Stock Deals vs Asset Deals: Tax and Accounting

Introduction

In June 2024, Home Depot paid $18.0 billion for SRS Distribution, the roofing, landscaping and pool supplies distributor. It recorded $11.0 billion of goodwill and $5.8 billion of intangible assets, along with $1.1 billion of deferred tax liabilities, and expects only about $1.0 billion of the goodwill to be deductible for tax. Two months later, Alphabet paid $2.7 billion in cash to character.ai, the chatbot start-up, for a non-exclusive license to its language model technology, canceled the convertible instruments it held in the company and hired some of its employees. Alphabet accounted for the arrangement as a business combination, recorded $2.7 billion of goodwill and $413 million of intangible assets, and all of that goodwill is deductible for tax.

The accounting model was the same in both cases. What differed was what each buyer acquired in legal form. Home Depot acquired SRS by merger, buying the company rather than its assets, so SRS's assets kept their existing tax bases and most of the premium produces no deductions. Alphabet acquired rights and people, not Character's shares, so its tax basis reflects what it paid. At the 21% federal rate, deductions on $2.7 billion of goodwill over fifteen years are worth about $570 million of tax before discounting. The choice between buying shares and buying assets, and the tax, legal and accounting consequences that follow, is one of the first questions in structuring any deal.

A buyer can acquire a business in three legal forms, and each has its own tax treatment.

Stock Purchases and Mergers

In a stock purchase, the buyer acquires the target's shares from its owners, and the target continues to exist, now as a subsidiary, with all its assets, contracts and liabilities intact. This works when the owners are few, as with a private company or a subsidiary of another group. For a public company with thousands of shareholders, the same result is achieved by merger: in a reverse triangular merger, the most common structure, a subsidiary formed by the buyer merges into the target, the target's shareholders receive the consideration and the target survives as a wholly owned subsidiary. For tax purposes, a reverse triangular merger for cash is treated as a purchase of the target's stock.

When much of the consideration is paid in the buyer's own shares, the deal can qualify as a tax-free reorganization under Section 368, provided it meets the conditions on continuity of the target shareholders' interest and of the target's business. The target's shareholders then defer tax on the shares they receive, and the buyer inherits the target's tax bases, as in any stock deal. Most large public mergers paid largely in stock are structured to qualify.

Tax-free reorganization

An acquisition that meets the requirements of Section 368 of the Internal Revenue Code, including that a substantial part of the consideration is the buyer's stock and that the target's business continues. Target shareholders defer tax on the stock they receive, paying tax only on any cash, and the target's assets keep their existing tax bases.

Asset Purchases

In an asset purchase, the buyer acquires specified assets and assumes specified liabilities directly from the target company, which receives the price and remains in existence with whatever it did not sell. Each asset has to be transferred individually, contracts assigned, often with counterparties' consent, permits reissued and employees rehired. A cash merger in which the target merges into the buyer, a forward merger, is treated for tax as a sale of assets by the target followed by its liquidation.

Two variations give asset treatment without an asset transfer. Elections under Sections 338(h)(10) and 336(e) let a qualifying purchase of shares be taxed as if the target had sold its assets. And a buyer that acquires all the interests in a partnership or a limited liability company taxed as one is treated for tax as having bought its assets, which is why acquisitions of pass-through businesses often deliver a step-up without any election.

An Asset Deal Is Not an Asset Acquisition

The terms are easily confused. Asset deal describes the legal and tax form of a transaction. Asset acquisition is an accounting classification: a purchase of assets that do not make up a business, accounted for at cost without goodwill, as explained in business combination or asset acquisition?. A buyer that acquires all of a company's operating assets, staff and customer contracts in an asset deal is still acquiring a business, so it applies the acquisition method and records goodwill, exactly as it would after a stock purchase. Alphabet's arrangement with Character, described in its 2024 annual report, was a business combination even though it bought no shares.

The central tax difference is the buyer's basis in the assets. In a stock deal, the target's assets keep their carryover basis, usually far below the price paid, and the buyer's premium is locked inside its basis in the target's shares, which generates no deductions unless the shares are later sold. In an asset deal, the buyer's tax basis in each asset equals the part of the price allocated to it, a step-up that turns the premium into future deductions.

Step-up in tax basis

The increase in the tax basis of a target's assets, from the target's historical basis to the price the buyer paid, that results from an asset purchase or a share purchase treated as one for tax. The stepped-up amounts are depreciated and amortized for tax, so the buyer recovers part of the price through lower taxes.

The Value of the Step-Up

Acquired goodwill and most other acquired intangibles are amortized for US tax over fifteen years, straight line, under Section 197. Tangible property is depreciated over its tax life, and equipment and other property with a life of twenty years or less can be deducted in full in the first year: the One Big Beautiful Bill Act made 100% bonus depreciation permanent for property acquired after January 19, 2025, and used property qualifies when it is bought from an unrelated party rather than received with a carryover basis. Inventory written up in the deal reduces taxable income as it is sold.

The value of the step-up is the present value of those tax savings. A step-up of $800, all in assets amortized over fifteen years, produces deductions of about $53 a year and federal tax savings of about $11 a year at 21%, worth roughly $96 discounted at 8%. If part of the step-up falls on equipment eligible for bonus depreciation or on inventory, the savings come sooner and the value is higher. For a buyer, this is part of what the business is worth to it, and in a negotiation it can be shared with the seller through a higher price.

Allocating the Price for Tax

In an asset deal, the price has to be split among the assets for tax as well as for the books. Section 1060 requires the residual method: the price is allocated to seven classes of assets in order, from cash, through securities, receivables, inventory and other tangible and intangible assets, up to their fair market values, and whatever remains falls into the last class, goodwill and going concern value. Buyer and seller both report the allocation to the Internal Revenue Service on Form 8594, and they usually agree it in the purchase agreement so that their filings match.

The two sides' interests in the allocation differ. The buyer prefers more of the price in assets it can deduct quickly, such as inventory and equipment, and less in fifteen-year intangibles. A seller taxed as an individual, such as the owners of a pass-through business, prefers more in goodwill, which produces capital gain, and less in assets whose sale produces ordinary income, such as inventory or equipment on which depreciation is recaptured. A C corporation seller pays the same 21% rate on either kind of gain, so the allocation matters less to it.

The buyer's gain from a step-up is often the seller's cost, and the size of that cost depends on how the seller is taxed.

C Corporations and Double Taxation

When a C corporation sells its assets, the corporation pays tax on the gain, and its shareholders pay tax again when the proceeds are distributed to them. When its shareholders sell their shares instead, there is only one layer of tax, at the shareholder level. Take a target with assets whose tax basis is $200, owned by individuals whose basis in the shares is also $200, sold for $1,000, with shareholders taxed at a 20% capital gains rate:

The asset sale leaves the shareholders $134 worse off, while the step-up is worth only about $96 to the buyer. No price adjustment can make both sides better off, so a standalone C corporation is almost always sold as a stock deal, and public companies, which are nearly all C corporations, are acquired by merger with carryover basis. That is why acquisitions of public companies, such as Chevron's of Hess, typically create large deferred tax liabilities, the subject of asset write-ups and the deferred taxes they create.

Pass-Through Sellers

The arithmetic changes when the target is an S corporation or a partnership. Their income is taxed only once, at the owner level, so an asset sale does not add a corporate layer (except for the built-in gains tax on an S corporation that converted from C corporation status within the past five years): the owners pay roughly the same tax whichever way they sell, apart from differences in the character of the gain. The buyer's step-up then comes at little cost to the seller, and asset deals, or stock purchases with an election to treat them as asset purchases, are the norm for private pass-through targets. A seller may still ask for a higher price to compensate for ordinary income on recaptured depreciation or for state taxes, and buyers often agree to a gross-up because the step-up is worth more to them.

Sellers With Losses or Subsidiaries

Other sellers face a smaller penalty from an asset sale. A C corporation with large tax losses can use them to shelter the corporate-level gain, so the double tax largely disappears, though the losses themselves stay with the seller and are lost to the buyer. And a corporate group selling a subsidiary often has a tax basis in the subsidiary's shares close to the subsidiary's basis in its assets, so a deemed asset sale under Section 338(h)(10) costs the group little more than a share sale while giving the buyer a full step-up. Carve-outs of divisions from large companies are therefore frequently structured to deliver a step-up.

The acquisition method applies in the same way to a business bought in either form. Assets and liabilities are recorded at fair value, intangibles are identified on the same basis, and goodwill is the residual, as described in purchase price allocation. The differences arise in three places: deferred taxes, tax attributes and the liabilities that come with the business.

Deferred Taxes and Goodwill

In a stock deal, the gap between fair values and carryover tax bases creates deferred tax liabilities at closing, which increase goodwill by the same amount, and the goodwill itself is usually not deductible. Home Depot's $1.1 billion of deferred tax liabilities on SRS, which its fiscal 2025 annual report attributes mainly to the difference between the book and tax bases of the intangible assets, illustrates the pattern. Some goodwill can still be deductible after a stock deal, for instance where the target already held tax-deductible goodwill from its own earlier purchases of assets; Home Depot does not break down the source of the roughly $1.0 billion it expects to deduct.

In an asset deal, book and tax bases start out close, so few deferred taxes arise at closing and goodwill is smaller, since there is no deferred tax liability to add to it. The goodwill is tax-deductible, and because it is amortized for tax but not for the books, a deferred tax liability builds up over the following years as the tax basis falls below the book amount. That liability, unlike the one created at closing in a stock deal, represents tax already saved in cash.

Tax Attributes Stay or Go With the Entity

A target's net operating losses, credit carryforwards and other tax attributes belong to the legal entity. In a stock deal they come with it, subject to the annual cap that Section 382 imposes after an ownership change, as described in Section 382 limits on acquired NOLs. In an asset deal they stay with the seller, which can use them against its gain on the sale. A target whose main tax asset is a large pool of losses is therefore worth more to a buyer as a stock deal, while a seller with losses may prefer to sell assets.

Unknown Liabilities

The largest non-tax difference is liability. A stock buyer acquires the whole entity, including liabilities nobody has yet identified, such as undisclosed litigation, environmental contamination or unpaid taxes from earlier years. The accounting records those that meet the recognition rules at fair value, including contingencies covered in contingencies and litigation reserves, but the economic exposure is broader. An asset buyer, by contrast, takes on only the liabilities it agrees to assume, although some, such as certain environmental, product and employment obligations, can follow the assets under successor liability laws.

Beyond tax, the forms differ in how easily the deal can be completed. A stock deal leaves contracts, licenses, permits and employment relationships in place, although contracts with change of control clauses can still require counterparties' consent. An asset deal requires each contract to be assigned, which can give customers, suppliers and landlords leverage to renegotiate, and requires permits to be reissued, which can take months in regulated industries. The table summarizes the main differences:

The protections a buyer negotiates follow the structure. In a stock deal, the purchase agreement carries extensive representations about the target's liabilities, backed by indemnities, escrows or representations and warranties insurance, and specific indemnities for pre-closing taxes. In an asset deal, the focus shifts to the definition of excluded liabilities and to the allocation of the price, which affects both parties' taxes.

For a private target, the structure is a negotiated term with real value. A banker advising a buyer estimates the present value of the step-up from the expected allocation, the tax lives of the assets and the buyer's tax rate, and compares it with the cost to the seller, including any gross-up. Where a step-up is available cheaply, as with a pass-through target or a subsidiary of a corporate group, the buyer can afford to pay more than a stock buyer and still earn the same return, which is why sponsors bidding for such businesses build the tax savings into their models.

The step-up also enters valuation. The tax savings belong in the cash flow forecast, as part of the tax line in unlevered free cash flow, and for a buyer they are an addition to the target's standalone value that a stock buyer of the same business would not receive. Comparing bids from buyers who can deliver different structures therefore means comparing after-tax proceeds to the seller, not headline prices.

For reading financial statements, the structure explains several figures that otherwise look puzzling: why one acquirer reports cash taxes well above its book tax expense while another reports the reverse, why some acquisitions carry large deferred tax liabilities and others almost none, and why goodwill on similar deals differs. The business combination note states whether goodwill is deductible, and that single disclosure usually reveals which kind of deal was done.