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In this article, we look at the tax implications of buying or selling a farm and explore how different entity types and transaction structures (asset vs. stock sale) raise a range of issues for purchasers and sellers.
Broadly speaking, acquisitions can be structured as either asset or stock sales. In a taxable stock acquisition, the buyer acquires stock from the target company’s shareholders, who are taxed on the difference between the purchase price and their basis in the target’s stock. In a taxable asset acquisition, the selling entity is taxed on the excess of the purchase price over its basis in the assets sold.
What is the structure of the entities being bought or sold?
The structure of the entity or entities being bought or sold—C corporation, S corporation, partnership, LLC, or individual—raises certain tax situations for the buyer and seller. The end game is to try and get capital gains treatment on as many assets as possible to minimize tax exposure. But this can be tricky in some instances.
In the sale of a corporation, double taxation still exists, so both the corporation and the individual shareholders are taxed on a going forward basis. Corporate transactions are usually structured as stock sales, however, there are a number of reasons stock sales are less attractive to buyers, which we’ll discuss in future columns. In a stock sale, the seller will receive capital gains treatment, however, an increase or step up in basis does not occur for the buyer. Therefore, the buyer is unable to realize additional tax savings from an increase in deductions. This creates the incentive for the buyer to pay a lower price. And while S corporation sales are only taxed at the individual level, both S corporation and C corporation transfers will usually result in the buyer negotiating for a lower price. In this case, it might be more advantageous to consider an asset sale. Regardless of the type of transaction, it is important to consult with a team of advisors
along the way to optimize the structure of the deal when buying or selling a farm.
Partnerships and Sole Proprietorships
With a partnership, the buyer can get the step up in basis, depreciate assets, and realize deductions. The seller is taxed at ordinary rates on these types of ordinary assets. Whatever you paid for those assets, that is your basis. “Hot” assets or ordinary income assets can come back to bite you without proper planning. “Hot” assets are business assets that would generate ordinary income if sold—usually inventory and accounts receivable—and are taxed as ordinary income. The same is true for any debt forgiveness. Keep in mind that structuring a sale over time, may still trigger big gains in year one. Planning is a must!
For sole proprietorships and single-member LLCs, the buyer and seller are given the same treatment as in partnership transactions.
To the extent there is intrinsic value besides the assets themselves, there can be a goodwill allocation for intangible assets. The buyer can recognize capital gains treatment on them, and the seller can amortize them.
Common Mistakes We See
We’ve talked about the importance of having advisors help you with buying or selling a farm. Here’s one example. One of the common mistakes we see people make when engaging in merger and acquisition activity is thinking that selling over time (an installment sale) will also defer tax liability. In fact, the proceeds from the sale may be taxed immediately, even before they have been realized. This can create a cash flow crunch. Even though you might structure the sale over time, you still may be immediately liable for the taxes on 100% of the proceeds from the sale. This can occur not only on the sale of an entire operation, but also on the sale of any ownership interest in a business.
We’ve talked about the common structures and tax implications to be aware of and when to get assistance. Remember, mergers and acquisitions are complicated, and it’s vital to get good advice.