Business buyers usually would rather buy the assets of a business than the stock of the corporation owning the business. If you buy stock, you buy sins. You buy potential lawsuits and the company tax history.
When you buy assets, instead of stock, the sins stay with the old owners. You get a fresh start at depreciating the purchased business. You may also get to amortize purchased goodwill over 15 years. To do that, you have to allocate the business purchase price among the assets. How?
Buyers want to allocate the purchase price to short-lived assets – inventories and equipment, in particular — to deduct the purchase price as fast as possible. Most equipment can be depreciated over a seven-year life, but many assets can be written off even faster. Sellers would rather allocate the purchase price to land (non-depreciable), buldings (39-year life) and goodwill (15-year life).
The tax law encourages buyers and sellers to agree by requiring them to file Form 8594, disclosing the allocation, with their returns. By matching the buyer and seller 8594s, the IRS can keep taxpayers from taking opposing positions for tax advantage.
When Peco Foods bought two Mississippi poultry-processing plants, they agreed on a purchase price allocation with the seller and duly filed Form 8594. But then they tried to improve it. They hired an appraisal company to do a “cost segregation study.” Engineers looked over the purchased buildings and identified components that were really part of the manufacturing machinery and should therefore be written off over a shorter life. They filed tax returns using the results of the study.
The IRS didn’t like that. The seller reported gains based on the sale of buildings, which normally provide favorable capital gain rates. If the purchase price had been allocated more to machinery in the first place, the IRS would likely have collected higher taxes because additional purchase price allocated to machinery is normally recaptured depreciation on the machinery, taxable at ordinary rates. So the IRS on exam said that the cost segregation study didn’t change the allocation, and the assets had to be written off more slowly.
The Tax Court last year upheld the IRS, and last week the Eleventh Circuit Court of Appeals agreed (footnotes and citations omitted, my emphasis):
The Tax Court found that the decision to allocate the purchase price separately among the three assets clearly evidences Peco’s intent not to allocate any part of the purchase price to subcomponent assets. We agree. The term “Real Property: Improvements” is not ambiguous, and therefore, the original Canton allocation schedule is binding upon Peco.
In binding Peco to both agreements, the Commissioner can be assured that both the buyer (Peco), and the respective sellers, (Green Acre and MD), treat the assets consistently for federal tax purposes. As the Danielson court observed, “‘where parties enter into an agreement with a clear understanding of its substance and content, they cannot be heard to say later that they overlooked possible tax consequences.'”
The Moral? If you want to do a cost segregation study on newly-purchased assets, you need to do it in time to write it into the purchase agreement. The tax law doesn’t provide a cost-segregation mulligan.
Cite: Peco Foods, Inc & Subsidiaries, CA-11, No. 12-12169