How does the tax cost bump work in an asset purchase?

The bump is the buyer’s tax gain from buying assets rather than shares: each asset enters the buyer’s books at what the buyer paid for it, not at the seller’s older tax cost. After years of depreciation the seller’s cost can sit far below value, so the difference can be large. It is not automatic, though. It depends on how the price is divided and on how the tax rules treat each asset.

How the price becomes a cost

Section 68 of the Income Tax Act says that when an amount can reasonably be regarded as partly the consideration for a particular property, that part is treated as the seller’s proceeds and as the cost to the person acquiring it, whatever the contract says. The CRA notes that a sales agreement may set a price for each asset, a value for inventory and an amount for goodwill. The parties agree the split, but it has to be reasonable, not merely convenient.

From cost to deductions

Depreciable property cannot be deducted all at once. The CRA says its cost is deducted over several years as capital cost allowance, and it publishes the classes of property with the rate that applies to each. The allocation therefore decides which class each dollar of the price lands in and how quickly it is deducted. The CRA also notes that the old eligible capital property system was replaced by Class 14.1 from January 1, 2017.

The same split on the seller’s return

The seller sees the mirror image. The CRA says a seller may have a recapture or a terminal loss of capital cost allowance when assets are sold, and the Income Tax Act includes recaptured amounts in income. A larger allocation to heavily depreciated equipment can therefore raise the seller’s taxable income at the same moment it raises the buyer’s deductions. That is why the split is negotiated, and why each side’s accountant should review it. Purchase price allocation explains how the schedule is built.