At time of closing and at the advice of the Seller's CPA, the settlement sheet indicated an allocation of the sales price of $800 thousand to real estate and $2.3 million to goodwill. The CPA's thought process was that if the exchange failed, the bulk of the taxes would be capital gains taxes and not depreciation recapture taxes as the real estate was being valued below the depreciated value. In addition, the CPA for the Buyer knew that the amortization of goodwill was over a 15 year period vs. a 39 year period for commercial real estate, thereby affording his client greater amortization deductions against income each year. Both CPAs also were trying to avoid higher transfer taxes for the Buyer and Seller by understating the real estate value.
Well, as their intentions and thought processes were logical, neither were aware that the gain on goodwill could not be deferred in a 1031 exchange. Since the real estate assigned value was less than the depreciated value, there was no tax savings to be had on the real estate sale. Hence, the full $2.3 million of goodwill was taxable, costing the Seller approximately $700 thousand in taxes as opposed to no taxes owed if the real estate was valued at the full $3.1 million sales price.
Given this revelation came at the settlement table upon review of the settlement sheet, the Buyer was not willing to adjust the allocation negotiated by the two CPAs, proving that Bad Advice Can Cost Thousands! Involving the Qualified Intermediary in the negotiations would have saved this Seller $700 thousand in taxes. Perhaps next time the advice of an expert will be sought!