Pre-closing Purchase Price Allocations Tax Strategies for Purchasing Going Concern Properties Innovative Solutions to Taxing Problems
Tax Strategies for Purchasing Going Concern Properties When a business, as well as its underlying and dependent real and personal property is being sold as a package for a single lump sum, it is important to consider four individual components of value that are typically embedded in such transactions. These components of value commonly represented in going concern properties are land, buildings, tangible personal property (TPP) and intangible personal property (IPP), also commonly known as business enterprise value. It is critical to proactively identify, calculate, and allocate these components to avoid inflated taxation at the closing, or thereafter. Most properties involved in commercial ventures eventually face these issues; therefore, the purchaser must carefully consider proactive analysis and tax planning. Such properties typically include hotels, resorts, golf courses, health care facilities, television stations, regional shopping centers, and any other special purpose buildings. CONTENTS Tax Strategies for Purchasing Going Concern Properties 1 Top Ten Prerequisites for Managing and Minimizing Tax Liability on a Going Concern Property Acquisition 3 A prudent buyer of such properties must be sure that a formal and objective allocation is incorporated into the closing documents of the transaction, ensuring accurate valuation to effectively manage future tax liability that may result from the transaction. Proactively addressing certain issues prior to closing is critical for minimizing and managing the associated tax effects. Unfortunately, allocations of the entire going concern purchase price among these components of value are usually made after the acquisition of the property is complete. As a result, significant opportunities to objectively document the proper market values in the sales agreement and closing documents are missed, inhibiting the purchaser s ability to manage acquired assets and minimize tax liabilities over the period of the investment. Failure to proactively segregate, track, and consistently report the total going concern consideration paid for acquired assets will inevitably result in higher tax liability, including erroneous assessments, inflated real estate transfer taxes on the acquisition, and future property taxes that are not market supported. Tax Strategies for Purchasing Going Concern Properties 1
By incorporating a proactive purchase price allocation and asset identification strategy into the normal due diligence and pre-closing process, a buyer can significantly impact the amount of income, property, and transfer taxes payable at or after closing. In addition, the buyer is able to better manage and minimize the overall tax liability associated with those assets over the entire investment holding period, increasing overall investment yields and maximizing shareholder value. When commercial real property is acquired, it is important to identify and segregate the commingled value of the real property from the tangible and intangible personal property to better manage and minimize the taxation of these assets and determine if they meet the following criteria: Accommodates an established and profitable business with specialized furniture, fixtures, and equipment used in connection with the business Requires a trained, specialized, and experienced staff Seeks repeat business from its clients Relies on brand or name recognition to attract and retain clients Has pre-sold future business on the books that would be transferable on a sale Has existing vendor contracts in place Possesses all of the other hallmarks of a profitable going concern Requires a government license or permit to operate This approach is especially beneficial if the acquisition includes a bulk sale of properties, particularly where there has been no breakout of the aggregate sales price among each individual property s going concern. If no segregation in sales prices has occurred, the problem is compounded. Neither of the individual going concern values are necessarily objectively allocated among the properties, nor are the underlying values of the components of each of those going concerns. Not all states tax tangible personal property, but most of them tax real property. Portfolio allocations will enable the buyer to leverage the beneficial impact of the individual purchase price allocations at the property level, given that the real and tangible personal property assets are closely reviewed and proactively allocated. 2 www.ryanco.com
Top Ten Prerequisites for Managing and Minimizing Tax Liability on a Going Concern Property Acquisition 1 The buyer and seller should systematically agree to a purchase price allocation and document those values at or before the closing. Doing so in writing will formally and precisely allocate the total going concern value between the real estate (land and buildings), the TPP, and the IPP for each property where these components of value are present and included in the transaction. 2 The buyer and seller should negotiate the allocations incorporated into the actual sales agreement and closing documents. These allocations must be reasonable and supported by generally accepted appraisal practices, standards, and guidelines. 3 If an appraisal is prepared for the lender, all Uniform Standards of Professional Appraisal Practice (USPAP) required allocations of non-realty issues should be documented within the report and used as the basis for the allocations at closing. Otherwise, an independent study should be commissioned and used prior to closing. 4 When allocating IPP at closing, it is preferable to allocate this total amount into the five permitted Financial Accounting Standards Board (FASB) categories of FASB No. 141 to avoid the entire IPP amount being subsequently characterized as non-depreciable goodwill. 5 At closing, the buyer should always require the seller to deliver a formal Bill of Sale evidencing the sale and transfer of title for only the TPP, with a designated consideration shown therein. The deed transferring title to the real estate should also identify only the real estate value, if permitted locally. A separate Bill of Sale for the IPP with its own separate considerations is also recommended. 6 At closing, the buyer, seller, and associated representatives should always ensure that any real estate recordation or transfer taxes are reported and paid, based only on the segregated real estate value of the sales price, not the larger, total going concern sales price. Tax Strategies for Purchasing Going Concern Properties 3
7 Pre-closing, the buyer and seller should consult with their tax advisors, attorneys, and accountants or auditors to confirm that there are no adverse effects on any existing special tax status for the company. For example, this would be important for a Real Estate Investment Trust (REIT) buyer where there are maximum amounts of non-realty that can be acquired and exploited without jeopardizing their special Internal Revenue Service (IRS) status. 8 Comprehensive asset tagging or rationalization should be conducted and completed prior to closing, whenever possible. The resulting market value of the TPP being purchased should be identified and recorded on the Bill of Sale that is delivered at closing to the buyer. Otherwise, a post-closing review should be conducted as soon as possible to set those values and remove any phantom assets from the seller s transferred asset ledger. This review and adjustment should take place before any large refurbishments of rooms and facilities are undertaken by the buyer. This is particularly important for a REIT. 9 Buyers must pay special attention to ensure that the sales price paid and allocated to the real property that is shown on the closing statements is consistently disclosed and reported. This is particularly important in taxing jurisdictions where sales prices and transfer tax payments are disclosed to the assessor who may be utilizing recent sales prices as the basis for future ad valorem real property assessments. The same care must be exercised when completing and filing any required income and expense forms. Generally, these forms can serve as a useful vehicle to further establish and separate the real estate value for assessment purposes. Assessors will likely use the reported value as the unadjusted basis for the next reassessment for ad valorem real property tax purposes, if consistently and repeatedly disclosed contemporaneously to the local jurisdiction. 10 The buyer must review carefully the first post-closing real and personal property tax assessments when issued by the local assessor to ensure that they reflect only the allocated, reported, and applicable components of the total sales price. If discrepancies exist, the buyer must file a timely appeal and aggressively challenge the proposed real or personal property tax assessment. 4 www.ryanco.com
The acquisition of any going concern that includes real property, TPP, and IPP will usually produce erroneous and inflated taxation if these prerequisites are ignored. Most of it will be unintended and unbudgeted. The key to proactively avoiding over-taxation is to adopt a best practice approach for acquisitions that mitigates detrimental impact on projected investment yields. Determining a pre-closing purchase price allocation for the values of each type of asset being purchased will prevent the going concern value from being used to represent the entire real estate value for ad valorem real property tax assessment purposes. Additionally, it will eliminate the possibility of a separate and additional personal property assessment, which inevitably leads to over-assessment by the taxing jurisdiction and grossly inflated property taxes for the new owner. It is critical to avoid using the total going concern value to calculate any applicable real estate transfer or recordation taxes in cases where the value should be based on the sales price of the real estate alone. Furthermore, completing any assessor questionnaires or income and expense surveys post closing must be done carefully and consistently. If done properly, it is likely that the correct real estate value will be used by the assessor in subsequent assessments. Asset tagging or rationalization can help remove phantom assets and establish an accurate baseline for furniture, fixtures, and equipment values going forward, particularly if a large, future refurbishment of the premises is anticipated. Finally, breaking the allocated IPP value into the five FASB mandated subcategories will avoid the situation where all of the IPP value is designated as un-depreciable goodwill, increasing the buyer s future federal and state income tax deductions. Tax Strategies for Purchasing Going Concern Properties 5
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