Post-deal depreciation: impact of certain nonrecognition transactions.

• Author: Smith, Annette B.

When planning an incorporation or reorganization transaction, taxpayers and their advisers often focus on choice of entity, conservation and preservation of tax attributes, and reducing the tax cost and may not examine in depth the related accounting method and depreciation issues that arise as a result of the transaction. These items may not be addressed until well after the transaction, when either the target company or the acquirer is preparing the posttransaction tax return.

Relevant Transactions

It is important to consider the effects of Sec. 168(i)(7) on transactions described in Secs. 332, 351, 361, 721, or 731 (Sec. 168(i)(7) transactions). These transactions are "step-in-the-shoes" transactions, meaning that posttransaction the acquirer or transferee will follow the target or transferor's pretransaction methods, and in general no gain or loss is recognized. Separate rules (not addressed in this item) apply with respect to asset acquisitions or deemed asset acquisitions.

Depreciation Rules

Under Sec. 168, depreciation deductions are determined by using the applicable depreciation method, recovery period, and convention. In Sec. 168(i)(7) transactions, the parties to the transaction need to give special consideration to the midquarter convention, related depreciation calculations, and bonus depreciation. Other aspects of calculating depreciation after a Sec. 168(i) (7) transaction are not discussed in this item.

Generally, for most tangible personal property, the applicable convention is the half-year convention. By applying the half-year convention, a taxpayer treats all property placed in service during any tax year as placed in service on the midpoint of that tax year. In certain circumstances, however, the midquarter convention is required. When the midquarter convention is required, the taxpayer treats all property placed in service during any quarter of a tax year as placed in service on the midpoint of that quarter. This convention is required under Sec. 168 if 40% or more of the aggregate bases of certain property are placed in service during the last three months of a taxpayer's tax year (Regs. Sec. 1.168(d)-1).

Test for Sec. 168(i)(7) Transactions

For purposes of applying the midquarter convention, a special rule applies for taxpayers that have entered into a Sec. 168(i)(7) transaction. If property transferred in a Sec. 168(i)(7) transaction also was placed in service by the transferor in the same tax year as the...