In situations where the deal pricing analysis has not been done for closing, it can still be completed immediately after the closing.
If you bought an operating hotel recently and paid transfer taxes on either the total acquisition price or the acquisition price less a small amount for furniture, fixtures and equipment, you paid too much transfer tax.
The purchase of an operating hotel includes real estate, tangible personal property and intangible personal property. The price should be allocated across those three asset classes, and the transfer tax paid on only the amount attributable to the real estate.
A deal pricing analysis looks at the particular deal and models the price in a little more detail than the dealmaker needs to because he is buying all assets as a going concern. Using the buyer’s investment criteria and all assumptions that were made in determining the price, a deal pricing analysis determines the implied prices paid for the real estate, tangible personal property and intangible personal property.
In disclosure states where a transfer tax is imposed, most have a process for applying for a refund within a specified timeframe. Typically there is a two-year statute of limitations to apply for a transfer tax refund. The deal pricing analysis model has been used to identify the amount of the price attributable to the intangibles and support the application for a refund of overpayment of transfer taxes.
Refunds of overpayment of transfer taxes on a hotel acquisition have been successful in Washington state, Nevada, New York State, and Pennsylvania, to name a few. Obviously, the transfer tax amount has to be significant enough to warrant the refund process, and in some jurisdictions the transfer tax rates are very significant.
If the buyer is not a real-estate investment trust, there are federal tax benefits to booking the intangibles as Sec. 197 assets. The amount of the price attributable to the intangibles qualifies as Sec. 197 assets and would be amortized over 15 years versus 39 year depreciation if left in the real-estate category. Many taxpaying entities have cost segregation studies done post-acquisition to further accelerate depreciation of the real estate, but this process still does not identify the intangibles.
To maximize the federal tax benefits, a deal pricing analysis is performed to allocate the price to real estate, tangible personal property and intangible personal property. Therefore, the real estate portion is allocated between land and improvements. The cost segregation is then applied to the “improvements” portion of the real estate component. For example, a US$10 million acquisition might be allocated as follows for federal income tax purposes:
Real Estate US$7 million
Improvements US$ 6.16 million
Tangible Personal Property US$1 million
Intangible Personal Property US$3 million
The US$3 million is booked as Sec. 197 assets and receives 15 year amortization. The cost segregation analysis would look at the US$6.16 million on the improvements to accelerate whatever is allowable under the Internal Revenue Service rules.
DPA post closing
In previous articles we discussed that buyers of operating hotels optimally should use a deal pricing analysis to close the transaction and get multiple benefits such as reduced transfer taxes, reduced exposure to real estate tax increases, additional federal tax benefits, and documentation that provides the support for audit/appeals.
In situations where the deal pricing analysis has not been done for closing, it can still be completed immediately after the closing so the buyer can still reap benefits in terms of supporting documentation for audit/appeals. The timing of the work is important to lend credibility to owner’s representations. However, it is possible to use the deal pricing analysis post-closing to get federal tax benefits from booking the intangibles or even as much as two years after closing to recover some of the overpayment of transfer taxes.
The deal pricing analysis model has survived scrutiny by the IRS and local jurisdictions. It has been successfully used for more than 15 years to allocate prices paid for operating hotels and to receive multiple tax benefits in terms of federal, state and local. Every potential owner should consider a deal pricing analysis whenever they buy an operating hotel.
Bernice T. Dowell is a Senior Managing Consultant for Paradigm Tax Group in Washington, D.C. A former Senior Manager of KPMG and President of Cynsur, LLC, she has focused her career in real estate transfer and property taxes on hospitality assets and the concept of removing the value of intangibles from a going concern. She began this endeavor as an employee in Marriott’s Tax Department in 1991. While at Marriott she was a member of the inaugural class at George Washington University for the Master’s of Science in Finance program and focused her senior thesis on the topic of hotel investment analysis and the contributory value of a trade-name to a going concern.
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