Taxation

Understanding the Tax and Legal Aspects of an Asset Sale

When selling or acquiring a business, one of the most important structural decisions is whether the transaction will be structured as an asset sale or a stock (or equity) sale. Each approach has distinct legal and tax implications for both buyers and sellers. At Vanguard Legal PLLC, our attorneys regularly advise on business sale structures and work closely with your tax advisors to help you understand — and minimize — your overall tax exposure.

Asset Sale vs. Stock Sale: Key Differences

In an asset sale, the buyer purchases individual business assets — such as equipment, inventory, intellectual property, contracts, and goodwill — rather than acquiring ownership of the entire legal entity. The seller retains the legal entity itself (such as a corporation or LLC) and may need to wind it down after the sale.

In a stock sale, the buyer acquires the ownership interests (stock or membership units) of the company, stepping into the shoes of the prior owners. The entity’s assets and liabilities remain intact.

Aspect	Asset Sale	Stock Sale
Ownership Acquired	Specific assets (and sometimes liabilities)	Equity in the company
Buyer’s Tax Basis	Stepped-up basis in purchased assets	Carryover basis in assets
Tax Impact on Seller	Possible double tax for C corporations	Typically single-level tax
Complexity	May require retitling assets and contracts	Simpler operationally
Liabilities	Buyer can choose which liabilities to assume	Buyer assumes all entity liabilities

Why Buyers Prefer Asset Sales

From a tax perspective, buyers often favor asset sales because they receive a step-up in basis in the acquired assets, equal to the purchase price. This higher basis allows the buyer to claim future depreciation or amortization deductions, reducing post-acquisition taxable income.

Buyers also benefit from being able to cherry-pick assets and liabilities, limiting their exposure to unknown or contingent obligations.

Why Sellers Often Prefer Stock Sales

Sellers typically prefer stock sales because they usually trigger capital gains tax treatment and avoid double taxation. For corporations, selling assets can create two layers of tax — one at the corporate level when assets are sold, and another when proceeds are distributed to shareholders. A stock sale generally results in a single level of tax to the shareholders.

Tax Consequences by Entity Type

Entity Type	Tax Consequences of Asset Sale
C Corporation	Two levels of tax: (1) corporate tax on the gain from selling assets; (2) shareholder tax when proceeds are distributed. Buyers get stepped-up basis.
S Corporation	Generally one level of tax at the shareholder level. Gain is passed through to shareholders. Certain items (e.g., depreciation recapture) may be taxed as ordinary income.
LLC or Partnership	Single-level tax at the owner level. Each partner reports their share of the gain. Sale may generate ordinary income (for inventory, receivables, or depreciation recapture) and capital gain (for other assets).
Sole Proprietorship	All gains and losses are reported directly by the owner. Similar to partnership treatment.

Tax Treatment of Specific Assets

An asset sale typically requires an allocation of the purchase price among different asset categories, as required under IRC §1060. This allocation affects the tax character of gain or loss recognized by the seller and determines the buyer’s basis for depreciation and amortization.

Asset Category	Tax Treatment for Seller	Tax Treatment for Buyer
Inventory	Ordinary income	Deductible cost when sold
Accounts Receivable	Ordinary income (if previously deducted)	Collectible with no deduction
Depreciable Equipment	Depreciation recapture taxed as ordinary income	New depreciation based on purchase price
Real Property	Capital gain, except for recapture portion	Depreciable/amortizable based on allocation
Goodwill & Intangibles	Capital gain	Amortized over 15 years under §197

Depreciation Recapture

Depreciation recapture occurs when the sale price of a depreciated asset exceeds its adjusted tax basis. The previously claimed depreciation deductions are “recaptured” and taxed at ordinary income rates, which can significantly increase the seller’s tax liability. This is a common issue in asset sales of equipment-heavy businesses.

Purchase Price Allocation

Both buyer and seller must agree on an allocation of the purchase price among asset classes for tax reporting purposes, generally using IRS Form 8594. Proper allocation can materially impact each party’s tax liability. For example:

Buyers may want to allocate more to depreciable assets to accelerate deductions.
Sellers may prefer allocation to goodwill or capital assets for favorable capital gain treatment.

Negotiating this allocation is a critical step in the transaction process and should be supported by valuation data.

Section 338 Elections: Stock Sale Taxed as an Asset Sale

In some cases, a buyer acquiring stock in a corporation can make an election under IRC §338 (or §338(h)(10)) to treat the transaction as an asset sale for tax purposes.
This allows the buyer to enjoy the benefits of an asset purchase — such as a stepped-up basis — while the transaction remains legally a stock sale.

This election is commonly used in acquisitions of S corporations or C corporations that are members of consolidated groups, and it must be jointly elected by the buyer and seller. However, the election can accelerate tax liability for the seller, so careful modeling is essential.

Tax Tips to Mitigate the Tax Consequences of an Asset Sale

Plan Early: Engage tax and legal advisors early in the process to structure the transaction optimally.
Evaluate Entity Type: Consider whether converting an entity type (e.g., C corp to S corp) before sale might reduce tax exposure.
Review Depreciation Schedules: Identify assets with large recapture potential and consider planning opportunities.
Negotiate Purchase Price Allocation: Strategic allocation can minimize ordinary income recognition.
Consider Installment Sales: Spreading payments over time can defer recognition of gain.
Leverage Net Operating Losses (NOLs): If available, these can offset gain recognized on asset sales.
Coordinate with Accountants: Ensure alignment between tax reporting and transaction documents.