Existing Business Purchase

[Tax Prep by Deb]

I have a client (Corporate) that purchased an existing Froster Freeze restaurant in 2023.  I have the complete purchase agreement and have the break down of the purchase.  A good chunk of the proceeds was to purchase the existing building and land.  The building I assume is depreciated over 37 years.  The equipment and fixtures was also part of the purchase and also depreciated.  There is a 5000 no compete clause that was paid not sure to handle that, also the remainder of the sale over 700,000 was for the actual business, no goods associated at all.  

I have never done anything like this so need some guidance.  Is the 700,000 depreciated/amoritized or just considered the basis of the business and not deducted at all until he sells?  Also what about the 5,000.  It was listed as non compete but not sure how this fits in at all.

Any help will be greatly appreciated.

[jklcpa]

The covenant not to compete and the goodwill are both amortizable assets amortized over fifteen year life under section 197.  See article below from The Tax Advisor for a more complete discussion.

https://www.thetaxadviser.com/issues/2021/may/tax-issues-noncompete-agreements.html

 

As for the price paid for fixtures snd equipment, you have the price that the purchaser paid, and it is to be allocated over the assets that were purchased and depreciated over their respective tax lives.

If you have the seller's depreciation schedule, you can use that as a starting point for your allocations of the purchase price For the depreciable assets, and use each individual asset's basis compared to the total of its category as a starting point first or the allocations.

[Lee B]

Did your client form a new corporation and buy the assets from the previous owner or did your client buy the stock of the previous corporation?

Is your client's corporation a regular corporation or did your client did elect S status in a timely manner?

Did the purchase agreement included a detailed valuation list of the Building, Land and the various fixtures and equipment?

Was the non compete agreement included in the purchase agreement or was it a separate agreement?

 

 

[Tax Prep by Deb]

New corporation, C Corp,.   It was actually two different sales.  Building and assets where done on one closing and the actual business purchase on a different sale.  I have pretty detailed records, just wasn't sure to handle the 700,000 portion.

[Lee B]

38 minutes ago, Tax Prep by Deb said:

New corporation, C Corp,.   It was actually two different sales.  Building and assets where done on one closing and the actual business purchase on a different sale.  I have pretty detailed records, just wasn't sure to handle the 700,000 portion.

(the actual business purchase on a different sale) If the building,land and assets had already been sold on the first closing, what was left to be sold?

Please be more specific

Thanks,

 

[Lee B]

(Building and assets were done on one closing)

Does the first purchase agreement include a detailing listing of the Bldg, Land, furniture and fixtures with $ values for each listed item?

[Tax Prep by Deb]

What was left was the actual business, location, name ect.  I am assuming goodwill.  The total deal was about 1.6 Million and when building and other assets are accounted for the 700,000 is what was left.

 

[Lee B]

Perhaps someone else can be more helpful than I can.

[Tax Prep by Deb]

2 hours ago, Lee B said:

(Building and assets were done on one closing)

Does the first purchase agreement include a detailing listing of the Bldg, Land, furniture and fixtures with $ values for each listed item?

Yes

[Max W]

Non-compete clauses are not legally enforceable in CA.     

[Lee B]

15 hours ago, Tax Prep by Deb said:

Yes

Then these are the values that will be used to set up your depreciation schedule

[Lee B]

16 hours ago, Tax Prep by Deb said:

What was left was the actual business, location, name ect.  I am assuming goodwill.  The total deal was about 1.6 Million and when building and other assets are accounted for the 700,000 is what was left.

 

Depending on the details on what was included in the second closing for $700,000 will probably be amortized.

[jklcpa]

OP should have a form 8594 that shows the categories of assets. With new C corp being created, any cash or assets coming in should be recorded, and the other side of the entry to capital stock or loans from shareholders, if any is to be repaid.

Then, assuming the payment for the business purchase was made from the new C corp funds, record the depreciable assets using the values as they are shown in the purchase agreement.  Treat each of the items purchased as you would any other business that went out and bought these things. Don't get overwhelmed by the fact that this is an entire business purchase with many pages of terms of sale and intent documents.

That is: for land, building, fixtures, and equipment. If the values shown on the list of assets purchase do actually add up to the sales price for those assets, then you may use those figures as your basis for depreciation. If, however, you were provided with a sale price for a category of assets (for example, the equipment) but the list is the seller's depreciation schedule with historical cost, then you will have to allocate a portion of that purchase price to each asset purchased.

For the remaining amounts, the $5,000 covenant, and the final $700,000 you say is not accounted for, those are both intangible assets amortizable under sec 197 using a 15 year life.  In your posts above saying the $700K is left over and not labeled as anything after all other assets are purchased, then I would treat that amount of $700K as GOODWILL, again amortizable under 197 using a 15 year life.

 

[jklcpa]

Someone should be preparing form 8594, and both the seller and purchaser are supposed to include this with their respective tax returns. If you look at the snippet below that is a portion of the 8594, from what you describe of the sale, all of the building, land, equipment, and fixtures will be shown in class V. Then, the covenant is a Class VI asset, and the remaining $700K of goodwill is a Class VII asset. You will note that the Class VI and VII assets are combined on one line, and also note that the instructions state that these items are amortized under sec 197. 

https://www.irs.gov/instructions/i8594

 

[Max W]

FASB has 10 years for amortizing Good Will, intangibles, etc.

CA does not legally recognize non-compete agreements.

[jklcpa]

1 hour ago, Max W said:

FASB has 10 years for amortizing Good Will, intangibles, etc.

CA does not legally recognize non-compete agreements.

FASB is the Financial ACCOUNTING Standards Board that governs accounting rules that can differ substantially from tax law.

The tax code section for amortizing these particular intangibles is 1.197-2(f) which states the period of amortization is over 15 years.

 

Quote

(f) Computation of amortization deduction—(1) In general. Except as provided in paragraph (f)(2) of this section, the amortization deduction allowable under section 197(a) is computed as follows:

(i) The basis of an amortizable section 197 intangible is amortized ratably over the 15-year period beginning on the later of—

. . .

 

 

I did not address any state issues, and hopefully with Deb being from CA, she is already aware of differences from the federal.

[Tax Prep by Deb]

I am not seeing a form 8594 but there is a detailed breakdown that clearly shows the 700,000 as goodwill.  I thought I had seen it early on when I set the books up bit couldn't remember where, but fortunately I had scanned all documents in and it was an attachment to the closing papers.

[jklcpa]

7 minutes ago, Tax Prep by Deb said:

I am not seeing a form 8594

It is almost never included with the legal documents. It is prepared by either the seller's or purchaser's tax preparer, and each party to the transaction is supposed to include it with the return for the year of sale/purchase. The ones I've had, one of the party prepares and shares with the other party so that there is no chance that the forms aren't the same.