Cost segregation studies; purchase price allocations

By John Finocchario The Daily Record Newswire Cost segregation studies are often used as a powerful tax saving strategy when a taxpayer purchases a building. Often times, a building is purchased for a flat purchase price that does not provide a breakdown of the actual assets purchased. Taxpayers are required to depreciate buildings over a 39 or 27.5 year life. A cost segregation study breaks down the purchase price into the actual assets that were purchased. This often results in a portion of the purchase price being allocated to assets with a shorter depreciable life. By accelerating the depreciation deductions over depreciable lives as short as 5, 7 or 15 years, significant tax savings can be obtained. So what happens when a building is purchased as part of a larger asset acquisition? Section 1060 of the Internal Revenue Code requires that certain asset acquisitions provide an allocation of the purchase price between different asset categories. Both the buyer and seller complete a Form 8594, Asset Acquisition Statement Under Section 1060, which breaks out the purchase price among different asset classes. These classes include such things as accounts receivable, fixed assets and Section 197 intangibles. Because different asset classes can have different tax ramifications on the sale of those assets, this form ensures that both the buyer and seller are treating the sale consistently. Most contracts for asset acquisitions include purchase price allocations. A formal agreement is made between the buyer and seller on how the consideration is to be divided amongst the different business assets. Both the buyer and seller would use this information to complete the Form 8594. The big difference between the purchase of a building in a regular trade or business transaction and an asset acquisition under Section 1060 of the IRC is the fact that an allocation is required under Section 1060. Although a purchase price allocation would allocate a portion of the proceeds to a building, many taxpayers would still perform a cost segregation study to further allocate that portion into shorter lived assets. This practice took a significant hit earlier this year when the Tax Court ruled in the case of Peco Foods Inc. that prior purchase price allocations could not be adjusted as the result of a cost segregation study. The purchase price agreements in Peco allocated the purchase price among specific categories including "Machinery and Equipment" and "Real Property Improvements." The agreement also provided that the allocation was for financial accounting and tax purposes. Peco later performed a cost segregation study allocating some of the purchase price which was allocated to real property to shorter lived assets. The court ruled that Peco could not change the useful lives of assets originally classified as real property in the purchase agreement. The allocation in the agreement was ruled to be the final agreed upon purchase price allocation for purposes of Section 1061. The result of Peco does not preclude taxpayers from using cost segregation studies to maximize their tax savings. There are still cost segregation opportunities in these situations. Purchase price allocations need to be written to avoid any unintended tax consequences to either party. Allocations should clearly state the intent of both parties as it relates to the price allocation and asset classification. Ideally, a cost segregation study would be performed before the closing of the transaction. This would often not be practical however, so other steps can be taken to allow an opportunity to perform a study in the future. If possible, limit the use of detailed allocations in the agreement. The Form 8594 allocates assets based on class type. All fixed assets, including building, machinery and equipment, furniture and fixtures, and improvements are Class V assets on the Form 8594. Taxpayers should consider following the same allocations on the 8594 in the purchase agreement and try to limit any more detailed allocations. This would provide a much more broad allocation and could possibly allow further segregation within a class type in the future. The agreement could also state that the allocations and classifications contained in the agreement are not intended to be binding for federal income tax purposes. It is also important to remember that the Peco ruling was applicable to a specific transaction. Taxpayers who are considering, or have previously performed a cost segregation study on a building acquired in an asset acquisition should review the facts of Peco and compare their situation to those in the case. It is very possible that the taxpayer's asset allocation in the purchase agreement is ambiguous enough to allow for a future cost segregation study. If it is determined that the facts are similar to Peco and a cost segregation has already been performed, a taxpayer should consider filing a Form 3115, Application for Change in Accounting Method, to change the depreciation methods back to those methods consistent in the original agreement. This would provide the taxpayer with IRS audit protection. Most importantly, taxpayers need to be sure that the appropriate tax and cost segregation experts are consulted in any asset acquisition to be sure that all tax consequences are considered before any agreements are finalized. A cost segregation study can result in tremendous tax savings when done correctly and within the rules of the Internal Revenue Code. ---------- John Finocchario, CPA, is a manager in the tax department at Mengel, Metzger, Barr & Co. LLP. He may be reached at Jfinocchario@mmb-co.com. Published: Thu, Jun 21, 2012