TL;DR: Buyers push for asset sales. Sellers prefer stock sales. The tax difference on a $10 million deal can exceed $1.1 million in after-tax proceeds. Know the structure before you sign the LOI.
The buyer is not your friend. Neither is the deal structure they propose.
According to Morgan & Westfield, one of the most-cited M&A advisory sources in the lower middle market, few transactions under $50 million are structured as stock sales. Buyers fight for asset sales. They have good reason to. The tax benefits are substantial, and unless you understand the mechanics, you will give them away for nothing.
Here is what you need to know before your first letter of intent.
The basic split
An asset sale is exactly what it sounds like. The buyer purchases specific assets: equipment, inventory, customer lists, goodwill, intellectual property. Not the legal entity that owns them. Your LLC or corporation continues to exist. You retain the liabilities attached to it. The buyer gets a clean start.
A stock sale transfers ownership of the entity itself. The buyer acquires your shares. Everything inside the company transfers with it: assets, contracts, permits, employees, and liabilities. The buyer inherits your history, good and bad.
That liability exposure is why buyers push hard for asset sales. The step-up in tax basis is why they push even harder.
The basis problem
In an asset sale, the buyer resets their cost basis on every acquired asset to whatever price is negotiated for it. On a $10 million deal, if $5 million is allocated to equipment, the buyer can deduct that $5 million quickly against future income. Under current law, 100% bonus depreciation is permanent for qualifying assets placed in service after January 19, 2025. A $5 million equipment allocation generates a $5 million Year 1 deduction, worth roughly $1.85 million in immediate tax savings at a 37% effective corporate rate.
In a stock sale, the buyer gets none of that. They inherit your historical tax basis, which is often a fraction of what they paid. The only deduction available is amortization of goodwill over 15 years. On a $10 million stock deal, that is $666,667 per year in deductions spread across a decade and a half. The economic difference runs into seven figures on a single transaction.
That basis advantage is what you trade away when you agree to an asset sale structure.
What it costs you
Sellers pay for this trade in two ways: depreciation recapture and tax rate differentials.
In a stock sale, the entire gain is typically taxed at long-term capital gains rates: 15 to 20% federal, plus 3.8% Net Investment Income Tax for higher earners. Maximum combined federal rate: 23.8%.
In an asset sale, the IRS disaggregates your gain. Every piece of previously depreciated equipment is subject to Section 1245 recapture, taxed as ordinary income at rates up to 37%. If you fully depreciated $800,000 of machinery over the years and the buyer allocates $800,000 to it in the purchase price, you pay ordinary income rates on all of it. Only gains above the original purchase price revert to capital gains treatment.
IronClad Wealth Management's analysis shows the tax difference between an asset sale and a stock sale for a capital-intensive manufacturing business can exceed $1.19 million on a $10 million transaction. That is not a rounding error. That is real after-tax proceeds that disappear because of the deal structure.
C-corps pay twice
If your business is a C-corporation, asset sales carry an additional risk: double taxation.
The corporation pays 21% federal corporate tax on the asset sale gain. When you distribute the after-tax proceeds as a shareholder, you pay capital gains tax on top of that: up to 23.8% federally. The combined effective rate can approach 40 to 44% on the same dollars.
S-corp and LLC owners are not immune from recapture, but they avoid the double-taxation problem because gains flow through to personal returns only.
Know your entity type before entering any sale process. Your corporate structure determines your exposure. Your exposure determines your negotiating position.
The 338(h)(10) compromise
When buyer and seller are deadlocked on structure, S-corp sellers have one tool most business owners have never heard of: the Section 338(h)(10) election.
This election treats a stock sale as an asset sale for federal tax purposes, without legally transferring the assets. The buyer gets the step-up in basis and the depreciation benefits. The seller avoids double taxation because gains flow through to personal returns, not first to a corporation. Contracts, licenses, and permits stay in place because the entity does not change hands at the legal level.
Per RKL LLP, the election requires mutual consent from buyer and all shareholders. The buyer must acquire at least 80% of the seller's stock in a qualifying purchase. And the election is only available when the seller is a U.S. S-corporation or a qualifying corporate subsidiary.
The catch: the 338(h)(10) does increase your tax burden compared to a clean stock sale. You are giving the buyer a benefit. You should be paid for it. If a buyer pushes for this election without offering additional consideration, they are capturing your tax dollars at no cost. Negotiate the premium before you agree.
Purchase price allocation: where the real money lives
In any asset sale, you and the buyer must agree on how to allocate the purchase price across the IRS's seven asset classes and file Form 8594 per IRS Section 1060 rules. That allocation determines your tax bill.
Allocation to goodwill generates capital gains for you. Allocation to depreciable equipment generates ordinary income recapture. Buyers will push to load value onto equipment and inventory. Sellers should push to load value onto goodwill and customer relationships.
This is one of the most negotiated elements of any asset deal, and one of the most overlooked by sellers without experienced M&A counsel. The difference between a goodwill-heavy allocation and an equipment-heavy allocation can mean $200,000 to $400,000 in additional taxes on a mid-market transaction.
Never leave allocation language for later. Lock it down in the LOI.
Earnouts add another layer
IBBA Market Pulse Q4 2024 data shows earnout use in lower-middle-market deals has grown to roughly 10% of $5 to $50 million transactions. Earnouts can bridge valuation gaps. They can also trap sellers on taxes.
Earnout payments received post-closing in an asset sale context are typically taxed as ordinary income, not capital gains. If you negotiated a $1 million earnout and the deal is structured as an asset sale, you may owe up to 37% in federal income tax on that million instead of the 23.8% you expected. Understand the tax treatment of every dollar in your deal structure before you sign.
What to do before the LOI
Before you enter any sale process, before you hire a banker, before you take a buyer call, run both scenarios.
Get a tax advisor to model your after-tax proceeds under an asset sale and a stock sale based on your entity type, your depreciable asset base, and your current tax basis. The difference will sharpen your negotiating position immediately.
Identify your recapture exposure. Every fully depreciated piece of equipment is ordinary income waiting to be triggered. Know the number before the buyer does.
If you are a C-corp owner, consider whether an S-corp conversion makes sense well before you go to market. That conversion has a built-in waiting period for optimal tax treatment. The time to act is years before the sale, not months.
And if a buyer proposes an asset sale late in the process, after you have already received an LOI at a particular price, recognize what is happening. They are shifting the tax burden onto you without adjusting the price. That is a re-trade. You can push back, and you should.
How Patriot Growth Capital approaches structure
When PGC evaluates an acquisition, we look at more than EBITDA. We look at entity type, asset composition, depreciable basis, and how the purchase price allocation will land for both sides. Our view on how veteran-led PE differs from traditional search funds starts with transparency on structure and economics, not just headline multiples.
The structure of your deal is not an afterthought. For a business owner who built something over 20 to 30 years, the difference between an asset sale and a stock sale can mean the difference between a comfortable retirement and a tax bill that changes the plan entirely.
Get experienced M&A counsel before you sign anything. Know the mechanics. And do not give away the basis step-up for free.
