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Q: Accounting/ Tax Treatment of Loan Payment ( Answered,   0 Comments )
Subject: Accounting/ Tax Treatment of Loan Payment
Category: Business and Money
Asked by: dparrot-ga
List Price: $50.00
Posted: 10 May 2006 14:37 PDT
Expires: 09 Jun 2006 14:37 PDT
Question ID: 727411
Company A is getting a $1.4M loan to purchase Company B that has an
independently determined value equal to the loan.  Company A will repay
the loan over ten years.  I know that Company A can deduct the
interest payments.  The principle payments represent negative cash
flow to Company A but I also know that it is not considered an expense
item.  Is it possible to shelter the principle payments from Federal
tax by treating an equal amount as depreciation (i.e. $140,000 of
depreciation/year over 10 years)?
Subject: Re: Accounting/ Tax Treatment of Loan Payment
Answered By: leapinglizard-ga on 29 May 2006 01:33 PDT
Dear dparrot,

According to IRS Publication 535, Business Expenses, the cost of
investigating the purchase of an existing business can be amortized as
a start-up expense. However, the purchase itself is neither amortizable
nor depreciable.

To understand why this is so, consider first of all that the IRS requires
three conditions of any depreciable property.

    In order for a taxpayer to be allowed a depreciation deduction for
    a property, the property must meet all the following requirements:

        * The taxpayer must own the property. Taxpayers may
        also depreciate any capital improvements for property
        the taxpayer leases.

        * A taxpayer must use the property in business or in an
        income-producing activity. If a taxpayer uses a property
        for business and for personal purposes, the taxpayer can
        only deduct depreciation based only on the business use
        of that property.

        * The property must have a determinable useful life of
        more than one year.

Internal Revenue Service: A Brief Overview of Depreciation,,id=137026,00.html

The difficulty is with the last condition, since Company B in your
scenario, or any company in general, does not have a determinable
useful life.

The following informal explanation gives examples of how an asset can
have a determinable useful life.

    In general, property that you own can be depreciated if it meets
    all of the following requirements:

        * It is used in a trade or business (which will be the focus
        of our discussion here) or held for the production of income
        as an investment property.

        * It has a finite period of usefulness in your business
        that can be estimated with some confidence, and that is
        longer than one year.

        * It wears out, decays, gets used up, becomes obsolete,
        or loses value from natural causes.


    Some business assets are not depreciable, but the costs can be
    recovered through amortization; that is, they can be deducted in
    a series of equal amounts over time for a specified period. An
    example of this is the cost of starting your business, which
    can be deducted over a period of 60 months after the business
    begins to operate.

Tax Guide: Which Assets Can Be Depreciated?

Because companies do not have a finite period of usefulness that can
be confidently estimated, and because they do not naturally wear out or
degrade, they cannot be claimed as depreciable property.

However, certain expenses involved in starting up a business do qualify
for amortization, which is similar to depreciation.

    Investigation expenses that can be deducted over the 60-month
    period include those relating both to business conditions
    generally, and those relating to a specific business, such
    as market or product research to determine the feasibility of
    starting a certain type of business. The costs of checking out
    the various factors involved in site selection would also be an
    amortizable investigation expense.

    Amortizable costs of creating a business include advertising,
    wages and salaries, professional and consultant fees, and costs
    of travel before the business actually begins.

Tax Guide: Business Startup Expenses

In Chapter 9 of Publication 535, Business Expenses, the IRS draws a clear
distinction between the cost of investigating a purchase and the cost of
making the purchase. The former is amortizable, while the latter is not.

    Purchasing an active trade or business.

        Amortizable start-up costs for purchasing an active trade
        or business include only investigative costs incurred
        in the course of a general search for or preliminary
        investigation of the business. These are the costs that
        help you decide whether to purchase a new business and
        which active business to purchase.  Costs you incur in
        an attempt to purchase a specific business are capital
        expenses that you cannot amortize.


        In June, you hired an accounting firm and a law firm
        to assist you in the potential purchase of XYZ. They
        researched XYZ's industry and analyzed the financial
        projections of XYZ. In September, the law firm prepared
        and submitted a letter of intent to XYZ. The letter
        stated that a binding commitment would result only
        after a purchase agreement was signed. The law firm and
        accounting firm continued to provide services including a
        review of XYZ's books and records and the preparation of
        a purchase agreement. In October, you signed a purchase
        agreement with XYZ.

        The costs to investigate the business before submitting
        the letter of intent to XYZ are amortizable investigative
        costs. The costs for services after that time relate
        to the attempt to purchase the business and must be

Internal Revenue Service: Publication 535: Chapter 9

Thus, the cost to Company A of investigating the purchase of Company
B can be amortized over five years. However, the cost of the purchase
itself is not amortizable, nor is it depreciable.



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