Cost Segregation · Brief · Pro level
Purchase price allocations versus cost segregation: when the contract binds
In a Section 1060 asset acquisition, an allocation schedule the parties agree to in writing binds them under the Danielson rule — Peco Foods lost a cost segregation study because the contract said 'building.' How to negotiate allocation language that leaves room for a later study.
When a business is bought as assets rather than stock, Section 1060 governs how the price spreads across what was bought — and a written allocation the buyer and seller both sign is binding on both of them under Section 1060(a), enforceable against the taxpayer even when the IRS is free to disregard it. That single sentence is why a cost segregation study planned for after closing can die in the purchase agreement drafted before it. The controlling cautionary tale is Peco Foods, Inc. v. Commissioner: the buyer agreed to allocations to "processing plant building" and similar line items, later commissioned a study reallocating those dollars to 5- and 15-year property, and the Tax Court — applying the Danielson rule that a taxpayer may not disavow the plain terms of its own agreement absent proof that would void the contract — held the buyer to the schedule it signed.
How Section 1060 allocations work
An applicable asset acquisition — any transfer of a trade or business where basis follows price — requires both parties to use the residual method of Treas. Reg. §1.1060-1 and §1.338-6: consideration fills seven classes in order (cash, marketable securities, receivables, inventory, then Class V tangible property including real estate and equipment, Class VI intangibles, and residual Class VII goodwill), and both parties report the result on Form 8594 attached to the return for the acquisition year. The classes themselves are coarse — all of a building and its components sit together in Class V — so Section 1060 itself rarely constrains a study. The constraint comes from the contract: parties routinely negotiate an allocation schedule far more granular than the regulation requires, because the seller cares intensely about ordinary income versus capital gain, depreciation recapture, and state transfer taxes.
What Peco Foods actually held
Peco bought two poultry plants and agreed, in the purchase agreements, to detailed schedules assigning specific dollars to items including "processing plant building." Years later its study reclassified roughly $5 million of those dollars into shorter-life property. The Tax Court held the agreed terms unambiguous, applied the strong-proof/Danielson standard, and disallowed the change; the Eighth Circuit affirmed in 2013. Two points travel well beyond poultry. First, the binding effect runs against the taxpayer only — the Commissioner may still challenge an allocation as inappropriate, an asymmetry written into Section 1060(a) itself. Second, ambiguity is the taxpayer's friend: had the schedule said only "real property," the court's own reasoning suggests a component-level study within that line would not have contradicted the agreement.
Negotiating with a future study in mind
Allocation language and its effect on a later study.
| Contract language | Study risk |
|---|---|
| "Building — $8,400,000" as a schedule line | High: Peco Foods on all fours |
| "Real property and improvements at [address] — $8,400,000" | Low: sub-allocation within the line is open |
| "Land $1.2M; improvements $8.4M," plus sub-allocation clause | Lowest: land carve-out fixed, components open |
| No written allocation at all | Open — but Form 8594 consistency and exam risk both rise |
Practical drafting rules. Keep the schedule at the class or site level; add an express clause that either party may further allocate within a line item for tax reporting so long as the line-item totals are respected; fix the land number if the seller insists on something (land allocation is the one figure a study cannot help with anyway); and never let deal counsel copy a lender's appraisal breakdown into the tax schedule — appraisals itemize components, and itemization is the trap. If the deal closed with bad language, the study is not automatically dead: it can still classify dollars within an agreed line item, and it remains fully available for line items the agreement never touched. What it cannot do is move dollars across the lines the parties fixed. The engineering and documentation standards are the same as any acquisition study under the Cost Segregation Audit Techniques Guide — the ATG itself flags contractual allocations as an examiner checkpoint. For the study baseline, see what a cost segregation study is.
Frequently asked questions
- Does a purchase agreement's allocation schedule prevent a later cost segregation study?
- It can. Under Section 1060(a), a written allocation agreed by buyer and seller binds both parties unless the IRS finds it inappropriate. In Peco Foods v. Commissioner (T.C. Memo. 2012-18, aff'd 8th Cir. 2013), the Tax Court held a buyer to its contractual allocation to 'processing plant building' and disallowed a later study that would have reclassified components — the taxpayer could not disavow its own agreement.
- What is a Section 1060 applicable asset acquisition?
- A transfer of assets constituting a trade or business where the buyer's basis is determined by the price paid. Section 1060 requires both parties to allocate consideration using the residual method of the Section 338 regulations — through seven asset classes, with real and personal tangible property in Class V and goodwill last — and to report consistently on Form 8594. A written allocation agreement binds both parties.
- How should a buyer draft the allocation to preserve a future cost segregation study?
- Allocate at a level of generality that does not pin down building components: a single line for 'real property and improvements' or 'tangible assets at [address],' with express language that the parties may further sub-allocate within agreed line items for depreciation purposes. Avoid schedules that separately state 'building' with a dollar figure — that is the language that bound the taxpayer in Peco Foods.