How the IRS taxes asset sales differently from stock sales

What to take away

Asset sale or stock sale: the choice that sets every number after it

The price is agreed before anyone asks what is being sold. Then the structure decides who pays what.

In an asset sale the buyer purchases the equipment, the receivables, the name and the goodwill. The seller pays tax asset by asset. In a stock sale the buyer purchases the shares. The company keeps its assets, its basis and its history.

That single difference drives the buyer's depreciation, the seller's rate, and how much of the price survives to the closing wire. It is also the first thing a lender reads in the file, because the collateral schedule follows the structure.

The risk each side carries under the two structures is set out in asset sale versus share sale.

How Section 1060 splits an asset sale into seven classes

Section 1060 applies to any direct or indirect transfer of a trade or business where the buyer takes a carryover or stepped-up basis. It requires both parties to allocate the price the same way, and the allocation stops being negotiable once the forms are filed.

Consideration is applied in that order. The parties value Classes I through IV, the residue becomes Class V, and anything left over runs down to Class VI and then Class VII. Goodwill is the plug. It absorbs whatever the buyer pays above the hard assets.

A seller with a low basis in equipment may want a large Class VII number, because goodwill held long term is a capital asset. The buyer amortizes that same goodwill over 15 years under Section 197. Both sides can be right about the same dollar, which is why allocation fights are common.

What Form 8594 requires from the buyer and the seller

Form 8594, Asset Acquisition Statement Under Section 1060, is filed by both parties with the return for the year of sale. It reports total consideration and the amount allocated to each class. Each side gives the other a copy.

The Instructions for Form 8594 (11/2021) | Internal Revenue Service set out the allocation method and the reporting duty. A supplemental Form 8594 is filed when the allocation changes later, which is routine after a purchase price adjustment, a contingency, or an earnout payment. If you plan to structure an earnout, budget for the supplemental filing.

The form is not optional. A buyer that fails to file can lose the step-up it paid for. A seller that reports a different allocation than the buyer invites a matching notice.

Worked example: a $2,000,000 machine shop

A buyer pays $2,000,000 for a machine shop in an asset purchase. The seller's adjusted basis in the equipment is $300,000. The parties agree on these values.

The seller reports $180,000 on receivables with a zero basis. The seller reports $200,000 on inventory. The seller reports $900,000 on equipment carrying a $300,000 basis. The non-compete and customer list are Section 197 intangibles. Goodwill is capital gain.

The buyer takes a $900,000 basis in the equipment and a $700,000 Section 197 intangible amortized over 15 years.

If the parties cannot agree on Class V, the residual method settles it: the excess after Classes I through IV becomes Class V, then VI, then VII. The IRS does not demand a separate appraisal for each class, only a reasonable allocation.

The underlying rules on dispositions sit in Publication 544 (2025), Sales and Other Dispositions of Assets | Internal Revenue Service.

Where stock sale gain lands: capital treatment under Publication 542 and Publication 550

In a stock sale the seller sells shares. The corporation keeps its assets and its basis, and the seller's gain is the amount realized less the basis in the shares.

A C corporation does not recognize gain when it issues or sells its own shares. Publication 542 (01/2024), Corporations | Internal Revenue Service covers corporate treatment of stock sales, liquidations and reorganizations. The shareholder recognizes the gain or loss.

For an individual, Publication 550 (2025), Investment Income and Expenses | Internal Revenue Service covers capital gains and basis. Shares held more than one year produce long-term gain. Shares held one year or less produce short-term gain taxed at ordinary rates.

Basis is usually what the seller paid for the shares plus capital contributions, less returns of capital. A founder paid $50,000 and sells for $2,000,000. That yields a $1,950,000 gain. Held long term, the top rate is 20 percent plus the 3.8 percent net investment income tax.

A Section 338 election lets the parties treat a stock purchase as an asset purchase for tax purposes. The buyer gets a step-up, and the seller pays tax on the deemed asset sale. It surfaces when the buyer wants basis and the seller is a corporation that can absorb the gain.

A stock sale is simpler at closing: no asset-by-asset allocation, no Form 8594 for the sale itself, no re-titling of equipment. That simplicity is why sellers ask for it and buyers resist it.

Installment reporting under Section 453 and Publication 537

Section 453 lets a seller spread gain across the years payments arrive. It applies when at least one payment comes after the year of sale. The seller reports gain as cash comes in rather than all at closing.

Publication 537 (2025), Installment Sales | Internal Revenue Service explains the mechanics. The seller computes a gross profit ratio, gross profit divided by total contract price, and applies it to each payment.

The ratio does the work. Take a $2,000,000 asset sale with $400,000 down. The seller carries a $1,600,000 note. At a 60 percent gross profit ratio, every $100,000 of principal carries $60,000 of gain and $40,000 of basis coming back.

Installment reporting is a cash flow tool, which is one reason seller financing terms matter as much as the headline price.

There are limits. Depreciation recapture cannot be deferred under Section 453; it is reported in the year of sale even if no cash arrives. Inventory sold in the ordinary course cannot use the method, and neither can dealers in real property or publicly traded stock.

A pledge rule can also trigger gain if the seller pledges the note as loan security, so read it before signing.

The buyer's basis is the full purchase price, not the cash paid, so the buyer depreciates the whole allocated basis while the note is outstanding. Interest on the note is ordinary income to the seller and a deduction to the buyer, subject to the imputed interest rules.

Tax rate comparison line by line: ordinary income versus capital gains

The structure decides the rate. Here is the comparison for a seller.

The top ordinary rate for a sole proprietor is 37 percent, plus self-employment tax on some income. The top long-term capital gains rate is 20 percent, plus the 3.8 percent net investment income tax. That gap is why sellers ask for stock deals and buyers ask for asset deals.

The gap is narrower than it looks. A seller with a high basis in equipment pays little ordinary tax on the equipment portion. A seller with a low basis in shares pays capital gains on nearly the whole price. Basis, holding period and asset mix decide the outcome.

A C corporation adds a second layer: the corporation pays on its gain, and the shareholder pays again on the distribution. That is why many small businesses are organized as S corporations or LLCs.

For a seller, the after-tax number is the real price. A $2,000,000 asset sale split evenly between ordinary income and capital gain can net less than an $1,800,000 stock sale taxed entirely as capital gain. Run both before signing.

Double taxation, basis step-up and the price a buyer will actually pay

A buyer pays more for a step-up. It is the difference between the seller's old basis and the price, and the buyer recovers it through depreciation or amortization.

A stock purchase gives no step-up without a Section 338 election. The buyer inherits the target's basis and its history, including contingent liabilities. That is why buyers discount stock deals.

The discount is not small. A buyer might pay $2,000,000 for assets. That same buyer might pay $1,700,000 for stock. The buyer loses the depreciation shield in a stock deal. The buyer also takes on unknown liabilities. The seller keeps the capital gains rate and gives up part of the price.

Double taxation hits C corporations hardest: corporate tax on the gain, then shareholder tax on the distribution. An S corporation avoids the corporate layer, though gain still flows through and keeps its character.

The asset mix matters too. A buyer that wants the customer list and the goodwill pays for Class VI and Class VII. A buyer that wants the building pushes value into Class V. Settle the allocation before closing, not after.

Clean financials support the goodwill number. A seller that can normalize the owner's salary presents a defensible earnings figure, which is what Class VII rests on. Without it, the buyer discounts the whole deal.

Several offers on one business can look very different after tax. The share sale vs asset sale canada guide compares five offers once allocation and rates are applied.

State treatment in California, New York and Texas compared

Federal rates are only part of the bill. States tax the same gain under their own rules, and the spread is wide.

California taxes capital gains as ordinary income. There is no separate rate. The top marginal rate is 13.3 percent, plus a 1 percent mental health services tax above $1 million. Asset and stock sales can both land at the top, so the federal gap is the main difference.

New York has its own schedule. Long-term capital gains for individuals reach 10.9 percent in New York City, with a lower state rate outside the city. New York also offers a qualified emerging technology and manufacturing credit that can reduce the effective rate on certain gains, so a manufacturer should check eligibility before closing.

Texas has no personal income tax, so an individual seller pays no state tax on the gain. A Texas business may still owe franchise tax on its own activity.

Other states matter. Florida has no personal income tax. Illinois taxes capital gains as ordinary income. Massachusetts applies 5 percent plus a 4 percent surtax on high earners. Washington taxes capital gains above a threshold.

The state where the seller resides usually taxes the gain, not where the business operates. A California seller with $1,950,000 of long-term gain can pay more than $270,000 in state tax on top of federal tax. A Texas seller with the same gain pays zero. That difference can decide which offer wins.

Common questions

Does the buyer or the seller file Form 8594?

Both file. Each attaches Form 8594 to its return for the year of sale and gives a copy to the other party. A supplemental form is filed if the allocation changes later.

Can a stock sale get a basis step-up?

Only with a Section 338 election, which treats the stock purchase as an asset purchase. The seller pays tax on the deemed asset sale, so the election usually requires a price adjustment.

Can I defer all tax with an installment note?

No. Depreciation recapture is reported in the year of sale, and interest is ordinary income as received. Only the deferred gain portion follows the payments.

Which structure gives the seller the lowest rate?

A stock sale usually does, because the gain is capital gain. An asset sale can still win if the seller has high basis in the assets or the buyer pays a premium for the step-up.