July 7, 2013
In an unpublished opinion, the Eleventh Circuit affirmed the Tax Court’s decision in Peco Foods. As we described in our earlier coverage here, the Tax Court held that the taxpayer could not subdivide broader classes of assets acquired in two transactions into discernible subcomponents for depreciation purposes because the taxpayer had agreed to an express allocation (in both agreements at issue) to the broader classes “for all purposes (including financial accounting and tax purposes).” The Tax Court decided that because of that express allocation, the Danielson rule and language in section 1060 prevented the taxpayer from subdividing the asset classes (and thereby getting accelerated depreciation for some of those subclasses).
The taxpayer challenged the Tax Court’s application of the Danielson rule on appeal (among other things). The taxpayer argued that under the Eleventh Circuit’s decision in Fort, the Danielson rule applies only where a taxpayer challenges the form of a transaction. And since the subdivision of assets for depreciation purposes is not a challenge to form, the taxpayer argued that the Danielson rule did not apply.
The Eleventh Circuit made no mention of its decision in Fort, nor did it explain whether Peco’s attempt to subdivide the acquired asset classes for depreciation purposes was a challenge to the form of the transactions. Instead, the Eleventh Circuit summarily affirmed the Tax Court’s holding that the express allocation in the agreements was unambiguous and binding under section 1060 and the Danielson rule. So unfortunately for taxpayers—for whom the Danielson rule is a one-way street in the IRS’s favor—the Eleventh Circuit did nothing to explain how its decision in Fort limits the breadth of the Danielson rule.
April 1, 2013
With oral argument scheduled for April 18 in Peco Foods v. Commissioner, No. 12-12169, the Eleventh Circuit will soon decide a case that involves the scope of the Danielson rule. That rule, established in Danielson v. Commissioner, 378 F.2d 771, 775 (3d Cir. 1967), provides that “a party can challenge the tax consequences of his agreement as construed by the Commissioner only by adducing proof which in an action between the parties to the agreement would be admissible to alter that construction or to show its unenforceability because of mistake, undue influence, fraud, duress, etc.” The Eleventh Circuit has expressly adopted the Danielson rule.
In Peco Foods, the Commissioner used that rule (along with the allocation rules under section 1060) to prevent the taxpayer from subdividing broader classes of purchased assets (to which the purchase agreement had expressly allocated a portion of the purchase price) into discernible subcomponents for depreciation purposes. The taxpayer is a poultry processor that purchased the assets at two poultry processing plants in the mid- to late-1990s. In each of the purchase transactions, Peco and the seller agreed to allocate the purchase price among listed assets “for all purposes (including financial accounting and tax purposes).” The first agreement allocated purchase price among 26 listed assets; the second allocated purchase price among three broad classes of assets.
Prompted by the Tax Court’s decision in Hospital Corporation of America v. Commissioner, 109 T.C. 21 (1997), Peco commissioned a cost segregation study that subdivided the listed assets into subcomponents. Some of these subcomponents fell into asset classes that are subject to accelerated depreciation methods. For instance, Peco subdivided the class of assets listed as “Real Property: Improvements” on the original allocation schedule into subcomponents that were tangible personal property subject to a 7- or 15-year depreciation period under section 1245. If they were classified as structural components of nonresidential real property, the assets would have been subject to a 39-year depreciation period under section 1250.
With the segregation study in hand, Peco applied to change its accounting method for those subcomponents with its 1998 return and claimed higher depreciation deductions on subsequent returns. The IRS disallowed these deductions and issued a notice of deficiency; the taxpayer filed a petition in Tax Court.
In a Tax Court Memorandum opinion by Judge Laro, T.C. Memo 2012-18, the Tax Court upheld the Commissioner’s deficiencies. The Tax Court’s decision was based on both the Danielson rule and section 1060(a), the latter of which provides that if the parties in an applicable asset acquisition “agree in writing as to the allocation of any consideration,” the agreement “shall be binding on both the transferee and transferor unless the Secretary determines that such allocation . . . is not appropriate.” The taxpayer argued that section 1060 serves only to allocate purchase price among assets under the residual method of section 338(b)(5) and that section 1060 does not bar further subdivision of the allocation for purposes of determining useful lives for depreciation. The Tax Court held that the directive in section 1060 that an allocation by the parties “shall be binding” trumps the application of the residual method of section 338(b)(5).
The Tax Court also rejected the taxpayer’s argument that Danielson was inapposite. The taxpayer had relied on United States v. Fort, 638 F.3d 1334 (11th Cir. 2011), in which the Eleventh Circuit held that “the Danielson rule applies if a taxpayer ‘challenge[s] the form of a transaction.’” (citation omitted) Since the taxpayer in Fort had challenged the specific tax consequences of the form of the transaction but not the form itself, the Eleventh Circuit found that Fort fell outside the scope of the Danielson rule. The Tax Court held that while the taxpayer in Fort had not challenged the form of the transaction, the taxpayer in Peco—by “seeking to reallocate the purchase price among assets not listed in the original allocation schedules”—sought to challenge the form of the transaction. Therefore, reasoned the Tax Court, because there was no ambiguity to the allocations in the purchase agreements under the applicable contract laws of the states in which the agreements were entered, Danielson applies to prevent the taxpayer from subdividing the listed into distinct components for depreciation purposes.
On appeal, the taxpayer contests the Tax Court’s holdings with respect to both section 1060 and Danielson. In its brief, the taxpayer argues that whether an asset is tangible personal property or a structural component of a building is a matter of facts and circumstances and that the words used to describe the asset “are of no utility in connection with its categorization as a structural component.” The taxpayer also argues that classifying assets for depreciation purposes is not a challenge to the form of the transaction (unlike, for example, treating the transaction as a merger or lease rather than an asset acquisition, which would have been a challenge to form) and therefore, under the holding in Fort, the Danielson rule does not apply.
In his opposition brief, the Commissioner echoes the Tax Court’s holding that the taxpayer’s subdivision of listed assets for depreciation purposes is an attempt to “restructure the form of the transaction” and therefore falls within the purview of the Danielson rule (and is not excluded by the rule articulated in Fort). The Commissioner then goes a step further, arguing that the taxpayer was not merely “changing the classification of assets” but also “added assets.” Moreover, the Commissioner insists that what the taxpayer did with respect to depreciation “goes considerably deeper than merely a change to the classification for depreciation purposes.”