Critical Lessons from the Peco Foods Case: Purchase Price Allocations Should Allow Flexibility for Future Cost Segregation
The U.S. Tax Court's 2012 ruling in Peco Foods, Inc., T.C. Memo. 2012-18, which disallowed a taxpayer's changes to a purchase price allocation based on a post-acquisition cost-segregation study, generated significant discussion among those performing and receiving cost-segregation studies. The Tax Court's decision, affirmed by the Eleventh Circuit in 2013 (No. 12-12169 (11th Cir. 7/2/13)), imparts several critical tax lessons for all taxpayers in an acquisition mode, regardless of whether they plan to pursue a cost-segregation study. The Peco Foods Case Peco Foods Inc. acquired all of the assets of two poultry processing plants in the late 1990s. The purchase agreement for each plant included a detailed schedule allocating the purchase price among the various assets purchased. Both agreements stated that Peco and the sellers would allocate the purchase price among the assets for all purposes, including tax and accounting purposes, in accordance with the allocation schedules. Following the acquisitions, Peco hired a third party to perform a cost-segregation analysis of the two plants to substantiate accelerated depreciation deductions for personal property that Peco originally classified as part of the acquired buildings. The study determined that segregating the various units of property entitled Peco to accelerated depreciation expense of approximately $5.3 million from 1998 through 2002. Peco filed IRS Form 3115, Application for Change in Accounting Method, to report the changes in depreciation class lives and methods of the segregated assets. Before filing the Form 3115, Peco had filed at least one tax return using depreciation class lives and methods in accordance with the allocation schedules from the asset purchase agreements. [ILLUSTRATION OMITTED] The IRS issued a notice of income tax deficiency, and Peco sought relief in the Tax Court. The IRS argued that Peco couldn't modify the purchase price allocations in a manner inconsistent with the original allocation schedules in the purchase agreements. Peco argued that the purchase price allocations were unenforceable because the allocations were ambiguous. Thus, Peco argued, it should be able to adopt the revised allocation schedules. The Tax Court concluded that Peco was not entitled to the accelerated depreciation deductions. It found that the written agreements between Peco and the sellers JL of the processing plants superseded the residual method that would otherwise be used for purchase price allocations because the written agreements clearly identified which amounts paid for the purchase of the plants should be allocated to buildings and were not ambiguous. Therefore, Peco was bound by the allocation schedules in the asset purchase agreements. Lesson 1: Applicable asset acquisitions: Answer only the questions asked. Sec. 1060 prescribes special allocation rules for determining a purchaser's basis and a seller's gain or loss in an applicable asset acquisition. An applicable asset acquisition is any transfer of the assets constituting a trade or business in which the purchaser's basis is determined by reference to the amount paid for the assets. Both the purchaser and the seller in an applicable asset acquisition generally should file Form 8594, Asset Acquisition Statement. The form fulfills the purchase price allocation reporting requirements under Sec. 1060, reporting the fair market value (FMV) and the allocation of purchase price, respectively, among Class I--VII assets, using the classification system of Regs. Sec. 1.338-6(b). It should be noted that furniture, fixtures, equipment, land, and buildings (among other assets) are all considered Class V assets. But Form 8594 doesn't necessarily determine how a taxpayer should allocate the purchase price. Sec. 1060(a) states that if, in connection with an applicable asset acquisition, the purchaser and the seller agree in writing on the allocation of any amounts paid or to the FMV of any of the assets, the agreement generally is binding on both parties unless the IRS determines the allocation is not appropriate. …