Treating receivables as cash equivalents in a bargain purchase transaction.

• Author: Johnson, David Brian

The Tax Court's decision and reasoning in UFE, Inc., 92 TC 1314 (1989), may enable taxpayers to treat accounts receivable acquired as part of a qualified asset purchase under Sec. 1060 as cash equivalents, or Class II assets. The treatment of receivables as cash equivalents when Sec. 1060 mandates an allocation of consideration would be particularly advantageous to a corporate taxpayer acquiring assets in a bargain purchase.

The purchase of assets that make up a trade or business is an applicable asset acquisition for Sec. 1060 purposes. The purchase price of such an acquisiiton is allocated among the acquired assets using the same rules as for Sec. 338 qualified stock purchase elections. Generally, accounts receivable are included among Class III (noncash equivalent) assets, along with inventory, fixed assets, patents and prepaid expenses, etc. Under the residual method of purchase price allocation, consideration paid in a Sec. 1060 applicable asset acquisition is allocated first to cash (Class I assets) on a dollar-for-dollar basis, then to cash equivalents (Class II assets), such as marketable securities, certificates of deposit, etc., to the extent of fair market value (FMV), and finally to Class III and Class IV assets. Consideration remaining after the allocation to Class II assets is allocated among Class III assets based on relative FMVs, with any remaining consideration allocated to Class IV assets, or nondepreciable goodwill and going convern value.

A bargain purchase transaction occurs when the assets of the corporation acquired are appraised at an FMV in excess of total consideration paid for the assets. Under the residual method of allocation, all noncash equivalent assets receive a tax basis less than FMV. For example, assume that the remaining purchase price to be allocated to the Class III assets is $400,000, and the total FMV of the Class III assets is $630,000. If accounts receivable have a face amount and an FMV of $100,000, an allocation based on relative FMVs will allocate a tax basis of $63,492 to the accounts receivable. When the full face amount of the accounts receivable is collected, an additional $36,508 will be recognized as income. This additional income is, in essence, an allocated portion of the gain, or "bargain" realized by the "new corporation" on the purchase of the assets.

When significant amounts of depreciable or amortizable assets are acquired by the purchasing entity as part of a bargain purchase, the...