Tax Consequences of Buying a Business in Arizona

Asset Purchase vs. Equity Purchase

What are the two ways to buy a business, and why does the choice matter for taxes?

Every business acquisition is structured in one of two ways. In an asset purchase, you buy the individual assets the business uses — equipment, inventory, real estate, contracts, customer lists, trade name, and goodwill — and usually leave the seller's legal entity behind. In an equity purchase, you buy the ownership of the entity itself (the stock of a corporation or the membership interests of an LLC), and that entity keeps owning all of its assets and owing all of its debts. The two structures produce very different federal income tax results for the buyer, so you should decide the structure before you sign a letter of intent, not after.

Why do buyers usually prefer an asset purchase?

Buyers generally prefer an asset purchase for two federal income tax reasons. First, you receive a cost basis in the assets equal to what you paid, which lets you depreciate and amortize the purchase price and lower your future taxable income. Second, you generally do not inherit the seller's federal income tax liabilities or its tax history. Sellers often prefer the opposite structure, so the deal structure is almost always a negotiated point that affects price.

Buyer Tax Consequences in an Asset Purchase

What is my cost basis in the assets I buy?

In an asset purchase your basis in each asset is its cost — the portion of the purchase price allocated to that asset, plus liabilities you assume and the costs you incur to complete the deal, such as legal and accounting fees. This is called a stepped-up basis because it is fresh and generally higher than the seller's old basis. That new basis is what you depreciate, amortize, or recover when you later sell the asset, so it is the single most valuable tax feature of an asset deal.

How do I allocate the purchase price among the assets?

Federal law does not let you assign the price however you wish. Internal Revenue Code Section 1060 requires you to use the residual method, which sorts the assets into seven classes and allocates the price to each class in order, up to fair market value, with anything left over landing in the last class as goodwill:

• Class I — cash and bank deposit accounts.
• Class II — actively traded securities, certificates of deposit, and foreign currency.
• Class III — accounts receivable and similar debt instruments.
• Class IV — inventory and property held for sale to customers.
• Class V — all other tangible assets, such as furniture, fixtures, equipment, vehicles, buildings, and land.
• Class VI — Section 197 intangibles other than goodwill, such as customer lists, trademarks, licenses, and covenants not to compete.
• Class VII — goodwill and going-concern value (the residual).

The allocation matters because assets in different classes are written off at very different speeds. You will generally want more of the price in fast-write-off classes (equipment, which can often be deducted immediately) and less in goodwill (a slow 15-year write-off), while the seller usually wants the reverse. Because the number affects both parties, the allocation is normally negotiated and written into the purchase agreement.

Do the buyer and seller have to file IRS Form 8594?

Yes. Both the buyer and the seller must file IRS Form 8594, Asset Acquisition Statement, with their federal income tax returns for the year of the sale, and the two forms must report the same allocation. Filing an allocation that contradicts the seller's is a red flag that can trigger an IRS examination, which is one more reason to lock the allocation into the signed purchase agreement so both sides report identically.

Can I immediately deduct the cost of equipment and other tangible assets?

Often, yes. Two rules let a buyer accelerate the write-off of tangible business property, and both apply to used assets bought from an unrelated seller, which is exactly what you acquire in most business purchases:

• Bonus depreciation (Section 168(k)). The One Big Beautiful Bill Act, signed July 4, 2025, restored and made permanent 100% bonus depreciation for qualifying property acquired and placed in service after January 19, 2025. Qualifying property generally means depreciable tangible assets with a recovery period of 20 years or less — machinery, equipment, computers, furniture, and vehicles. That means much of the equipment you buy can be fully deducted in the year you place it in service.
• Section 179 expensing. As an alternative or supplement, Section 179 lets you elect to expense qualifying property up front. For 2026 the maximum deduction is $2,560,000, and it begins to phase out once your total qualifying purchases exceed $4,090,000.

Whether to use these deductions in full is a planning decision. A large first-year deduction is not always ideal — for example, if your income in the first year is low, you may prefer to spread deductions into later, higher-income years. Discuss the timing with your CPA.

How do I write off goodwill and the other intangible assets I buy?

Goodwill and most other purchased intangibles are Section 197 intangibles, which you amortize (deduct) in equal amounts, straight-line, over 15 years. This category includes goodwill, going-concern value, the value of a workforce in place, customer and supplier relationships, trademarks and trade names, and business licenses and permits. Unlike equipment, these assets cannot be deducted immediately — the 15-year period is fixed by statute even if you expect the value to be used up much sooner.

How is a covenant not to compete taxed to me as the buyer?

A covenant not to compete that you obtain from the seller in connection with buying the business is a Section 197 intangible. That means you amortize what you paid for it over 15 years — even if the covenant itself only prohibits competition for three or five years. Buyers are frequently surprised that a three-year non-compete produces a fifteen-year write-off, so factor that slow recovery into how much of the price you allocate to it.

How is purchased inventory treated?

Inventory is not depreciated or amortized. Your cost of the inventory you buy becomes part of your cost of goods sold and is deducted as you sell each item. Until you sell it, the cost stays on your books as an asset.

Buyer Tax Consequences in a Stock or Equity Purchase

How am I taxed when I buy the stock or membership interests instead of the assets?

When you buy the equity of the business, your basis in the stock or interests equals what you paid, but the basis of the assets inside the entity does not change — it carries over from the seller. This carryover basis is the key drawback for a buyer: you get no step-up and therefore no fresh depreciation or amortization deductions from the money you spent, even though you may have paid far more than the entity's old asset basis. Your purchase price is locked up in your stock basis and does not reduce your taxable income until you eventually sell the equity.

Do I inherit the seller's tax history and liabilities in an equity purchase?

Yes. Because the entity survives the sale, you step into its entire tax profile. You generally inherit its remaining tax attributes, such as net operating loss and credit carryforwards, but the change in ownership triggers the Section 382 limitation, which sharply restricts how much of those losses you can use each year. Just as important, you also inherit the entity's liabilities, including unpaid or unreported federal income and payroll taxes. This is why thorough tax due diligence and strong indemnification provisions matter so much more in an equity deal than in an asset deal.

Can I get a basis step-up even though I bought stock?

Sometimes. The tax law allows certain elections — principally under Sections 338(h)(10) and 336(e) — that let a stock purchase be treated as an asset purchase for federal income tax purposes, giving you the step-up and future deductions you want. These elections have strict eligibility requirements (they generally apply to S corporations or corporate subsidiaries), they usually must be made jointly with the seller, and they can shift tax cost onto the seller, so they are a negotiated item. If a step-up is important to you, raise these elections with your tax advisor before you agree on price and structure.

Special Rules When You Buy an LLC

What are the federal income tax consequences of buying an LLC?

How the purchase of an LLC is taxed depends on how the LLC is taxed and on how much of it you buy. Under IRS Revenue Ruling 99-6:

• Single-member LLC (a disregarded entity). Buying the membership interest is treated as buying the LLC's underlying assets directly, so you get asset-purchase treatment and a full basis step-up.
• Buying 100% of a multi-member LLC (taxed as a partnership). The partnership terminates, and you are treated as having purchased the LLC's assets — again, asset-purchase treatment and a step-up.
• Buying less than all of a multi-member LLC. The LLC continues as a partnership and you are treated as buying a partnership interest. To get a step-up in your share of the LLC's inside asset basis, the LLC should make a Section 754 election, which produces a Section 743(b) basis adjustment in your favor. Confirm this election is made — without it, you lose the depreciation and amortization benefit of the price you paid.
• LLC that has elected to be taxed as an S or C corporation. The purchase is taxed under the corporate rules described above, not the partnership rules.

Other Federal Income Tax Issues for the Buyer

Can I deduct interest on money I borrow to buy the business?

Interest on debt you incur to acquire and operate the business is generally deductible as business interest, but the deduction is capped by the Section 163(j) business interest limitation, which for most taxpayers limits the deduction to a percentage of adjusted taxable income. Many smaller businesses are exempt from this limitation under a gross-receipts test, so whether it affects you depends on the size of the business. Your CPA can tell you whether the limit applies.

Are payments to the former owner under a consulting or employment agreement deductible?

Reasonable amounts you pay the former owner for genuine post-closing services under a consulting or employment agreement are deductible as ordinary business expenses when paid. Be careful, though: if the IRS concludes the payments are really disguised purchase price rather than compensation for services, it can require you to capitalize them instead of deducting them. The agreement should reflect real, documented services at a reasonable rate.

What about the seller's unpaid federal taxes in an asset deal?

A major federal tax advantage of an asset purchase is that you generally do not assume the seller's federal income tax liabilities — you buy clean assets and leave the seller's tax problems with the seller's entity. That protection is one reason buyers favor asset deals. Keep in mind that separate successor-liability rules can apply to certain state taxes and to some employment tax situations, so you should still confirm the seller's tax standing during due diligence.

Protecting Your Tax Position at Closing

What should a buyer do to protect the tax outcome of the purchase?

Decide on asset versus equity structure early, because it drives everything else. Negotiate the purchase price allocation and write it into the purchase agreement so that your Form 8594 and the seller's match. Confirm any needed elections — Section 338(h)(10), Section 336(e), or a Section 754 election for a partial LLC purchase — are documented before closing. Keep records of every acquisition cost so you can add them to basis. Above all, involve a business purchase attorney and a CPA before you sign, because the tax structure is far easier to get right at the front end than to fix after the deal closes.

This article provides general information about federal income tax rules and is not tax or legal advice for your specific transaction. Federal tax law changes, and the right structure depends on the facts of your deal. Consult a qualified attorney and CPA before buying a business.

Talk to an Arizona Business Purchase Attorney

Arizona business and tax attorney Richard Keyt and his son, attorney and former CPA Richard C. Keyt, prepare business purchase and sale agreements and help buyers structure acquisitions to minimize federal income tax and avoid inheriting the seller's liabilities. Together they have formed 10,000+ Arizona LLCs and counseled clients on buying and selling Arizona businesses.

To hire us to help you buy a business, submit our online Business Purchase Questionnaire at keytlaw.com/bizq, call Richard Keyt at 480-664-7478, or email him at rk@keytlaw.com. You can also call his son former CPA and business law attorney Richard C. Keyt at 480-664-7472 or email him at rck@keytlaw.com.

To book a free office, phone or Zoom video consultation go to the Keyt's online calendar.

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