(Editor’s note: This is Part I of a two-part column on deducting the costs of buying a business. See part II here.)
When acquiring a business, there are significant costs for planning, negotiating, brokering and conducting due diligence on the transaction. Portions of those costs may be immediately deductible, capitalized and amortized over as many as 15 years, or even capitalized permanently until the business is sold or closed.
Generally, costs made to increase the value of property must be capitalized. Regulations issued in 2003 addressed both costs incurred to create or acquire intangibles and costs incurred to facilitate the acquisition of a trade or business, capital-structure shifts and certain other transactions. The terms “facilitate” and “facilitative” are pivotal.
In general, under Code Section 263(a), a taxpayer must capitalize costs incurred to facilitate certain transactions, whether the transaction comprises a single step or multiple steps and regardless of whether a gain or loss is recognized. These are the so-called “covered” transactions:
• An acquisition of assets that constitutes a trade or business [whether the taxpayer is the acquirer in the acquisition or the target of the acquisition].
• An acquisition by the taxpayer of an ownership interest in a business entity if, immediately after the acquisition, the taxpayer and the business entity are related.
• An acquisition of an ownership interest in the taxpayer.
• A restructuring, recapitalization or reorganization of the capital structure of a business entity.
• A tax-free capital contribution to a corporation or partnership.
• A formation or organization of a disregarded entity.
• An acquisition of capital.
• A stock issuance.
• A borrowing.
• Writing an option.
Whether a cost incurred in connection with a covered transaction is facilitative to the transaction is a question of facts and circumstances and includes costs incurred “in the process of investigating or otherwise pursuing the transaction.” The regulations clarify that determination of “the value or price of a transaction is an amount paid in the process of investigating or otherwise pursuing that transaction.” In applying the facts and circumstances to the costs, a “but for” the transaction analysis is relevant but not determinative.
Therefore, the fact that a taxpayer would not have incurred a cost without entering into the transaction does not automatically require capitalization of the cost. The cost paid to acquire tangible or intangible property, including target shareholder stock, is not facilitative of a covered transaction. Rather, it represents the cost of the property acquired.
On Jul. 2, 2018, the IRS released an LB&I Process Unit on transaction costs, providing a three-step approach for analyzing the costs during an examination. The first step is determining the proper legal entity to take transaction costs into account. In some cases, costs are incurred by one taxpayer on behalf of another. For example, a United States-based parent of a worldwide group may incur investment banking costs on behalf of its subsidiaries to facilitate a global acquisition. Under Regulation Section 1.263(a)-5(k), an amount considered to have been paid by a party to the transaction includes an amount paid on its behalf by another party to the transaction. n
Kevin Eagan is a managing director in the Tax Group at CBIZ & MHM New England. He can be reached at keagan@cbiz.com. CBIZ & MHM has offices nationwide, including in Providence and Boston.
