Documenting deductible transaction costs for acquisitive transactions.

• Author: Strong, David L.

In Chief Counsel Advice (CCA) 201624021, the IRS outlined its position regarding the ability of a target in a Sec. 338(h)(10) transaction to use the safe-harbor election provided by Rev. Proc. 2011-29. Under Rev. Proc. 2011-29, success-based fees (those contingent on the successful closing of a transaction) incurred in certain transactions can be treated as 70% nonfacilitative and 30% facilitative. Because much has been written about the treatment of success-based fees (see, e.g., Salza, "The Application of the Success-Based Fee Safe Harbor to Milestone Payments," 45 The Tax Adviser 718 (October 2014)), this item provides only a brief summary of their treatment before turning to the specific facts addressed in CCA 201624021.

The general rule for success-based fees is that amounts incurred that facilitate certain acquisitions must be capitalized to the property acquired. If the costs incurred in connection with a transaction do not facilitate that transaction, the costs would be considered investigatory and possibly deducted currently, depending on the specific circumstances. Past rules required taxpayers to document the allocation of success-based fees incurred in a transaction between facilitative and nonfacilitative costs prior the filing of their tax return. Controversy existed, though, regarding the type and extent of documentation required to establish a taxpayer's allocation of costs between facilitative and nonfacilitative activities. As a way to reduce the controversy, the IRS issued Rev. Proc. 2011-29, which allows a taxpayer in certain transactions to make a safe-harbor election to allocate the success-based fees between nonfacilitative and facilitative activities based on an established percentage (the 70%/30% split described earlier).

This safe-harbor election was expressly limited to covered transactions as defined in Regs. Sec. 1.263(a)-5(e)(3). The regulations define a covered transaction as any of the following:

(i) A taxable acquisition by the taxpayer of assets that constitute a trade or business.

(ii) A taxable acquisition of an ownership interest in a business entity (whether the taxpayer is the acquirer in the acquisition or the target of the acquisition) if, immediately after the acquisition, the acquirer and the target are related within the meaning of section 267(b) or 707(b).

(iii) A reorganization described in section 368(a)(1)(A), (B), or (C) or a reorganization described in section 368(a)(1)(D) in which stock or...