We are not encouraging you to start a Christmas tree farm. Our title pertains to the fact that, as a consulting firm, we frequently address repeat issues that are evergreen, like certain trees. (To learn more about us, Click Here.)
One of these evergreen issues is the List of Assets. What List?, you ask. The List that should be attached to all business assets sales agreements. Why?
Well, common sense dictates that a list should be attached to avoid overlooking something, such as leasehold improvements, assets not always on the business premises, etc.
In the old days, prior to 1986, it was common for the Buyer and Seller of business assets, partnership interests, etc. to allocate the purchase price in the manner that was most advantageous to the party reporting the sales transaction.
For example, the Seller would often allocate a larger amount of the sales price to capital gain assets to reduce the Seller's tax burden while, conversely, the Buyer would allocate a greater portion of the sales price to depreciable assets in order to maximize the Buyer's depreciation deductions. In other words, many taxpayers chose the route most beneficial to them for tax purposes and, in the process, treated the sales transaction differently from the other party to the sale.
In an effort to stem these perceived and actual abuses, as part of the 1986 Tax Act, Congress enacted Internal Revenue Code §1060. Roughly speaking, the 1986 addition to the Code requires the Seller and Buyer (referred to in statutory legalese as the Transferor andTransferee) to consistently allocate and report to the IRS the consideration received or paid.
If a list of the value of the assets is attached to a written agreement, then both parties are bound by such a List unless there is evidence of fraud or other misconduct. The statute, however, does not make a List mandatory, which means that, in some transactions, Lists are not present. Hence, the persistent or evergreen inquiries we receive about sales transactions with no lists or incomplete lists. Recently, we received a call from Pittsburgh about a business sale in which over $100,000 of leasehold improvements were not listed as assets sold.
As a practical matter, it is virtually impossible to correctly report a sale of business assets for tax purposes without a list of assets. If there is no list, how do the Buyer and Seller report a sales transaction?
The simple answer is they have to communicate with each other after the sale. In the real world, however, quite a few sales transactions do not result in 100% satisfaction between the parties and, consequently, they do not want to talk after the sale. In cases of no or inadequate communications, each party is forced to guess what values to use and keep their fingers crossed that there won't be an audit.
Congress gave the IRS carte blanche authority to develop regulations that require the parties to report the sales price allocations to the IRS. Exercising its authority, the IRS developed Form 8594 (Asset Acquisition Statement) which has to be filed by both the Buyer and Seller, according to Internal Revenue Code §1060(b). Form 8594 allows the IRS to compare how the Buyer and Seller are reporting the sales transaction.
Initially, all of the assets purchased had to be divided into four categories. Acquisitions after February 14, 1997 have to be divided into five categories because of the advent of more classes of amortizable assets such as goodwill. If there is no list of assets attached to the sales agreement, then it is a fairly safe bet that the parties will not come up with the same numbers. The lack of a List and the probability of reporting different values may well trigger an audit. From a tax perspective, evergreen advice is to make sure a list of assets, with agreed values, is attached to the sales agreement.
Leaving aside the wonderful world of taxation, there are other reasons to attach a list of assets and values. Listing the assets (preferably prior to the closing day) allows the parties to question items that require attention but are often overlooked. For example, if a walk-in refrigerator is being sold, is there an accompanying warranty? What inventory items are being sold and do they require special attention, such as refrigeration or safety containers?
Returning to the above-mentioned forgotten leasehold improvements in Pittsburgh, listing leasehold improvements is important for another reason. At the end of a lease, real estate leasehold improvements almost always revert to the Landlord. It follows then that if the lease is not assigned, but is negotiated from scratch by the new Tenant-Buyer, the leasehold improvements are not received by the Buyer and cannot be depreciated because they are owned by the Landlord.
If you or your clients need a good checklist to use for business sales or purchases, take a look at the one we use. Click Here.
By Tax and Business Professionals, Inc.
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Manassas, VA 20110
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