The buyer is insisting on an asset sale so they can get a tax step-up on our equipment and software, but this structure will trigger massive depreciation recapture taxes for us compared to a stock sale. How do we calculate and negotiate a tax gross-up to bridge this valuation gap?

Question

Tyler Smith · Accepted Answer

Buyers prefer asset sales because they can step up the tax basis of the acquired assets and write off the depreciation, which significantly reduces their future tax bill. For you as the seller, an asset sale can be a tax disaster. It often triggers ordinary income tax rates on depreciation recapture and inventory, which are much higher than capital gains rates.

To bridge this valuation gap, you must negotiate a tax gross-up. First, have your CPA run a detailed tax model comparing the net after-tax proceeds of a stock sale versus an asset sale. This will give you the exact dollar amount of the tax differential, which is the cost of the buyer's step-up.

Once you have this number, present it to the buyer as a non-negotiable adjustment to the purchase price. Explain that you are willing to agree to an asset sale structure to give them the tax benefit, but they must increase the purchase price to ensure your net, after-tax cash proceeds are identical to what you would receive in a stock sale.

Smart buyers expect this negotiation. They will model the present value of their future tax savings from the depreciation write-offs. Since their tax savings are often larger than your incremental tax hit, there is plenty of room to negotiate a mutually beneficial gross-up that keeps the deal moving forward.