Tax Implications of Business Mergers and Acquisitions: Asset Purchase vs. Stock Purchase, IRC 338(h)(10), and Earn-Outs

By Yarik Yarosh, CPA ·September 5, 2026 ·7 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

The way a business acquisition is structured for tax purposes can shift hundreds of thousands of dollars between buyer and seller, even when the total purchase price stays the same. Under IRC 1060, the purchase price in an applicable asset acquisition must be allocated among the acquired assets using the residual method, starting with cash and cash equivalents (Class I) and ending with goodwill and going concern value (Class VII). The allocation matters because tangible assets like equipment and vehicles can be depreciated over 5-7 years (or expensed immediately under Section 179 and bonus depreciation), real property improvements qualify for cost segregation, and goodwill is amortized over 15 years under IRC 197. A buyer who allocates $500,000 to equipment (100% bonus depreciation) instead of $500,000 to goodwill (15-year amortization) saves $66,667 in present-value tax costs at a 21% rate and a 5% discount rate. The seller’s preference is generally the opposite: allocating more to goodwill (taxed at long-term capital gains rates) and less to equipment (taxed at ordinary income rates as depreciation recapture under IRC 1245). This inherent conflict makes the purchase price allocation a negotiated term of the deal.

✓Key takeaway

Asset purchase vs. stock purchase:

Factor	Asset Purchase	Stock Purchase
What is acquired	Individual assets and assumed liabilities	Stock/ownership interests of the entity
Buyer’s basis in assets	Stepped-up to purchase price (allocated under IRC 1060)	Carryover basis (target’s historical basis)
Depreciation/amortization for buyer	New depreciation from stepped-up basis	Continues target’s existing depreciation schedule
Liabilities	Buyer assumes only specifically identified liabilities	Buyer inherits ALL liabilities (known and unknown)
Contracts/licenses	May need to be reassigned (some not assignable)	Continue automatically (no assignment needed)
Seller’s tax (C-Corp)	Double tax: corporate gain + shareholder gain on liquidation	Single tax: shareholder capital gain on stock sale
Seller’s tax (S-Corp/partnership)	One level: ordinary income (recapture) + capital gain, pass-through	One level: capital gain on stock/interest sale
IRC 338(h)(10) election	N/A (already an asset purchase)	Treats stock purchase as deemed asset sale for tax purposes

IRC 1060 asset classes (residual method):

Class	Assets	Buyer’s Depreciation
I	Cash and cash equivalents	None
II	Actively traded securities, CDs, foreign currency	None (or market)
III	Accounts receivable, mortgages, credit card receivables	None (collected)
IV	Inventory	Deducted as COGS when sold
V	Tangible assets (equipment, vehicles, furniture, real property)	5-39 years (or Section 179/bonus)
VI	Intangibles (except goodwill): customer lists, patents, covenants not to compete, licenses	15 years (IRC 197) or useful life
VII	Goodwill and going concern value	15 years (IRC 197)

How does deal structure affect taxes for buyer and seller?

Hypothetical example

Round numbers. A profitable S-Corp is being sold for $3,000,000. The business has:

Item	Book Value	FMV
Accounts receivable	$200,000	$200,000
Inventory	$100,000	$100,000
Equipment (fully depreciated)	$0	$300,000
Real property (building)	$200,000	$500,000
Customer list	$0	$400,000
Noncompete agreement	$0	$200,000
Goodwill	$0	$1,300,000
Total	$500,000	$3,000,000

Seller’s S-Corp basis in stock: $500,000.

Scenario 1: Asset purchase

Seller’s tax (S-Corp pass-through to owner):

Asset	Sale Price	Basis	Gain	Character
Accounts receivable	$200,000	$200,000	$0	N/A
Inventory	$100,000	$100,000	$0	Ordinary
Equipment	$300,000	$0	$300,000	Ordinary (IRC 1245 recapture)
Real property	$500,000	$200,000	$300,000	IRC 1250 recapture (25%) + LTCG
Customer list	$400,000	$0	$400,000	LTCG (IRC 197)
Noncompete	$200,000	$0	$200,000	Ordinary income
Goodwill	$1,300,000	$0	$1,300,000	LTCG
Total gain			$2,500,000

Character	Amount	Tax Rate	Tax
Ordinary income (equipment recapture + noncompete)	$500,000	37%	$185,000
IRC 1250 recapture (real property)	$50,000	25%	$12,500
LTCG (real property + customer list + goodwill)	$1,950,000	23.8%	$464,100
Total seller’s tax			$661,600

Buyer’s Year 1 deductions:

Asset	Allocation	Year 1 Deduction
Equipment ($300K, 100% bonus)	$300,000	$300,000
Building ($500K, 39-year + cost seg)	$500,000	~$125,000 (cost seg reclassification)
Customer list ($400K, 15-year IRC 197)	$400,000	$26,667
Noncompete ($200K, 15-year IRC 197)	$200,000	$13,333
Goodwill ($1.3M, 15-year IRC 197)	$1,300,000	$86,667
Total Year 1 deductions		$551,667

Scenario 2: Stock purchase (no 338(h)(10) election)

Seller’s tax:

Item	Amount
Stock sale price	$3,000,000
Stock basis	$500,000
Gain	$2,500,000
Character	100% LTCG
Tax (23.8%)	$595,000

Seller saves $66,600 vs. asset purchase ($661,600 - $595,000).

Buyer’s Year 1 deductions:

Item	Details
Equipment	Already fully depreciated (no new deductions)
Building	Continues existing depreciation ($200K basis, ~35 years remaining)
Goodwill	$0 (no step-up, no amortization)
Customer list	$0 (no step-up)
Total Year 1 deductions	~$5,714 (only remaining building depreciation)

Buyer loses $545,953 in Year 1 deductions vs. asset purchase.

Scenario 3: Stock purchase with IRC 338(h)(10) election

Feature	Treatment
Legal form	Stock purchase
Tax treatment	Deemed asset sale
Seller reports	As if assets were sold (same as Scenario 1)
Buyer gets	Stepped-up basis (same as Scenario 1)
Best for	S-Corp targets where buyer wants step-up and contracts auto-transfer

Price allocation negotiation:

Seller Wants	Buyer Wants
More to goodwill (LTCG at 23.8%)	More to equipment (100% bonus, immediate deduction)
Less to noncompete (ordinary income at 37%)	More to noncompete (IRC 197 amortization, reasonable length)
Less to inventory (ordinary income)	Accurate inventory (COGS deduction when sold)
More to stock sale (single tax, all LTCG)	Asset purchase (stepped-up basis, new depreciation)

Earn-out payments:

Treatment	Details
Installment sale (IRC 453)	Seller reports gain as payments are received; buyer deducts interest on deferred payments
Contingent consideration	Buyer allocates earn-out to goodwill (15-year amortization when paid)
Consulting/employment agreement	Seller: ordinary income; Buyer: deductible compensation expense
Imputed interest (IRC 1274/7872)	If seller financing is below AFR, imputed interest applies

QSBS exclusion on sale (IRC 1202):

Requirement	Details
C-Corp stock	Must be a domestic C-Corp
Original issuance	Stock acquired at original issuance (not purchased on market)
5-year hold	Must hold for 5+ years
$50M asset test	Corporation had aggregate gross assets under $50M at time of issuance
Exclusion	100% of gain excluded (up to $10M or 10x adjusted basis)
Tax on $2.5M gain	$0 (if QSBS requirements met)

Illustrative numbers only, not a real client and not advice for your facts.

Can I spread the gain from a business sale over multiple years?

If the buyer pays in installments, you can report the gain proportionally under IRC 453 as you receive each payment. The installment method applies automatically to any sale where at least one payment is received after the tax year of the sale. Each payment consists of three components: return of basis (tax-free), gain (taxed at capital gains rates), and interest income (taxed as ordinary income). Dealer dispositions, sales of inventory, and sales of depreciable property to a related party don’t qualify for installment treatment. If you elect out of the installment method (by reporting the full gain in the year of sale), you cannot reverse that election without IRS consent.

Related guides:

Tax Implications of Business Acquisitions: Asset Purchase vs. Stock Purchase, IRC 338 Elections, and Due Diligence

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Cite this page

Yarik Yarosh, CPA. "Tax Implications of Business Mergers and Acquisitions: Asset Purchase vs. Stock Purchase, IRC 338(h)(10), and Earn-Outs." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-tax-implications-mergers-acquisitions-asset-vs-stock-purchase

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.