What Is Acquisition Debt?
Acquisition debt is a financial obligationtaken on during the construction, improvement, or purchase of a primary or secondary residence. Thus, a home mortgage loan is an example of acquisition debt.
TheInternal Revenue Service (IRS) provides certain tax advantages for home acquisition debt. This should not be confused with acquisition financing, which refers to loans used by a business to buy another business.
Key Takeaways
- Acquisition debt is financing obtained for the purchase of acquiring a home or residential property.
- Mortgages are a common form of acquisition debt, and may receive favorable tax treatment on the interest due.
- Corporations may also take on acquisition debt in order to refinance the terms of their debt capital or to buy back dilutive shares.
Acquisition Debt Explained
Taxpayers may be able to deduct the interest paid during the tax year for mortgages that qualify as home acquisition debt. The IRS considers home acquisition debt to be any mortgage obtained after Oct. 13, 1987 that was used to buy, build, or substantially improve a main or secondary home. The mortgage must also be secured by that home as collateral. If the mortgage amount is more than the cost of the home, plus the costs associated with any substantial improvements, only the debt that is not greater than the cost of the home plus improvements will qualify as home acquisition debt.
The IRS limits the total amount of mortgage debt that can be treated as home acquisition debt. The total amount cannot exceed $1 million, or $500,000 if a married couple is filing as separate taxpayers.Under the Tax Cuts and Jobs Act, which passed Congress in December 2017, beginning in 2018, the amount of home acquisition debt (for new loans) that can be deducted decreased, to $750,000 ($375,000 for married couples filing separately). The IRS considers an improvement to be substantial if it adds value to the home, extends the home's useful life, or adjusts the home to new uses.
Special Considerations
Acquisition debt can pose a risk if the borrower does not generate sufficient funds to cover required debt payments and find themselves underwater on the mortgage. This proved to be the case during the financial crisis that began in 2007. In response, Congress passed the Mortgage Forgiveness Debt Relief Act to allow homeowners whose lenders had forgiven part of all of their mortgage loans to avoid having to include the forgiven amounts in their income for tax purposes. According to the provision, “taxpayers may exclude from income certain debt forgiven or canceled on their principal residence.” As outlined in the Act, the exclusion applied to "qualified principal residence indebtedness.”
Acquisition Debt and Corporations
Businesses often use acquisition debt as a way to avoid issuing too many additional shares, which would be dilutive to shareholders and do damage to their stock price, and to benefit from favorable tax treatment for debt. Acquisition debt might include bridge (short-term) loans, borrowings available under their existing revolving credit lines, and bonds.
Often companies plan to reduce acquisition debt via a term out, or replace it with longer-term loans andbonds, and using cash flow generation to pay down borrowings. This minimizes the company exposure to floating interest rates by locking in the interest rates. Extended the term of debt obligations also preserves financial flexibility by allowing the company to spread its debt payments over several years.
FAQs
Acquisition indebtedness is any debt that is (1) used to buy, build, or substantially improve a qualified residence of the taxpayer, and (2) secured by the residence.
What is an example of acquisition debt? ›
Acquisition debt is a financial obligation taken on during the construction, improvement, or purchase of a primary or secondary residence. Thus, a home mortgage loan is an example of acquisition debt. The Internal Revenue Service (IRS) provides certain tax advantages for home acquisition debt.
How does an acquisition loan work? ›
An acquisition loan is a loan that's given to a company to purchase a specific asset, to acquire another business, or for other reasons that are laid out before the loan is granted. Typically, a company can only use an acquisition loan for a short window of time and only for the agreed upon purpose.
What happens to debt in an acquisition? ›
When a company makes an acquisition, it will either assume the target company's debt on its balance sheet, deduct it from the total sale price, or repay it before closing the deal. The buyer can also negotiate with the lender and reduce the target company's debt to lower the total acquisition cost.
What is acquisition with an example? ›
An acquisition is a transaction whereby companies, organizations, and/or their assets are acquired for some consideration by another company. Some examples of acquisitions include: Google's $50 million acquisition of Android in 2005. Pfizer's $90 billion acquisition of Warner-Lambert in 2000.
What happens in an acquisition? ›
An acquisition is a business transaction that occurs when one company purchases and gains control over another company. These transactions are a core part of mergers and acquisitions (M&A), a career path in corporate law or finance that focuses on the buying, selling, and consolidation of companies.
What is the maximum acquisition debt? ›
The amount of acquisition debt may not exceed 75% of the purchase price of the entity to be acquired.
What is the average acquisition debt? ›
Average acquisition indebtedness is the amount of outstanding principal indebtedness during that portion of the year the property is held. It is computed by determining the principal indebtedness of the property for the first day in each calendar month it existed and averaging all the sums.
When should you use debt in an acquisition? ›
Acquiring companies that are seeking smaller amounts of funding and hope to obtain this funding more quickly will often pursue debt financing as opposed to equity funding. Businesses that want to retain control and remain local are also likely to seek debt-based acquisition financing.
Who gets the money from an acquisition? ›
Acquired for cash: An acquiring company buys the acquiree for cash and pays out money to each security holder based on an agreed-upon valuation. You usually get money only for outstanding shares and vested options.
In a merger, the stockholders of the acquired corporation typically receive cash, stock of the surviving corporation or some combination of stock and cash.
How do you get paid in an acquisition? ›
In acquisitions, buyers usually pay the seller with cold, hard cash. However, the buyer can also offer the seller acquirer stock as a form of consideration. According to Thomson Reuters, 33.3% of deals in the second half of 2016 used acquirer stock as a component of the consideration.
What happens to cash in an acquisition? ›
If a company buys another legal entity, then the acquirer will gain the ownership of all of the assets and liabilities of the acquired company, and that will include cash. How much will depend on the detailed negotiation that took place before the deal was struck.
What happens when an acquisition fails? ›
If a merger or acquisition fails, it can be catastrophic, resulting in mass layoffs, a negative impact on a brand's reputation, a decrease in brand loyalty, lost revenue, increased costs, and sometimes the permanent closure of a business.
What does an acquisition mean? ›
An acquisition is defined as a corporate transaction where one company purchases a portion or all of another company's shares or assets. Acquisitions are typically made in order to take control of, and build on, the target company's strengths and capture synergies.
Why do companies acquire debt? ›
Debt can be cost-effective, providing growing businesses of all sizes with the funds to stock up on inventory, hire additional employees and purchase real estate or much-needed equipment.
How does a company acquire debt? ›
A company can choose debt financing, which entails selling fixed income products, such as bonds, bills, or notes, to investors to obtain the capital needed to grow and expand its operations.
