In capital-intensive transfers of commercial property ownership the new Tax Cuts and Jobs Act (TCJA) has increased the need for a Cost Segregation Study as a tool to assist in determining property valuations during the Purchase Price Allocation clause time frame in the negotiation of commercial property transactions. This need is directly connected to the new TCJA first year 100% bonus depreciation allowance on qualified property. Bonus depreciation can be applied to any new asset with a 20 year life or less.
In addition, the 100% depreciation is allowed for both new and used, or “in use,” qualifying property. Therefore, the Buyer has a compelling interest in having the Fair Market Value (FMV) of such property “stepped-up,” - the higher the value of the personal property, the greater the tax benefit to the Buyer.
The end result is every dollar identified in a Cost Segregation study for 5, 7 and 15 year assets for their business is now eligible for 100 percent first year bonus depreciation. This can mean a very substantial increased tax benefit for the Buyer and is certainly a motivation to the Buyer to want to have allocated more of the purchase price of a business to personal property assets with stepped-up FMV.
Under the TCJA legislation qualified property placed in service between September 28, 2017, and December 31, 2022 (or by December 31, 2023, for certain property with longer production periods), will qualify for the first-year bonus depreciation. After December 31, 2022, expensing of such property placed in service is as follows: 80% in 2023, 60% in 2024, 40% in 2025 and 20% in 2026.
Buyers and Sellers not only have competing interests on price, they also have competing interests on tax consequences. Typically Buyers and Sellers have a Purchase Price Allocation clause in the purchase agreement for a window of time, usually within 90 days of the closing of the transaction, to come to an agreement on the asset allocations of the purchase price for the purposes of the requirements of Form 8594.
The Seller will be resistant to any step-ups to FMV for personal property assets due to the likely increase in taxes resulting from the sale and the Buyer is in favor of increased valuations resulting in a greater tax benefit. Because of these competing interests it is vital that a Cost Segregation Study and a Valuation of Fixed Assets take place within the 90 day, or other allotted, window of time to ensure an agreed upon allocation of assets in the final purchase agreement.
An additional reason to have the Cost Segregation Study completed within the Purchase Price Allocation time frame results from a 2012 U.S. Tax Court Ruling in Peco Foods, Inc., T.C. Memo. 2012-18 which disallowed a change to the purchase price allocation agreement using a post-acquisition Cost Segregation Study. As shown in the Peco case, once the deal has closed, there is no going back to create the opportunity to reclassify property to gain a more favorable tax treatment.
Historically Buyers have yielded to the objections of the Seller to a “step-up” in FMV in order not to jeopardize the transaction and the Buyer would agree to allocate the purchase price based on the tax “basis” of the fixed assets. However with the new law the financial benefit for the Buyer may be too tempting to ignore and the Buyer will seek to allocate as much value as possible to personal property assets by seeking a step-up in value.
A solution to this competing interest may be for the Buyer to “gross up” the purchase price to offset the incremental tax liability to the Seller. This offers the potential of a “win-win” since the Buyer gets a higher tax benefit on the immediate expensing of personal property and the Seller gets covered on the extra tax liability with the higher selling price. The seller, to protect their position, should also conduct a Cost Segregation Study and Valuation of Fixed Assets to ensure a fair Purchase Price Allocation Agreement.
Our cost segregation team at Growth Management Group (GMG) is available to help you navigate the new law and its impact on commercial transactions. GMG can provide a complimentary high-level assessment of the impact that a Cost Segregation study will have on your tax situation in order to assist you in your decision.
The Asset Valuation team of Asset Services, Inc. can provide efficient and economical fix asset valuation. Asset Services, Inc. is a leading national and international provider of fixed asset inventory management and valuations.
This information is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. The information contained herein is of a general nature and readers should thoroughly evaluate their specific facts and circumstances with a qualified tax professional.