Step-Up in Basis: Tax Benefits for Asset Purchases

A step-up in basis is one of the most significant tax advantages of acquiring a business through an asset purchase rather than a stock purchase. By stepping up the tax basis of acquired assets to their fair market value at the time of acquisition, buyers can generate substantial tax deductions that reduce the effective cost of the acquisition.

According to the AICPA's Purchase Price Allocation Guide for M&A Transactions, the net present value of step-up tax benefits typically ranges from 10-20% of the total purchase price on a standard SME acquisition. For a $3 million deal, that can mean $300,000-$600,000 in present-value tax savings over the amortization period, a significant factor in determining the buyer's true effective acquisition cost.

When you buy assets at fair market value, your tax basis in those assets is the purchase price. This is the "step-up", the acquired assets are recorded at their current value rather than the seller's historical (often much lower) book value.

• Tangible assets: Equipment, vehicles, real estate, inventory are stepped up to FMV
• Intangible assets: Customer lists, trade names, non-compete agreements, technology are valued and stepped up
• Goodwill: The excess of purchase price over the FMV of identifiable assets becomes goodwill
• Depreciation/amortization: All stepped-up values can be depreciated or amortized for tax purposes

Consider a $3M acquisition with the following purchase price allocation:

• Equipment: $500K (depreciated over 5-7 years)
• Real estate: $800K (depreciated over 39 years for commercial property)
• Customer relationships: $400K (amortized over 15 years)
• Non-compete agreement: $200K (amortized over the agreement term, typically 3-5 years)
• Trade name: $300K (amortized over 15 years)
• Goodwill: $800K (amortized over 15 years under Section 197)

Total annual tax deductions from stepped-up assets can be $200K-$400K in the early years, saving $50K-$100K+ in taxes annually at a 25% effective rate. These non-cash deductions improve free cash flow available for debt service, which is why experienced buyers and SBA lenders model the step-up benefit into acquisition cash flow projections from day one.

• Asset purchase: Full step-up. All assets revalued to FMV. Maximum depreciation/amortization benefits.
• Stock purchase (default): No step-up. The buyer inherits the seller's tax basis in the assets, which may be fully depreciated or significantly lower than FMV.
• Stock purchase with 338(h)(10) election: Treated as an asset purchase for tax purposes. See 338(h)(10) Election guide.

Under IRC Section 197, most acquired intangible assets are amortized over 15 years:

• Goodwill
• Going concern value
• Customer lists and relationships
• Workforce in place
• Trade names and trademarks
• Patents, copyrights, and formulas
• Non-compete agreements (amortized over 15 years regardless of the actual term)
• Government licenses and permits

In asset acquisitions, the purchase price must be allocated across asset classes in a specific order:

1. Class I: Cash and cash equivalents
2. Class II: Actively traded securities, CDs, foreign currency
3. Class III: Accounts receivable, mortgages, credit card receivables
4. Class IV: Inventory
5. Class V: All other tangible and intangible assets not in other classes
6. Class VI: Section 197 intangibles (except goodwill and going concern)
7. Class VII: Goodwill and going concern value (residual)

Both buyer and seller must report the same allocation on Form 8594 (Asset Acquisition Statement).

• Buyer preference: Allocate more to short-lived assets (equipment, non-competes) for faster deductions
• Seller preference: Allocate more to goodwill (capital gains rate) and less to non-competes (ordinary income rate)
• Compromise: The allocation is negotiated as part of the purchase agreement and should be supported by independent appraisals
• IRS scrutiny: Unreasonable allocations can be challenged; always support with third-party valuations

Deloitte's Tax Considerations for Business Acquisitions guide recommends engaging an independent valuation firm to perform the purchase price allocation, particularly for deals above $2M. The cost of a third-party valuation ($5,000-$20,000) is trivial compared to the multi-year tax savings it supports, and it provides a defensible position in the event of an IRS audit.

• Step-up in basis generates significant tax deductions that reduce the after-tax cost of asset purchases
• Annual tax savings of $50K-$100K+ are common on $3M+ acquisitions
• Section 197 provides 15-year amortization for most intangible assets including goodwill
• Purchase price allocation is negotiable and should be addressed in the purchase agreement
• Consider the 338(h)(10) election for stock purchases where a step-up would be beneficial

Yes. SBA 7(a) loans commonly finance asset purchases, and the step-up applies fully. In fact, the additional depreciation and amortization deductions generated by the step-up improve the borrower's cash flow, which strengthens debt service coverage ratios. Many SBA lenders explicitly include the step-up tax benefit in their cash flow projections when underwriting the loan.

Not by default. In a standard stock purchase, the buyer inherits the seller's existing tax basis in the company's assets. However, a Section 338(h)(10) election, available for S corporations and certain subsidiary purchases, allows the transaction to be treated as an asset purchase for tax purposes while remaining a stock purchase legally. This gives the buyer the step-up benefit while avoiding the complexity of transferring individual assets, licenses, and contracts.

IRC Section 1060 requires a residual method: allocate first to tangible assets at fair market value, then to identifiable intangible assets (customer lists, trade names, non-competes), and finally the remainder to goodwill. Both buyer and seller must use the same allocation on Form 8594. While both goodwill and Section 197 intangibles amortize over 15 years, properly identifying specific intangibles can support the reasonableness of the overall allocation and reduce audit risk.