AS EXPLAINED BY BERNICE T. DOWELL
For non‐REIT hospitality investors, a Deal Pricing Analysis performed for the closing of your deal provides you with maximum tax benefits in the form of (1) reduced transfer taxes at closing, (2) reduced exposure to prospective real estate tax increases, and (3) federal income tax benefits from booking the value of the Section 197 intangible assets.
The Deal Pricing Analysis determines the effective price paid for the three major classes of assets that are purchased when buying an operating hotel—real estate, tangible personal property, and intangible personal property. While every deal is different and the exact allocation of the price for each asset class varies, on average (from successfully completing over 300 such allocations over the past ten years), the real estate component comprises approximately 70% of the price; the tangible personal property ranges from 1% to 10% of the price; and the basket of intangibles that are involved in the transaction comprise the remaining 20% to 29% of the total price.
The implied “price” paid for the intangibles can be booked for tax purposes as Section 197 assets, as all assets within this basket, e.g. contracts, licenses, warranties, franchise agreements, management contracts, trade names, trained workforce, etc., qualify as Section 197 intangibles. These assets can then be amortized over 15 years versus 39 year depreciation if they were simply left in the real estate classification as is usually done for GAAP.
So, entities that pay income taxes are missing an income tax benefit if they fail to allocate the price in this manner and recognize the value of the intangibles for income tax purposes. It should be noted that it is not necessary to book the intangibles for GAAP, although depending on the advice from the auditors, the intangibles could be booked for GAAP purposes as well. Many companies keep separate books for tax and GAAP. Stated alternatively, if books are maintained only for GAAP purposes, these records have to be “scrubbed” to be used properly for the income tax return. Part of that “scrubbing” process should be the separation of the intangibles value from the real estate and having a Deal Pricing Analysis report would allow the tax manager to do that.
The Deal Pricing Analysis model has successfully survived IRS scrutiny. One high profile, very large transaction underwent audit a couple of years after the purchase and the purchase price allocation came under close scrutiny of the IRS. The model was successfully defended and the audit was successfully completed.
To receive the maximum benefits that a Deal Pricing Analysis could afford you it should be performed contemporaneously with the closing of the deal. Unlike a cost segregation analysis which can be performed within a year post‐closing, the benefits of the Deal Pricing Analysis start with the closing. The implied price for the real estate can be broken down between land and improvements. Then the cost segregation team can start with the improvements value and break that down as allowed by IRS rules to accelerate depreciation on the real estate assets.
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Additional Articles on Deal Pricing Analysis
Using the total purchase price (as opposed to the true cost of real estate)
in closing documents results in higher transfer taxes, an inaccurate deed, higher future
tax assessments and lost federal income tax benefits.