In Uncategorized on 01/18/2012 at 00:30

Or, What You Call It Matters

Preparing an asset purchase-and-sale agreement often involves negotiating what you call the assets, and that can be just as important as what you pay for them. That’s what Judge Laro teaches in Peco Foods, Inc., and Subsidiaries, 2012 T.C. Mem. 18, filed 1/17/12.

Peco bought two poultry processing plants. Peco and the sellers itemized the assets “for all purposes (including financial accounting and tax purposes)” in their agreements. Most of the assets were stated to be real property, and initially Peco depreciated those assets using a 39-year, nonresidential realty, straight-line method.

Then Peco woke up, and hired two appraisers to appraise the property by components, with a view to preparing revised depreciation schedules. Both the experts were dead when this case came on for trial. Then Peco retained another expert to prepare a cost segregation study, based on those appraisals, in order to buttress an application to change its accounting method to pick up about $5.3 million of depreciation on the components. Oh yes, the preparer of the cost segregation study was also dead when the case came on for trial.

Ya gotta watch those poultry processing deals–they could be hazardous to your health.

Based on the component approach, Peco took double declining balance treatment over 15-year and seven-year lives on the components, claiming they were Section 481(a) adjustments, and depreciated them accordingly.

IRS disallowed the adjustments, claiming that Section 1060(a) mandates that what the parties say in the contract binds them, unless IRS decides the contract allocation is inappropriate. Peco claims it can use Section 338(b)(5) residual methodology.

Nope, says Judge Laro. “Peco, insofar as it seeks to elevate the residual method of section 338(b)(5) over the written allocations, misinterprets the law.

“Where the parties to an applicable asset acquisition agree in writing as to the allocation of the consideration or as to the fair market value of any of the assets, that agreement ‘shall be binding’ on both the transferee and the transferor unless the Commissioner determines that the allocation is not appropriate. Sec. 1060(a). However, where the parties to an applicable asset acquisition do not agree in writing to allocate any part of the consideration of the acquired assets, the residual method of section 338(b)(5) applies to determine the transferee’s basis in, and the transferor’s gain or loss from, each of the assets transferred. See West Covina Motors, Inc. v. Commissioner, T.C. Memo. 2009-291. Congress’ use of the phrase ‘shall be binding’, when viewed in the light of section 1060(a) as a whole, directs that the written agreement supersedes the residual method of purchase price allocation.” 2012 T.C. Mem. 18, at p. 14.

IRS’ interpretation of an agreement between seller and buyer can be set aside “only by adducing proof which in an action between the parties to the agreement would be admissible to alter that construction or to show its unenforceability because of mistake, undue influence, fraud, duress, etc.” 2012 T.C. Mem. 18, at pp. 12-13.

The agreements are clear and unambiguous: “for all purposes including financial reporting and tax purposes” means what it says.

IRS wins.

Takeaway- Have tax counsel on board when you negotiate that purchase-and-sale agreement. It might seem more expensive, but you’ll find it’s much less expensive than the alternative.

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