Explore tax strategies for selling S Corp stock with company real estate. Learn about unique M&A tax structures for closely held businesses, including the formation of a holding company and real estate distribution.
M&A Tax Structures for Closely Held Businesses
September 8, 2020
When it comes to buying closely held businesses, there’s a choice between acquiring the company’s assets or its stock. While asset acquisition provides flexibility in choosing assets and liabilities, stock acquisition might be necessary for certain assets like valuable intellectual property licenses. However, dealing with appreciated real estate can complicate matters, especially if the owner wants to avoid hefty taxes.
To address this, a unique tax structure was devised to tackle the challenge. Here’s how it worked:
- Formation of Holding Company: The owner of the target company would establish a holding company by exchanging their S corporation stock for holding company stock. This move involved a tax-free “F” reorganization under Internal Revenue Code Section 368(a)(1)(F).
- QSub Election: The holding company would then make a QSub (Qualified Subchapter S Subsidiary) election for the target company. This sets the stage for further steps.
- Real Estate Distribution: The target company would distribute its appreciated real estate to the holding company. This distribution wouldn’t trigger immediate taxes, as the target company was treated as disregarded for tax purposes, effectively making the holding company the owner of the real estate.
- Stock Sale to Buyer: Subsequently, the holding company would sell the target company’s stock to the buyer. This sale would be treated for tax purposes as if the holding company was selling assets, not stock, because the target company was disregarded for tax purposes.
The result: The target owner would have cash from the sale and stock in the holding company, which now owned the real estate. The buyer would possess the target company’s stock along with its assets, excluding the real estate.
An important aspect of this approach was a Private Letter Ruling (PLR) from the IRS. This ruling clarified that the taxable event in this proposed transaction would be limited to the gain from selling non-real estate assets to the buyer. The IRS reasoned that the formation of the holding company and the distribution of real estate were not taxable due to specific provisions.
It’s crucial to note that a PLR only applies to the taxpayer who requested it and can’t be directly used by others. However, it offers insight into how the IRS might approach similar situations.
Furthermore, treating the sale of the target stock as a sale of assets provides potential benefits, like a step-up in basis for tax purposes. While this specific tax strategy is tailored to the individual who sought the PLR, it sheds light on how the IRS might view comparable transactions in an audit scenario.
For the full IRS Private Letter Ruling (Release Date: 4/15/2011), you can refer to: IRS Ruling.
By John McCauley: I help people with M&A tax issues involving privately held companies.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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