Sellers generally prefer stock sales because the entire gain is taxed at long-term capital gains rates. Buyers generally prefer asset sales because they get a step-up in the asset tax basis, which increases future depreciation deductions. The negotiation of deal structure is one of the most consequential tax decisions in a business sale, the difference between the two structures can be worth hundreds of thousands of dollars to the seller.
In a stock sale, you sell your ownership shares directly to the buyer. The gain, the difference between your proceeds and your stock basis, is taxed as long-term capital gain if you held the stock for more than one year. There's no depreciation recapture, and no ordinary income from individual asset allocations. This clean tax treatment is why sellers prefer stock sales.
In an asset sale, the buyer purchases the individual assets and liabilities of the business rather than the equity. The purchase price is allocated across tangible assets (equipment, real estate), intangible assets (goodwill, customer lists), and covenants (non-compete agreements). Each category carries its own tax rate. Equipment is subject to depreciation recapture at ordinary rates. Non-compete payments are fully ordinary income. Only goodwill qualifies for long-term capital gains treatment.
The buyer's preference for an asset sale is driven by the step-up in basis. In a stock sale, the buyer inherits the seller's old asset basis, meaning limited future depreciation deductions. In an asset sale, the buyer resets the basis of each asset to its purchase price allocation, generating years of depreciation that reduce taxable income. This basis step-up can be worth significant after-tax value to the buyer.
In practice, the deal structure is negotiated. A buyer may agree to a stock sale in exchange for a price concession that compensates them for the lost depreciation benefit. Alternatively, for S-corporations and certain subsidiaries, a Section 338(h)(10) election can allow an asset sale to be treated as a stock sale for the seller, achieving the tax result of a stock sale without requiring the buyer to take on historical liabilities.
Key facts
- Stock sale: gain is taxed entirely at long-term capital gains rates (max 23.8% federal including NIIT)
- Asset sale: gain is allocated across categories, some at capital gains rates, some at ordinary income rates (up to 37%)
- Section 338(h)(10) election: available for S-corps and certain subsidiaries, allows asset sale treatment for buyer with stock sale tax treatment for seller
- Buyers typically offer less in a stock sale to compensate for the loss of the basis step-up
- Asset sales expose the buyer to fewer unknown historical liabilities, making them more attractive to buyers on risk grounds as well as tax grounds
What is a Section 338(h)(10) election?
A Section 338(h)(10) election is a joint election by the buyer and seller that allows the transaction to be treated as an asset sale for tax purposes while being structured as a stock sale legally. It's available for S-corporation stock and for stock of certain subsidiaries. For the seller, the entire gain is still taxed at capital gains rates (not allocated across asset categories). For the buyer, they receive a stepped-up basis in the assets. Both parties must consent to the election.
Can I negotiate the deal structure if the buyer insists on an asset sale?
Yes. A common approach is to request a 'gross-up', the buyer increases the purchase price to compensate you for the additional taxes you owe on an asset sale versus a stock sale. If the buyer values the basis step-up at $500,000 in future tax savings, a well-negotiated seller might capture half of that as a price increase.
