Can you write off your own business? Can you amortize the fair market value for YOUR business?

Generally business owners can depreciate or amortize costs incurred in organization and development of a business.  Intangible property can be amortized at cost over a certain period, usually 15 years. Additional property, plant and equipment (PP&E) items can usually be deducted for book and tax purposes via depreciation. But intangible assets such as goodwill cannot be expensed and deducted by the firm that developed the goodwill. Goodwill is recognized as an intangible asset only when ownership of a business changes hands. In essence, goodwill is a premium that the buyer pays over the fair market value of the assets of the company being purchased.

For example, if Investor A is purchasing Company X from Seller B for $10m, the fair market value of company X’s assets is $6m, the excess of purchase price ($4m) over fair market value of the assets is goodwill. Moreover, let us assume that the seller’s cost of the assets was $4m. Therefore, Seller B could depreciate $4m in original capital costs whereas the Buyer A would be able to depreciate and deduct for tax purposes his or her cost of the acquired assets at $6m and amortize and deduct goodwill of $4m. Assuming 35% combined marginal federal and state tax rate for both the Buyer/Investor A and the Seller B and the asset mix of only equipment and goodwill; Buyer A would be able to write off $10mm cost of the entire purchase over a number of years (the number of years can vary widely depending on the asset mix). In addition, Buyer A would generate $3.5m in tax saving as a result of depreciation and amortization deductions.

The idea of amortizing goodwill of a business you own would make most tax professionals cringe, yet this is what happened in a recent tax court case. In a case of an accountant who after having suffered a brain aneurysm sold his practice to another C.P.A for 900,000. Several months later the buyer CPA suffered a stroke and was unable to continue to operate the business. As a result, the buyer C.P.A sold the practice back to original seller subject to the same terms. The original seller recorded the purchase at $900,000 as the new cost basis of the business and amortized it over 15 years under section 197 provisions. The IRS disallowed the deduction on the basis of related party rules, in essence arguing that the CPA’s engaged in a sale-buyback scheme. Section 197 prohibits recognition of goodwill that is self-created. However, an exception allows recognition if the asset is required in an unrelated later transaction. The Tax Court found that the sale and repurchase of the CPA practice were unrelated transactions and allowed the amortization deduction.

It seems that the facts involving the CPAs’ respective medical conditions followed by hospitalizations and recovery periods along with executed sale and purchase agreements were sufficiently convincing to the judge despite the fact that the repurchase took place 4.5 month after the original sale.

For more information on the case read the Court Memo – Fitch, TC Memo 2012-358.

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