Transaction cost update.

• Author: Schwartzman, Randy A.

This item discusses recent taxpayer-favorable guidance provided by the IRS and the Tax Court on the tax treatment of transaction costs.

Background

A deduction is allowed under Sec. 162(a) for ordinary and necessary expenses paid or incurred in carrying on a trade or business. However, a taxpayer must capitalize transaction costs that facilitate the acquisition or creation of an intangible asset, the taxable acquisition of a trade or business, restructuring or reorganization of a business entity, and certain other covered transactions described in Regs. Sec. 1.263(a)-5.

The tax treatment of costs capitalized under Regs. Sec. 1.263(a)-5 depends on whether the acquirer or the seller incurs the costs in the transaction, whether the acquisition is an asset acquisition or a stock acquisition, and whether the transaction is taxable or tax free. The regulations provide that amounts an acquirer is required to capitalize in a taxable acquisitive transaction are added to the basis of the acquired assets in an asset transaction or to the basis of the acquired stock in a stock transaction. Amounts the target is required to capitalize in an acquisition of its assets in a taxable transaction are treated as a reduction of the target's amount realized on the disposition of its assets.

The regulations do not address the treatment of amounts a taxpayer is required to capitalize in certain other transactions to which Regs. Sec. 1.263(a)-5 applies (for example, amounts required to be capitalized in tax-free transactions, costs of a target in a taxable stock acquisition, and stock issuance costs). The IRS and Treasury stated in Notice 2004-18 that they intended to issue separate guidance to address the treatment of these amounts and at that time will consider whether such amounts should be eligible for the 15-year safe-harbor amortization period described in Regs. Sec. 1.167(a)-3.

Costs that are not inherently facilitative and costs that are incurred prior to a bright-line date are not required to be capitalized under Regs. Sec. 1.263(a)-5. While these costs are generally deductible under Sec. 162 if they are incurred to expand an existing trade or business, they are generally capitalized and amortized under Sec. 195 if they are incurred to enable the taxpayer to enter a new trade or business.

An amount is inherently facilitative under Regs. Sec. 1.263(a)-5(e)(2) if it is paid to secure an appraisal or other formal documentation relating to a transaction...