Most manufacturing business buyers seek an asset sale, rather than a stock sale for the tax benefits associated with an asset sale. When you purchase a $2 million dollar manufacturing company, you want a return on your investment.
Non-Transferable Assets
With an asset sale, you start receiving ROI in the first year in the form of tax deductions. Under section 1060 you allocate the purchase price among hard, non-transferable assets and any excess above the value of the hard assets, (good will).
An asset sale means a “stepped up” tax basis whereby you immediately begin depreciating or amortizing the entire purchase price. The entire purchase begins to pay for itself in the form of tax deductions with different asset categories being depreciable over a set number of years depending on the category.
However, manufacturing companies sometimes have incredibly valuable non-transferable assets that are not transferable in an asset sale. An example might be a direct vendorship with a Fortune 100 company, a key contract, a hard to get industry certification or a cage code.
The long term value of a direct vendorship with a company like Honeywell, for example, exponentially increases the value of a company. How can a buyer preserve these non-transferable assets and still get the same tax deductions? There is a little known way for an acquirer of manufacturing companies to have their cake and eat it too.
“There is a way for a buyer to acquire a target company’s
stock for legal purposes, but their assets for tax purposes.”
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It’s called a Section 338(h)(10) Election. There are some restrictions on the type of buyers and sellers that can take advantage of this election. The buyer MUST be either a C or an S corp. The selling entity MUST be an S corp. or a subsidiary in a consolidated group.
If you are considering the acquisition of a manufacturing company with valuable, non-transferable assets, check with the Business Broker and your CPA to see if the 338(h)(10) election can help you get the best of both worlds!