Allocating Purchase Price to Real Property vs Goodwill


#1

I noticed in a recent mobile home park Purchase and Sale agreement I came across that the buyer in the agreement allocated 70% of the purchase price towards the Real Property, and the remaining 30% to the business value, or “goodwill”. They then stated that the the amount allocated to Real Property could be subject to an increase as a result of an optional appraisal which could be ordered by the buyer.

Is this a common practice? I’m assuming this is done mostly to set the bar for depreciation allowances as well as property taxes. Does anyone have experience with structuring a PSA in this way, and if so has this proved beneficial?


#2

No. This isn’t common. And it is not a good practice if I am wrong and it is.

I don’t think you were looking at a good agreement, probably one that someone grabbed from a small business sales document where goodwill is a material factor in calculating the sales price.

You want the real property to be as low as possible and the improvements to be as high as possible for depreciation purposes. An appraisal is a good thing to have in hand upon sale, and if you are financing the purchase your lender will insist on one. The second best thing to have on file is the local tax appraisal, which sometimes is skewed towards high improvements versus the land.

There is undoubtedly some goodwill in the transaction, but most park buyers don’t want it in their calculations because you cannot depreciate it.


#3

Let me respond as a CPA and park owner. What you saw is not a common practice, and the way it was done was incorrect, but it can be very useful from a tax standpoint. The agreement should have allocated the sales price to land, land improvements ( roads, sewer, electric, water, possibly cable systems), park owned homes, park owned buildings, sign, equipment, vehicles and inventory or parts. All of that should have been done at fair market value. Then, whatever was left over should have been classed as goodwill.
From a tax standpoint, the goodwill may be amortized over 15 years, the same as the land improvements. There are different lives for the other assets, and all but cost of land end up being expensed one way or another, but that’s the subject of another post.
Conclusion: what you saw was wrong, but they were on to something. It just wasn’t done right.


#4

Allocating money towards goodwill IS the smartest strategy possible. As Carl mentioned, it allows for amortization at 15 years, which is faster than real property land (no depreciation) and the depreciation for buildings. Thus, the Buyer pays less in taxes.

Perhaps more importantly, the lower the value on real property the less likely it is you are going to get a property tax increase. (If you are buying a park for $1MM that the county appraiser has on the tax rolls at $200K, which is common, get ready for the pain, unless you use this strategy.) The allocation has to be reasonable but the reality is that a large portion of the value in a MHP IS the permit (the operating business, i.e. goodwill) and NOT in the land or physical improvements. Really? Yes, would you pay $1MM+ for 10 acres of dirt on the outskirts of town? No way, as the adjacent ground is worth 10% of that. But, would you pay $1MM if it had an operating business with an NOI of $100K (grandfathered in and with permitting rules that create a barrier to entry for competition)? Yes, you would. And there you have it, you are buying intangible value - you can amortize intangible assets for income tax purposes AND you cannot be taxed on them by county appraisers (in I believe any state).

Final bonus for the seller - if the county/state have sales/transfer taxes or stamps then the seller will have to only pay these on the allocated portions of land/improvements.

Anybody who tells you not do an allocation with goodwill is ignorant or a fool.


#5

Really good thread, thank you to the posters.

Any advice on how to fairly calculate the FMV of land improvements, in order to determine what’s left over for goodwill?


#6

My sense of it is that the best way to calculate FMV of land improvements is through the use of a qualified appraiser. They should use the cost/depreciation method or the replacement/depreciated method. In essence, you look to what the cost of the property improvements was, then calculate where they are on the scale from new to dust, and peg a value there, which you then inflate to the current value of the dollar (thus taking into consideration inflation). Another approach is the replacement cost method, where you calculate what it would cost to replicate the land improvements, then depreciate them to their current standard of use or life. Both answers should be somewhat close, depending upon the assumptions made.
And, of course, the assumptions are always the most difficult part… :-0)


#7

Has anyone done a cost segregation for a park ? It would be interesting to know what their take on this is. I have a guy at my real estate meetups who does cost seg as his own business . Ill try and ask the next time I see him.


#8

I just wanted to follow up on Augustine’s point too, as it’s a pretty big one. Has anyone else had success reducing their property tax assessment with the argument that a portion of the purchase is goodwill?


#9

We have purchased several communities in which we have allocated a substantial amount of value to Goodwill. True, you cannot depreciate Goodwill, but you can Amortize it over 15 years, which amounts to the same financial benefit. We have never had a contract that allows the buyer or seller to change the goodwill allocation based on a third-party report however.


#10

The reason I see for putting it in a contract is that it only matters if Buyer and Seller take inconsistent positions with respect to reporting. To the best of my knowledge, Goodwill is not “like-kind” to real estate. Land improvements (expense over 15-year) and Land (no basis reduction over time) are. Besides, the laws may change. So it’s not a bad idea to document how much is paid for Goodwill (not scheduled) versus Land & Land Improvements & Buildings (the “real property”, usually defined by “Exhibit A”) versus Other (the “personal property”, usually defined by Exhibit B and sometimes including IP).

In practice, the border between the FMV price paid for Goodwill and intangibles (e.g. license to operate) versus Land Improvements (physical pads & roads, water & sewer, etc) is hard for the IRS to argue with but equally hard for you to argue with. I think a reasonable (write-down-able reason) allocation is unlikely to be adjusted unless the counterparty does something they shouldn’t have that makes the IRS take a closer look.

I think we put something like, “A will cooperate with B’s price allocation provided it is reasonably calculated to satisfy IRS guidelines” in our last contract.


#11

Can someone explain the idea of amortizing goodwill over 15 years to me please? I’m not grasping what that means to me in terms of my tax return each year.

Thanks to all who have added to this thread…very informative.


#12

AugustinePropertyManagement - thanks for your post, helpful.

I wanted to comment on your statement - “And there you have it, you are buying intangible value - you can amortize intangible assets for income tax purposes AND you cannot be taxed on them by county appraisers (in I believe any state).” I just went through a battle with my county assessor. He raised the value of my park by 61% in one year. His rationale was that the park would sell for $850K so therefore it’s assessed value is $850K. He would not accept that I was paying for a business and not just the property (i.e., Goodwill). I gave the example that if I were to buy a McDonald’s franchise for $2 million that does not mean the property was worth that (thanks to Frank R. for that analogy). He again disagreed and told me that my taxes would “be even higher if I have to continue this discussion”. I sent him the recent appraisal which showed a land value of $250K and real property of about $150K (depreciated) but he would not budge.

So, some of us are taxed on potential income through property taxes and then again on actual revenue via income taxes . He even told me that he adds the full income potential of vacant lots as if they were revenue producing. And this park only has about 60% occupancy. If you have an effective way to fight this, I’d love to hear it. The park is in Minnesota.


#13

Mick,
Your experience is not unfamiliar to me. I am a real estate attorney and former county assessor (of a major metropolitan county), and I have failed to convince local assessors (especially in small towns/counties) of this way of thinking. They prefer to remain ignorant, or even worse obstinate. The “solution” is to go over their head with an appeal. There are generally three levels of appeal, with the final being at a state agency. You will be more likely to succeed at the later levels, where the decision maker (often an attorney/judge) is more easily convinced (i.e. smarter). The catch, of course, is that subsequent appeals will require more time and money, and in some cases the potential tax savings do not make the appeal worth it.

In your case, if the assessor makes threatening language - essentially to deter your appeal - try to get a written record of it, as this will be helpful in future appeals.

Lastly, the McDonald’s argument is a good one. I add to it by including a hypothetical vacant Hardees across the street and then ask if the $2MM valuation will move across the street if McDonald’s buys the vacant building for $100,000 and relocates.


#14

Thank you for the comments and insight.

I actually asked the assessor if the next level of review would be less biased (I am asking him to overturn his own work). He said “not likely as they defer to me”. We have an association for the manufactured housing industry in MN (MMHA). I am pushing them to work on the legislative front on this. In defense of the assessor, the state statute is written in such a way that it could be interpreted incorrectly as he has done. It assumes that an assessor knows that there is a value to the land and real property that is independent of any business operation located there. But, as many of us experience, they can be set in their ways and will not admit they are wrong.

I like your extension of the McDonald’s scenario. I also used the example of a hedge fund manager working out of a property. If he makes $10,000,000 a year, does that mean the property is worth that? Based on his questions to me, he really didn’t seem to grasp the concept.

Thanks again.


#15

Mick,
The second level, likely to a local board of equalization, will often defer to the local assessor. This necessitates a state appeal. (In some cases, you can go beyond that and file in circuit court.)

I am not familiar with the MN statute but I find it hard to believe there is any basis for an assessor to tax (for ad valorem purposes) the intangible personal property (i.e. goodwill). Good luck._


#16

This is a great discussion , thank you everyone for your contributions.


#17

And, as a corollary, what we are seeing across several states that we own property in is a ramp up in appraiser aggressiveness. These guys are going crazy. They must have all gone to some convention and heard a motivational speaker talk about how to increase property taxes. It’s gotten to be outrageous! Then they act all insulted and dismissive in the first level of appeals, you have to go to the second level to even be listened to, and we are at the third level (court is next) on one property. They all seem to have adopted the “potential income” approach, using crazy made up figures!


#18

Im half tempted to start pulling up mcdonalds on the appraisal districts by my to see what they are. I would think they have this one figured out.


#19

The problem is, they aren’t accountants, have no interest in theoretical differences between business goodwill and the value of the land. They see it as one in the same. Tough argument to make.
We have considered forming a management company and hitting each property with a humongous but legitimate, believable management fee, thus sucking lots of profit out of the properties. Then they’d have to value the properties at what the property is worth, not the goodwill…


#20

GREAT idea…share with us what you find out…