The manner in which you buy a business can have significant tax ramifications. Of the two ways to buy a business – by purchasing the stock or by purchasing its assets – an asset purchase can create better opportunities for bigger write-offs. Here’s why.
Disadvantages of a stock purchase.
When you buy a company’s stock, the cost basis you must use for depreciation is the value of the assets as shown on the company’s books at the time you purchase the stock. Any amount you pay over the book value of the assets cannot be depreciated.
Advantages of an asset purchase.
When you buy a company’s assets, you can allocate the purchase price among various assets of the business based on their fair market value at the time of the purchase. The amounts you allocate can then be used as the basis for the company’s depreciation deductions and to establish a loss or gain when you dispose of the assets at a later date.
For example, assume that you pay $100,000 for a business that has fixed assets with a fair market value of $100,000 and a book value of $50,000. If you buy the company’s stock, you can only depreciate $50,000 of fixed assets. But if you buy the assets of the business, you can take depreciation deductions on the full fair market value of the $100,000 in fixed assets.
Allocate asset values for maximum tax savings
Since some assets are depreciable and some are not, the way you allocate the purchase price to the various assets of the business is the key to maximizing deductions. When you’ve determined those allocations, make sure that the assets are listed in the sales contract and that a specific amount is assigned to each. You’ll need this information to support your deductions.
Handling Critical Assets
Goodwill is the amount you pay for a business in excess of the value of all the other assets of the business. The amount you allocate to goodwill is amortized over a 15-year period beginning in the month of acquisition. Be careful to assign a reasonable value to goodwill and to include it in the sales contract. If goodwill is left out of the contract, the IRS can assign a value to it and lower the value you allocate to another depreciable asset.
Seller’s agreements not to compete often assign a specific value to this item and typically
cover a fixed time period. The IRS allows agreements not to compete to be amortized over a 15-year period regardless of the fixed time period stated in the contract. Be careful not to overvalue an agreement not to compete of less than 15 years since it must be amortized over a 15-year period.
Consulting fees are often paid to sellers who remain active in the business over a period of time. If you allocate a portion of the purchase price to a consulting fee the amount is fully deductible.
Employment contracts are sometimes given to key employees before a business is sold. You acquire these contracts when you buy the business, so you can allocate a portion of the purchase price to them. The cost can be amortized over the life of the contracts and is deductible.
Lease purchase premiums are amounts paid by the buyer to acquire an existing lease at an attractively low rent. You can write off lease premium costs over the remaining term of the lease.
Subscription lists and customer lists may be amortized if its value can be ascertained and the list has a limited useful life, the duration of which can be determined with reasonable accuracy.
Business-buying traps to avoid
Don’t forget that while buildings are depreciable, land is not. If you buy buildings and land, be sure that the sales contract separately states the price of the buildings and the price of the land so you can determine depreciation deduction for the buildings.
To maximize depreciation deductions, some buyers often seek a relatively high purchase price allocation for fixed assets such as machinery and equipment. However, fixed assets may be subject to state sales tax and a high valuation can result in a higher sales tax. Some simple advance calculations will help you avoid this trap.