The buyer is demanding an asset sale to benefit from a tax basis step up, but our entity is an S corporation and this structure will trigger massive depreciation recapture and state tax liabilities for us. How do we negotiate a middle ground or a stock sale structure with a Section 338(h)(10) election to protect our net proceeds?

Question

Tyler Smith · Accepted Answer

This is a classic battle in deal structuring. The buyer wants an asset sale so they can write up your assets to fair market value and depreciate them, which significantly reduces their future tax bill. For you, an asset sale is a tax disaster that triggers ordinary income tax rates on depreciation recapture and potentially double taxation depending on your state.

To resolve this, you must analyze the deal on a net proceeds basis. Never negotiate on gross purchase price alone. If the buyer insists on an asset structure, you must demand a tax gross up. This means the buyer increases the purchase price to completely cover the incremental tax burden you incur by not doing a stock sale.

Alternatively, propose a stock sale with a joint Section 338(h)(10) election. This election allows the transaction to be treated as an asset sale for federal tax purposes while legally remaining a stock sale. This gives the buyer their coveted tax basis step up while keeping the transaction simple and clean. You must hire an experienced M&A CPA to model these scenarios before you sign the LOI. Knowing your exact tax walkaway number allows you to stand firm during negotiations. If the buyer refuses to cover the tax difference, they are simply trying to shift their tax liabilities onto your shoulders.