Are your clients buying commercial real estate? Pay attention. Alliteration not intended - just a bonus!
In July of 2013, the the Eleventh Circuit affirmed the Tax Court’s decision to disallow a taxpayer’s attempt to change purchase price allocations for a cost segregation study. The decision further clarified several critical issues you need to be aware of to protect your real estate-buying clients. Here’s a summary:
In the process of acquiring it’s real estate purchases, Peco Foods conducted appraisals of each property, and produced detailed schedules that allocated the purchase price among the assets purchased. Peco then filed at least one tax return using the MACRS class lives, methods and conventions that corresponded with this schedule.
Peco subsequently perform a cost segregation study on two of these plants, in an effort to capture accelerated depreciation deductions. Peco argued that the purchase price allocations in the contracts were unenforceable because the allocations were ambiguous.
However, the IRS disagreed, stating the original allocation schedules were binding.
Ultimately, the Tax Court concluded that Peco was wrong, and found that the written agreements between Peco and the original sellers superseded the cost segregation approach, because the purchase agreements clearly identified how much of the purchase price was allocated to real versus personal property.
In the end, Peco was bound by the allocation schedules they agreed to when buying the properties.
Advising your real estate investor clients on cost segregation studies:
- How your client defines or describes the assets being acquired can certainly have an impact. For instance, in Peco, the Tax Court found the use of the word “building” critical in defining section 1250 assets. The court also noted that the parties could have referred to one asset as the “processing plant” instead of the “processing plant building”.
- Under IRC section 1060, a real estate purchaser has to follow special allocation rules for determining the basis of the property being purchased. The purchaser (as well as the seller) should file Form 8594, Asset Acquisition Statement, in order to fulfill the Sec. 1060 requirements. However, Form 8594 doesn’t necessarily determine how a taxpayer should allocate the purchase price. In Peco, the agreements provided far more detail than required under Sec. 1060. Peco could have satisfied these reporting requirements by simply allocating the portion of the purchase price related to all the acquired depreciable assets in a single sum as Class V assets within its purchase agreement. Ultimately, there was no benefit for Peco to agree to a more detailed purchase price allocation.
- Your client should hire you to complete a cost segregation study on the property as part of the up-front acquisition due diligence, and draft the purchase agreements accordingly. The client’s decision makers generally don’t consider this issue, until long after a contract has been executed. Here’s another opportunity for you to be their tax advisor.
As the Peco case clearly demonstrates, taxpayers without strong tax advisors are prone to making short-term decisions with long-term negative implications. Communicate with your clients throughout the year. Let them know that you can help them proactively in the search, acquisition and accounting of their real property assets.
Ideally, a cost segregation preliminary analysis should be considered as part of the purchase negotiations to determine the tax impacts (positive and negative) of how the deal is structured. You, the CPA, can do this quickly and easily.
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