Structuring an Asset Deal under IRC 368
Even though an asset purchase isn’t generally a typical “reorganization” under Section 368, certain asset purchases may be structured in such a way as to qualify for tax-deferred treatment under these provisions. Here’s how it can play out:
- Tax-free Reorganization: If the deal is structured under a Type C (asset-for-stock) or Type A (merger) reorganization, the buyer may acquire assets without triggering immediate tax consequences for the seller, assuming the specific requirements for these reorganizations are met. This can help defer taxes on gains realized from the asset sale, making it a more tax-efficient transaction.
- Stock Consideration: For a reorganization under Section 368, stock is often used as consideration instead of cash. If a seller receives stock in the acquiring company, they may be able to defer paying taxes on the gain until they sell the new shares, which could create a deferral advantage. This is different from a straight asset purchase, where cash is typically used, and the seller recognizes gain immediately.
- Stepped-Up Basis: For the buyer, an asset purchase typically results in the ability to step up the basis of the assets to their fair market value (FMV), which can provide significant tax benefits in terms of depreciation and amortization deductions. However, if the purchase is structured under Section 368, the buyer might also get this stepped-up basis if it’s done as part of a reorganization.
- Continuity of Interest Requirement: To qualify for a tax-free reorganization under Section 368, a certain percentage of the consideration must be in the form of stock (typically at least 40%). This requirement ensures that the target company’s shareholders have a continuing interest in the business and is one of the key provisions that can impact the deal structure.
Key Considerations for Asset Purchases in a Reorganization
When structuring an asset purchase under Section 368, the following factors should be considered:
- Continuity of Business Enterprise (CBE): The buyer must continue the business of the acquired company after the transaction, which is one of the key requirements for a transaction to qualify under Section 368.
- Treatment of Liabilities: In many reorganizations, liabilities transferred along with assets must meet certain requirements to qualify for tax-deferred treatment. In an asset purchase that is structured under a reorganization, the buyer may be able to assume liabilities without triggering immediate tax consequences.
- Capital Gains vs. Ordinary Income: If the transaction is structured as a typical asset sale outside of Section 368, the seller will likely recognize capital gains on the sale of assets, depending on the nature of the assets. However, if structured as a reorganization, there may be opportunities to defer capital gains until later, especially if stock is received.
- State and Local Tax Considerations: Different states may have their own rules regarding reorganizations or asset sales, and these may affect how the transaction is treated. It’s important to consult with tax advisors to understand the full implications.
Conclusion
While IRC Section 368 is typically more applicable to stock acquisitions and reorganizations, certain types of asset purchases can still benefit from its provisions, particularly when the transaction is structured as part of a reorganization (e.g., Type C or Type A). By carefully structuring the deal and ensuring it meets the requirements for tax-free treatment under Section 368, both the buyer and seller can potentially benefit from deferred taxes and stepped-up basis.
If you’re considering structuring an asset deal with reorganization elements, it’s crucial to work with tax advisors to ensure compliance with all the technical requirements of Section 368 and to fully understand the implications for both sides.
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