Buying a business presents a host of both tax challenges and tax options. Knowing how you buy a business and how it’s going to be presented on a tax return can be just as important as the actual purchase price. As usual, I’m going to talk about things in a general sense. If you’re buying or selling a business, be sure to consult with a professional.
Alright, let’s start with the two types of sales. There are asset sales and stock sales (stock being the shares of a company, if it’s an LLC, it’s not stock it’s partnership units). An asset sale is where the assets of the company are sold where as a stock sale is where the stock or interest in the company is sold. Usually, if you’re the purchaser, you want an asset sale. If you’re the seller, usually a stock sale is the more beneficial. The primary reason an asset sale is better for the buyer (talking strictly from a tax perspective) is that the difference between the value of the assets and the purchase price of the transaction is amortizable goodwill while under a stock sale, that difference isn’t an amortizable expense. Of course a stock sale is usually an easier transaction administratively.
Let’s look at an example. You decide to buy a tanning salon for $30,000. It’s in a good location, it has below market rents for the next few years and the current owner has done a horrible job marketing the company so even though the assets of the company are only worth $20,000, you feel the $30,000 purchase price is a bargain based on the profit you’re going to bring in. Both sides agree on the value of the assets and both sides fill out and agree on a $20,000 allocation to tanning equipment and $10,000 of goodwill on Form 8883 (Asset Allocation Statement). Assuming you’re using a business structure, your business buys the “assets,” begins operating it and come tax time, the $20,000 in equipment is depreciated over a five or seven year life while the goodwill of $10,000 is amortized for tax purposes over 15 years.
Under a stock sale, let’s assume the tanning salon is owned by a company called Tanning Salon, Inc. and it’s taxed as a C-Corporation. For the same reasons above, you decide to buy the company for $30,000. The equipment has a value of $20,000 but it’s depreciable basis is $10,000 because the current owner has taken advantage of some of the more recent bonus depreciation provisions. Your “outside” basis in the stock is $30,000 so if you ever sold the stock in the company, this is what you’d use to compute your gain on the sale. Like in the asset sale example, you’d then start operating the business but now your depreciable value in the equipment is only $10,000 because you stepped into the shoes of the previous owner. There’s no goodwill to amortize under this type of transaction.
The final example has the tanning salon being owned by Tanning Salon, LLC and there are two owners who own a 50% piece of the LLC each. You’re buying out one of the 50% owners for $15,000 and you’re doing it by buying his interest in the LLC. The depreciable basis of the assets is $10,000. Since this company is a partnership for tax purposes and there’s a change in ownership of 50% or more, you’d have what’s called a technical termination. Under a technical termination, the LLC would file a “final” tax return on the date of the purchase (usually a short period return unless the sale happened at the company’s year end) and then there would be a second short period return that would take place from the date of the sale to the LLC’s normal year end date. In the “new” company, all of the depreciable assets would then restart. So you’d have a “new” basis in the asset that consists of the “old” companies purchase price in the asset less any depreciation and you’d depreciate them as if they were just purchased. This one can get messy so if you’re buying out an LLC member, like any of these situations, be sure you’re talking to an expert.
I really didn’t cover “everything” here (there’s entire books on the subject) so if you have a question on an issue I didn’t touch on, just leave me a comment and we can make this a living thread.