Peco Foods, Inc. & Subsidiaries v. Commissioner of Internal Revenue, 011712 FEDTAX, 13789-08

Docket Nº:13789-08
Opinion Judge:LARO, Judge:
Party Name:PECO FOODS, INC. & SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Attorney:James H. Williams, III and John S. Rice, for petitioner. William B. McClendon and Francis C. Mucciolo, for respondent.
Case Date:January 17, 2012
Court:United States Tax Court
 
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T.C. Memo. 2012-18

PECO FOODS, INC. & SUBSIDIARIES, Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 13789-08

United States Tax Court

January 17, 2012

James H. Williams, III and John S. Rice, for petitioner.

William B. McClendon and Francis C. Mucciolo, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

LARO, Judge:

Peco Foods, Inc. (Peco), is an Alabama corporation and the parent company of an affiliated group of corporations that file their Federal income tax returns on a consolidated basis.1 Peco petitioned the Court to redetermine respondent's determination of Federal income tax deficiencies of $120, 751, $678, 978, and $727, 323 for its taxable years ended March 28, 1998 (1997 taxable year), April 3, 1999 (1998 taxable year), and March 30, 2002 (2001 taxable year), respectively.2Following a trial of this case, we decide whether Peco may modify purchase price allocations which it agreed to in connection with its acquisition of certain assets at two poultry processing plants. We hold it may not.

FINDINGS OF FACT

Some facts were stipulated. We incorporate herein by this reference the parties' stipulation of facts and the exhibits submitted therewith. We find the stipulated facts accordingly. When the petition was filed with the Court, Peco's mailing address was in Tuscaloosa, Alabama.

I. Background

Peco is the common parent of an affiliated group of corporations. The other members of the affiliated group are Peco Farms, Inc. (Peco Farms), Peco Foods of Mississippi, Inc. (PFMI), and Peco Foods of Brooksville, Inc. At all relevant times, Peco and the members of its affiliated group were engaged in the business of poultry processing.

II. Acquisitions

A. Overview

During the mid-to-late 1990s, Peco acquired two poultry processing plants. First, Peco acquired a poultry processing plant in Sebastopol, Mississippi (Sebastopol plant). Second, Peco acquired a poultry processing plant in Canton, Mississippi (Canton plant). We collectively refer to Peco's acquisitions of the Sebastopol plant and the Canton plant as the acquisitions.

B. Sebastopol Acquisition

Peco, through PFMI and Peco Farms of Mississippi, LLC (LLC), acquired certain assets of the Sebastopol plant (Sebastopol acquisition) from Green Acre Farm, Inc. (Green Acre) for $27, 150, 000. The Sebastopol acquisition was effected through an asset purchase agreement dated December 29, 1995 (Sebastopol agreement). Included in the Sebastopol agreement was a schedule (original Sebastopol allocation schedule) which allocated the purchase price of the acquired assets between PFMI and LLC as the purchasing subsidiaries. In particular, Peco and Green Acre agreed to allocate the $27, 150, 000 purchase price among 26 assets "for all purposes (including financial accounting and tax purposes)" in accordance with the original Sebastopol allocation schedule. The original Sebastopol allocation schedule allocated the purchase price as follows:

Asset

PFMI

LLC

Total

Processing plant building

$3, 802, 550

-0-

$3, 802, 550

Holding shed #1

-0-

$64, 800

64, 800

Holding shed #2

-0-

75, 395

75, 395

Fuel tanks

-0-

61, 000

61, 000

Waste water treatment plant lagoon

112, 000

-0-

112, 000

Rail spur

-0-

86, 625

86, 625

Weightronic truck scale

-0-

55, 000

55, 000

Fencing

27, 700

-0-

27, 700

Utility extension

50, 000

-0-

50, 000

Concrete and paving

50, 000

-0-

50, 000

Site work

100, 000

-0-

100, 000

Hatchery real property

-0-

1, 509, 125

1, 509, 125

Feedmill

-0-

1, 005, 700

1, 005, 700

Waste water treatment plant

1, 879, 545

-0-

1, 879, 545

Egg farm

-0-

96, 625

96, 625

Land Processing plant

106, 500

-0-

106, 500

Hatchery

-0-

10, 000

10, 000

Feedmill

-0-

2, 500

2, 500

Egg farm

-0-

10, 000

10, 000

Waste water treatment plant

6, 000

-0-

6, 000

Rolling stock

-0-

280, 500

280, 500

Furniture and equipment

100, 620

-0-

100, 620

Machinery and equipment

3, 785, 420

2, 178, 720

5, 964, 140

Inventories (estimated)

384, 237

6, 265, 763

6, 650, 000

Accounts receivable (estimated)

4, 000, 000

-0-

4, 000, 000

Goodwill

-0-

1, 043, 675

1, 043, 675

Total

14, 404, 572

12, 745, 428

27, 150, 000

The Sebastopol agreement defined the term "Real Property" as "real property, leaseholds and subleaseholds therein, improvements, fixtures, and fittings thereon, and easements, rights-of-way, and other appurtenants thereto (such as appurtenant rights in and to public streets located within the state of Mississippi)". The term "Equipment" was defined as "tangible personal property (such as machinery, equipment, computer hardware and software, furniture, automobiles, trucks, tractors, trailers, tools, jigs, and dies) located within the state of Mississippi".

In connection with the Sebastopol acquisition, Peco engaged William A. Payne (Mr. W. Payne) of PayneSmall Investment Property Appraisals (PayneSmall) to appraise the Sebastopol plant (Sebastopol appraisal). The Sebastopol appraisal, dated January 25, 1996, listed more than 750 separately identifiable assets. That list generally reported the acquisition date, acquisition cost, cost multiplier, replacement cost, effective age, economic life, and depreciated life of each of the separately identified assets. Mr. W. Payne was deceased at the time of trial.

C. Canton Acquisition

Peco, through PFMI and LLC, acquired certain assets related to the Canton plant (Canton acquisition) from Marshall Durbin Food Corp. and Marshall Durbin Farms, Inc. (collectively, Marshall Durbin), for $10, 500, 000. The Canton acquisition was memorialized in an asset purchase agreement dated May 12, 1998. The Canton agreement included a schedule (original Canton allocation schedule) which allocated the purchase price among three assets. More specifically, Peco and Marshall Durbin agreed to allocate the $10, 500, 000 purchase price among 3 assets "for all purposes (including financial accounting and tax purposes)" in accordance with the original Canton allocation schedule. The original Canton allocation schedule allocated the purchase price as follows:

Asset

Purchase Price

Real property Land

$350, 000

Improvements

5, 100, 000

Machinery, equipment, furniture, and fixtures

5, 050, 000

Total

10, 500, 000

The Canton agreement defined the term "Real Property" as "real property, leaseholds and subleaseholds therein, improvements, fixtures, and fittings thereon, and easements, right-of-way, and other appurtenant rights thereto (such as appurtenant rights in and to public streets) associated with a processing plant located in Canton, Mississippi." The term "Equipment" was defined as "tangible personal property (such as machinery, equipment, furniture, automobiles, trucks, tractors, trailers, tools and jigs) used in * * * [the Canton plant]." Peco engaged Terry L. Payne (Ms. T. Payne) of PayneSmall to appraise the Canton plant (Canton appraisal) in connection with the Canton acquisition. The Canton appraisal was dated March 8, 1998. Included in the Canton appraisal were approximately 20 pages that listed more than 300 separate assets. That list generally reported the acquisition date, acquisition cost, cost multiplier, replacement cost, and depreciated value of each of the separately identified assets. Ms. Payne was deceased at the time of trial.

III. Cost Segregation Study

Peco commissioned Moore Stephens Frost, PLC (Moore Stephens), in or around 1999 to perform a segregated cost analysis (cost segregation study) of the Sebastopol and Canton plants. The cost segregation study subdivided the assets acquired by Peco into subcomponents based on the Sebastopol appraisal and the Canton appraisal. The results of that study were documented in at least two schedules (collectively, subsequent allocation schedules) and determined that subdividing the acquired assets into various subcomponents entitled Peco to an additional depreciation expense of $5, 258, 754 from 1998 through 2002. The cost segregation study was prepared by Jim Strobbe, who was deceased when the trial in this case was held.

IV. Federal Income Tax Reporting of Acquisitions

Peco filed a Form 1120, U.S. Corporation Income Tax Return, for the 1997 taxable year (1997 return). On the 1997 return, Peco depreciated certain assets acquired in the Sebastopol acquisition, including the property described as "Processing Plant [Building]" (Processing Plant Building), as nonresidential real property depreciable by a straight-line method over 39 years.

In December 1999, after the cost segregation study was complete, Peco filed a Form 1120 for the 1998 taxable year (1998 return). Attached to the 1998 return was Form 3115, Application for Change in Accounting Method. An attachment to the Form 3115 stated that, pursuant to section 2.01 of an appendix to Rev. Proc. 98-60, 1998-2 C.B. 759, 772, Peco proposed to change its method of accounting to "claim allowable depreciation". Attached to the Form 3115 was a schedule which proposed adjustments to the depreciation method of 55 assets. The attachment to the Form 3115 stated that each item of property "that is reclassified from nonresidential real property to an asset class of Revenue Procedure 87-56 that does not explicitly include section 1250 property, is section 1245 property for depreciation purposes." In total, Peco calculated the section 481(a)3 adjustment arising from the accelerated...

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