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limit is the product of the value of the business at acquisition (normally its selling price) times an
interest rate linked to the market for federal Treasury obligations. This amount of tax-loss
carryforward is available each year until the losses expire (15 to 20 years after they were incurred).
Since a corporation with significant losses would normally be valued at a relatively low amount, the
yearly available loss is likely to be relatively trivial.
Acquisition of the corporation‟s assets and liabilities for cash or through a cash merger eliminates
any use by the acquirer of the target‟s tax-loss carryforward, leaving it available for use by the target‟s
shell. This may be quite useful to the target, because, as discussed earlier, if it has not elected
subchapter S status for the past 10 years (or for the full term of its existence, if shorter), it is likely to
have incurred a significant gain upon the sale of its assets. This gain would be taxable at the corporate
level before the remaining portion of the purchase price could be distributed to the target‟s
shareholders (where it will be taxed again).
The acquirer may have lost any carryforwards otherwise available, but it does obtain the right to
carry the acquired assets on its books at the price paid (rather than the amount carried on the target‟s
books). This is an attractive proposition because the owner of assets used in business may deduct an
annual amount corresponding to the depreciation of those assets, subject only to the requirement that it
lower the basis of those assets by an equal amount. The amount of depreciation available corresponds
to the purchase price of the asset. This is even more attractive, because Congress has adopted available
depreciation schedules that normally exceed the rate at which assets actually depreciate. Thus, these
assets likely have a low basis in the hands of the target (resulting in even more taxable gain to the
target upon sale). If the acquirer were forced to begin its depreciation at the point at which the target
left off (as in a purchase of stock), little depreciation would likely result. All things being equal (and
especially if the target has enough tax-loss carryforward to absorb any conceivable gain), Morris
would likely wish to structure his acquisition as an asset purchase and allocate all the purchase price
among the depreciable assets acquired.
This last point is significant because Congress does not recognize all assets as depreciable. An asset
will generally be depreciable only if it has a demonstrable useful life. Assets that will last forever or
whose lifetimes are not predictable are not depreciable, and the price paid for them will not result in
future tax deductions. The most obvious example of this type of asset is land. Unlike buildings, land
has an unlimited useful life and is not depreciable. This has spawned some very creative approaches,
including one enterprising individual who purchased a plot of land containing a deep depression that
he intended to use as a garbage dump. The taxpayer allocated a significant amount of his purchase
price to the depression and took depreciation deductions as the hole filled up.
Congress has recognized that the aforementioned rules give acquirers incentive to allocate most of
their purchase price to depreciable assets like buildings and equipment and very little of the price to
nondepreciable assets such as land. Additional opportunities for this include allocating high prices to
acquired inventory so that it generates little taxable profit when sold. This practice has been limited by
legislation requiring the acquirer to allocate the purchase price in accordance with the fair market
value of the individual assets, applying the rest to goodwill (which may be depreciated over 15 years).
Although this legislation will limit Morris‟s options significantly, if he chooses to proceed with an
asset purchase, he should not overlook the opportunity to divert some of the purchase price to
consulting contracts for the previous owners. Such payments will be deductible by Plant Supply over
the life of the agreements and are, therefore, just as useful as depreciation. However, the taxability of
such payments to the previous owners cannot be absorbed by the target‟s tax-loss carryforward. And