Ramification of Depreciation Expense and Schedule in the Sale of a Business

There are many reasons a profitable business doesn’t show as much profit on the tax returns as the business actually generates, one of those reasons that will be highlighted here is depreciation.

Depreciation is a ‘non-cash’ expense recorded on a tax return that reduces the taxable profit of a business.  Depreciation is a write off associated with the capital expenditure on tangible assets.  Tangible assets would be physical equipment used to conduct business including what is commonly referred to as Furniture, Fixtures & Equipment (FF&E).  For example, a business that services customers in the field would have vehicles and equipment for the vehicles.  Purchases of the vehicles and equipment would be depreciated on a schedule to yield a tax write off for each year of the depreciation schedule.  Different classifications of equipment are depreciated over a different number of years, typically from one to seven years.  Depreciation does get recaptured upon the sale of a business as the basis of the equipment is reduced, if there is a profit realized on the sale of the equipment.  Obviously, consult a qualified accounting and tax professional to get an assessment of your situation.

What does Depreciation mean to the buyer of a business.  Under an asset sale purchase of a business, the basis of the FF&E are reset to the amount listed for the FF&E in the Purchase Price Asset Allocation form filed with the IRS.  Thus, buyers would be able to enjoy depreciation expense write offs based on the amount they allocate.  Under a stock sale scenario for the purchase of a business, the depreciation schedule is inherited by the buyer.  If the equipment is fully depreciated, the a buyer does not have anything left to depreciate in a stock sale scenario.

Here is a summary:

Depreciation under a Stock Sale Purchase of an On-Going Business

Con: Current depreciation schedule is inherited by the buyer.  Less depreciation write offs.
Pro: Usually a lower purchase price, partially to compensate for a lack of additional depreciation.  Also, more inherited corporate liability.  Consult with an attorney regarding stock sales.

Depreciation under an Asset Sale Purchase of an On-Going Business

Pro: Get to reset the Depreciation Schedule, which allows a possibly larger depreciation amount and write off going forward
Con: Usually a higher purchase price, partially to compensate for the additional capital tax burden the seller will be bear for the depreciated basis.  Consult with an attorney regarding asset sales of businesses.

For assistance with Exit Strategy Planning or with Acquiring a business, contact our client care manager Sonia Chhabra at  (888) 926-9193 or email cs@justelementary.com.