Structuring Asset vs Entity Purchases When Commercial Space for Sale Includes a Business

Structuring Asset vs Entity Purchases When Commercial Space for Sale Includes a Business

When you find commercial space for sale that comes with an operating business, you face a critical decision: should you buy the assets or the entity itself? This choice shapes everything from tax treatment to liability exposure, and getting it wrong can cost you significantly in the long run.

The distinction matters because purchasing a business and its real estate is fundamentally different from buying an empty building. The transaction involves not just bricks and mortar but also contracts, employees, inventory, intellectual property, and potential liabilities. Understanding the structural options helps you negotiate better terms and protect your interests.

Asset Purchase Structure

An asset purchase means you buy specific assets from the seller's business entity, which continues to exist. You pick and choose what you want: the building, equipment, inventory, customer lists, trade names, and specific contracts. The seller retains the legal entity and any liabilities you do not explicitly assume.

This structure offers several advantages for buyers. You get a stepped-up tax basis in the acquired assets, which typically means higher depreciation deductions going forward. More importantly, you generally avoid inheriting unknown liabilities. If the seller's business faces pending lawsuits, unpaid taxes, or environmental violations, those problems usually stay with the seller's entity.

The asset approach does require more documentation. You need separate bills of sale for different asset categories, assignment agreements for contracts you want to take over, and potentially consent from third parties whose agreements you are assuming. Lease assignments may require landlord approval, and some contracts may not be transferable at all.

From a real estate perspective, the asset purchase means you take title to the property through a standard deed transfer. You can conduct thorough due diligence on the property itself, including environmental assessments, title searches, and zoning reviews. Any issues discovered can be addressed before closing or reflected in the purchase price.

Entity Purchase Structure

An entity purchase means you buy the ownership interests in the company that owns both the business and the real estate. If the seller operates as an LLC, you purchase the membership units. For a corporation, you buy the stock. The entity continues operating with the same legal identity, but under new ownership.

This approach offers simplicity in one respect: you execute a single purchase agreement for the ownership interests rather than documenting transfers of individual assets. Contracts, licenses, and permits generally remain in place without requiring third-party consents. Employees remain employed by the same entity, avoiding potential issues with benefit plans or employment agreements.

However, entity purchases come with significant risks. You inherit everything, including liabilities that may not be apparent during due diligence. Past tax issues, employment claims, contractual disputes, product liability exposure, and environmental contamination all transfer with the entity. Even comprehensive representations and warranties from the seller provide limited protection if the seller lacks resources to satisfy indemnification claims years later.

The tax treatment also differs. Buyers typically do not get a stepped-up basis in the underlying assets, which means less favorable depreciation treatment. Sellers often prefer entity sales because they may qualify for capital gains treatment on the entire transaction, while asset sales can trigger ordinary income on certain assets like inventory or depreciation recapture.

Hybrid Approaches and Practical Considerations

Some transactions use hybrid structures to balance competing interests. One common approach involves an asset purchase combined with a Land Trust Deed or similar arrangement for the real estate component. Another option is purchasing the entity but making a Section 338(h)(10) election, which treats the transaction as an asset purchase for tax purposes while maintaining the legal form of an entity purchase.

When evaluating commercial space for sale with an operating business, consider these factors:

• Liability exposure: Does the business face significant litigation risk, environmental issues, or regulatory compliance concerns that make inheriting the entity dangerous?
• Contract transferability: Are key contracts, licenses, or permits difficult or impossible to transfer in an asset purchase?
• Tax implications: How do the different structures affect your depreciation deductions, the seller's tax liability, and the overall deal economics?
• Financing requirements: Does your lender have preferences or restrictions regarding the transaction structure?
• Third-party consents: What approvals do you need from landlords, franchisors, suppliers, or customers under each structure?

Due Diligence and Documentation

Regardless of structure, thorough due diligence is essential. For the real estate component, this includes title examination, survey review, environmental assessment, zoning compliance verification, and physical inspection. For the business component, you need financial statement analysis, tax return review, contract examination, employee benefit plan assessment, and intellectual property verification.

The purchase agreement should address how the price is allocated between real estate and business assets, which affects both tax treatment and potential future disputes. Include detailed schedules listing all assets, contracts, and assumed liabilities. Specify any excluded assets or retained liabilities clearly.

Representations and warranties should cover both property condition and business operations. For entity purchases, insist on comprehensive disclosure schedules and consider purchase price holdbacks or escrows to secure indemnification obligations. Title insurance for the real estate and representations and warranties insurance for the business can provide additional protection.

If you are purchasing an entity, review the operating agreement or corporate bylaws to understand any transfer restrictions or required approvals. You may need to document the transaction through an Assignment and Assumption of Contract for specific agreements that require formal assignment even in an entity purchase.

Negotiating the Structure

Sellers typically prefer entity sales for tax reasons and simplicity, while buyers usually favor asset purchases for liability protection. The final structure often results from negotiation, with price adjustments reflecting the different risk allocations and tax consequences.

If the seller insists on an entity sale, negotiate robust indemnification provisions, longer survival periods for representations and warranties, and meaningful escrow arrangements. Consider requiring the seller to resolve known issues before closing or to obtain tail insurance coverage for potential claims.

For asset purchases, be prepared to pay for the seller's increased tax burden or to accommodate concerns about contract transfers and third-party consents. Building flexibility into the timeline can help secure necessary approvals without jeopardizing the transaction.

The structure you choose when buying commercial space for sale with an operating business affects your tax position, liability exposure, and operational transition. Asset purchases generally offer better protection but require more documentation and third-party cooperation. Entity purchases provide simplicity but transfer all liabilities. Careful analysis of your specific situation, thorough due diligence, and experienced legal guidance help you structure the transaction to achieve your business objectives while managing risk effectively.

What are the tax implications of an asset purchase vs stock purchase for commercial property?

The tax treatment differs significantly between asset and stock purchases when commercial space for sale includes a business. In an asset purchase, buyers can allocate the purchase price across individual assets, often stepping up the basis for depreciation purposes and creating immediate tax benefits. Sellers, however, may face higher tax burdens due to ordinary income treatment on certain assets like inventory or equipment. In a stock purchase, buyers acquire the entity's existing tax basis without depreciation benefits, but sellers typically benefit from lower capital gains rates. Understanding these implications is critical before finalizing your transaction structure, as they directly impact your net proceeds and future tax obligations. Consult with tax advisors to model scenarios specific to your deal.

How do you allocate purchase price across real estate and business assets in a sale agreement?

Purchase price allocation is a critical component when commercial space for sale includes an operating business. The buyer and seller must agree on how the total purchase price splits among tangible assets like real estate, equipment, and inventory, and intangible assets such as goodwill, customer lists, and intellectual property. This allocation directly impacts tax liabilities for both parties, as real estate typically receives capital gains treatment while certain business assets may be subject to ordinary income rates. Your sale agreement should include a detailed schedule listing each asset category with its assigned value. Consider obtaining independent appraisals for significant assets to support your allocation and reduce IRS scrutiny. Both parties should consult tax advisors before finalizing the allocation to ensure compliance with Section 1060 reporting requirements and optimize their respective tax positions.

What liabilities do you assume when buying an entity that owns commercial real estate?

When you purchase an entity that owns commercial space for sale, you inherit all existing liabilities tied to that entity. This includes outstanding debts, pending lawsuits, tax obligations, environmental liabilities, and any contractual commitments. You also assume responsibility for leases, service agreements, and potential code violations. Unlike an asset purchase where you can selectively acquire property and walk away from unwanted obligations, an entity purchase means stepping into the seller's shoes completely. Hidden liabilities such as deferred maintenance, undisclosed liens, or employment claims can surface after closing. Thorough due diligence is critical, including reviewing financial statements, litigation history, and all contracts. Consider requiring indemnification provisions and obtaining representations and warranties insurance to protect against unknown risks that may emerge post-transaction.

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