Tax Tips
| Publication year | 1976 |
| Pages | 1480 |
| Citation | Vol. 5 No. 9 Pg. 1480 |
1976, October, Pg. 1480. Tax Tips
Many lawyers seem to have the feeling that an allocation of purchase price among various assets in a purchase and sale transaction is either unimportant or involves undue complexities. Neither view is true.
To illustrate the difference allocations can make, take the following example:(fn1) "A" bought some land on June 1, 1970 for $50,000 and concurrently built a building on it for $75,000 to start a Widget business. On June 1, 1971, "A" purchased all new machinery and equipment for $35,000, and currently has $10,000 worth of Widgets on hand. "A" used rapid depreciation to keep his taxable income from the Widget business low. On June 1, 1976, "A" sold his entire Widget business to "B" for $250,000 in cash. The parties allocate the purchase price as follows:
What is the net after-tax result of this $250,000 sale?
In this example, allocations made a difference of over $49,000 to the seller and almost $58,500 to the buyer in hard after-tax dollars.
What if "A" and "B" made no allocations in their contract? Undoubtedly, they would file tax returns indicating different valuations of the assets purchased. The IRS would then be free to argue for whatever allocations it thought justified. If you, as "A"'s lawyer, approved the contract with no allocations and the IRS later established that the allocations should be as listed in case "B", "A" might, at the very least, after the drawn-out and expensive audit and possible legal proceedings with the IRS, be looking for a new lawyer!
The starting point in any discussion of allocations is that the IRS will normally accept arm's length allocations of the purchase price between buyer and seller as establishing fair market value. Only if the allocations are obviously unrealistic will they be challenged. The tax court has also repeatedly held that it takes "strong proof" to overcome an arm's length allocation contained in a purchase and sale contract. This IRS policy and tax court position gives counsel for buyers and sellers considerable leeway in structuring a sale and purchase of assets.
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