation over purchase price allocation can become complex, as sellers may prefer allocations that minimize their own tax liabilities, often favoring allocations to capital assets or goodwill, which may be taxed at preferential capital gains rates. Buyers, on the other hand, are motivated to maximize allocations to assets that generate the fastest and largest deductions. The resulting allocation must be reasonable and defensible, as the IRS may challenge allocations that appear artificial or self-serving (see, e.g., West Covina Motors, Inc. v. Commissioner, 68 T.C.M. (CCH) 1116 (1994)).

Depreciation and Amortization: The Engine of Tax Savings

For buyers, the ability to depreciate or amortize the stepped-up basis of acquired assets is the primary tax benefit of an asset purchase. Tangible assets such as machinery, equipment, computers, and furniture are depreciated according to schedules prescribed by the IRS, which range from three to seven years for most business equipment. Recent changes in tax law, such as the expansion of bonus depreciation under the Tax Cuts and Jobs Act, allow buyers to immediately expense a significant portion of the cost of qualifying assets in the year of acquisition, although this benefit is subject to phase-out schedules.

Intangible assets, including customer relationships, trademarks, patents, and goodwill, are amortized over 15 years under Section 197. Goodwill, which often represents a substantial portion of the purchase price in business acquisitions, is only amortizable in an asset purchase. In a stock purchase, the buyer does not receive an amortizable basis in the acquired goodwill, which can be a significant disadvantage from a tax perspective.

To illustrate, consider a buyer who acquires a business for $5 million, with $2 million allocated to equipment (seven-year property), $1 million to customer relationships (15-year property), and $2 million to goodwill (also 15-year property). The buyer can claim annual deductions based on these allocations, reducing taxable income and generating substantial tax savings over time. At a 21% corporate tax rate, these deductions can translate into hundreds of thousands of dollars in tax savings over the life of the assets.

Managing Liabilities and Tax Attributes

Another advantage of asset purchases is the ability to selectively assume liabilities. In a stock purchase, the buyer inherits all of the target company’s liabilities, known and unknown, including potential tax exposures from prior years. In an asset purchase, the buyer can negotiate to assume only specific liabilities, reducing the risk of unpleasant surprises after closing.

However, asset purchases come with a trade-off: the buyer generally does not inherit the seller’s tax attributes, such as net operating loss carryforwards or tax credits. In a stock purchase, these attributes may be preserved (though often subject to limitations under IRC Section 382 and related provisions), potentially providing future tax benefits to the buyer. Buyers must weigh the value of these attributes against the benefits of a stepped-up basis and enhanced deductions.

Transaction Costs and Deferred Tax Implications

The costs incurred in connection with an asset acquisition, such as legal, accounting, and due diligence fees, are generally capitalized and amortized over 15 years if they relate to the acquisition of intangible assets. This treatment spreads the deduction over a longer period but ensures that buyers can ultimately recover these costs through tax deductions.

Accelerated depreciation and amortization can also create temporary differences between book income (as reported on financial statements) and taxable income, resulting in deferred tax liabilities. Buyers must account for these timing differences in their financial modeling and acquisition planning, as they can affect reported earnings and cash flow projections.

Legal Authority and Case Law

The tax treatment of asset acquisitions is governed by several key provisions of the Internal Revenue Code. Section 1060 requires that the purchase price in an applicable asset acquisition be allocated among the acquired assets based on their fair market value, and that this allocation be reported to the IRS. Section 197 provides for the 15-year amortization of goodwill and certain other intangibles. The IRS has issued detailed regulations and guidance on these provisions, and courts have addressed disputes over purchase price allocation and the reasonableness of allocations in cases such as West Covina Motors, Inc. v. Commissioner and Peco Foods, Inc. v. Commissioner (T.C. Memo. 2012-315).

Practical Steps for Buyers: Maximizing Tax Benefits

Buyers seeking to maximize the tax benefits of an asset acquisition should engage experienced tax advisors early in the transaction process. Tax modeling can help buyers understand the impact of different allocation scenarios and identify the most advantageous structure. Negotiating the purchase price allocation with the seller is a critical step, and the agreed allocation should be carefully documented in the asset purchase agreement and reported consistently to the IRS.

Buyers should also be alert to opportunities for bonus depreciation and other accelerated deduction provisions that may be available under current tax law. Planning for the impact of deferred tax liabilities and ensuring that transaction costs are properly capitalized and amortized will help buyers realize the full tax benefits of the acquisition.

Structuring a business acquisition as an asset purchase offers buyers significant tax advantages that can enhance the value of the deal. The ability to step up the basis of acquired assets to their fair market value unlocks powerful depreciation and amortization deductions, reducing taxable income and improving cash flow in the years following the acquisition. Careful negotiation and documentation of purchase price allocation, combined with proactive tax planning, allow buyers to maximize these benefits. While asset purchases may involve trade-offs, such as the loss of inherited tax attributes, the long-term tax savings often justify a higher purchase price and can be a decisive factor in deal structuring.

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Howard Law is a business, regulatory and M&A law firm in the greater Charlotte, North Carolina area, with additional services in M&A advisory and business brokerage. Howard Law is a law firm based in the greater Charlotte, North Carolina area focused on business law, corporate law, regulatory law, mergers & acquisitions, M&A advisor and business brokerage. Handling all business matters from incorporation to acquisition as well as a comprehensive understanding in assisting through mergers and acquisition. The choice of a lawyer is an important decision and should not be based solely on advertisements. The information on this website is for general and informational purposes only and should not be interpreted to indicate a certain result will occur in your specific legal situation. Information on this website is not legal advice and does not create an attorney-client relationship. You should consult an attorney for advice regarding your individual situation. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.