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When you buy business assets, no do-overs.

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Joe Kristan is a CPA at Roth & Company P.C.

When a business goes up for sale, the buyer often prefers to buy the business assets, rather than corporate shares or LLC interests. Buying only the assets minimizes the baggage you might assume if you buy the corporation stock. 

Tax planning often favors an asset purchase. If you buy assets, you normally get to re-start the depreciation of the business, and you can deduct purchased "goodwill" of the business over 15 years. Purchasers of stock normally get no "step-up" of the business assets for depreciation. 

The tax law wants business buyers and sellers to agree on the purchase price allocation. That is to keep the buyers and sellers from "whipsawing" the tax man. Sellers typically want to allocate sale price to non-depreciable land, to long-lived buildings, and to goodwill, because those gains are taxed at favorable capital gain rates. In contrast, buyers want to allocate purchase price to inventory and equipment - which they can deduct sooner, but which generate high-rate ordinary income to the seller. 

The buyer and seller have to report the allocation on Form 8594 with their tax returns so the IRS can make sure the buyer and seller aren't taking differing positions. If they do take differing positions, the IRS can assess each taxpayer based on the other taxpayer's allocation, they just step aside and let them fight it out.

A company named Peco Foodsbought two poultry processing plants in Mississippi. They went ahead and filed their Form 8594, as they were supposed to. Then they had second thoughts. 

They hired an appraisal company to do a “cost segregation study.” Engineers looked over the purchased buildings and identified components they considered to really be part of the manufacturing machinery, and therefore eligible to be written off over a shorter life. They filed tax returns using the results of the study, taking larger depreciation deductions.

The IRS didn't like that, as this led to a "whipsaw." They disallowed the additional deductions, saying the buyer was stuck with the original allocation. The Tax Court agreed, and now the Eleventh Circuit Court of Appeals has upheld the Tax Court:

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?  No do-overs. You only get one shot at the purchase price allocation when you buy a business. The purchase price allocation needs to be addressed early in your negotiations. If you want to have experts come in for a cost segregation study, you should do it as part of your due diligence before the deal closes, or under agreement afte the close with the seller. You can't unilaterally change the allocation. 

Be sure to consult with your own tax advisor at all stages of any business purchase or sale.

-Joe Kristan

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