Peco Foods v. Commissioner: purchase-agreement allocations bind the buyer

Peco Foods, Inc. v. Commissioner, T.C. Memo 2012-18, aff'd, 522 F. App'x 840 (8th Cir. 2013), holds that a taxpayer cannot cost-seg its way out of its own contract. Peco bought two poultry processing plants under asset purchase agreements that allocated the price among schedules of agreed categories; years later it commissioned cost segregation studies subdividing those categories into shorter-lived assets. Applying the Danielson rule alongside Section 1060's mutual-allocation regime, the Tax Court held the written allocations binding and disallowed the reallocation, and the Eighth Circuit affirmed.

The dispute

Peco acquired a Sebastopol, Mississippi poultry plant in 1995 for about $27.15 million and a Canton, Mississippi plant in 1998 for about $10.5 million. Both were applicable asset acquisitions under Section 1060 (see the Internal Revenue Code), which requires buyer and seller to allocate consideration among transferred assets under the residual method and, where they agree in writing, binds both parties to that allocation. Each agreement allocated the price among listed categories — items such as "Processing Plant Building" and "Real Property: Improvements" — and the parties reported consistently on their asset acquisition statements.

Later, Peco commissioned cost segregation studies that broke those contract categories into components: carving processing-plant building amounts into machinery-related systems, site improvements, and other short-life property, and claiming the resulting depreciation, ultimately seeking roughly $5.3 million of additional deductions via accounting method changes. The Commissioner disallowed the reallocations.

The holding

The Tax Court held for the government. Under Section 1060(a), a written allocation agreed between buyer and seller binds both unless the Commissioner determines it improper — and the taxpayer's escape route is narrower still. Under Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), and the Tax Court's related "strong proof" line, a party seeking to disavow the tax consequences of its own unambiguous agreement must offer evidence that would allow reformation of the contract: fraud, duress, undue influence, mistake. Peco offered none. The court found the schedule terms unambiguous — "Processing Plant Building" meant the building — and rejected the argument that the labels were mere placeholders open to later engineering refinement. The Eighth Circuit affirmed in an unpublished opinion.

The reasoning that matters

The decision is about symmetry and whipsaw. Section 1060 exists so that buyer and seller report the same deal the same way; the seller's gain character and the buyer's basis and recovery periods hang on the same numbers. Letting a buyer privately re-slice the allocation after closing would reintroduce exactly the mismatch the statute was written to prevent. The Danielson rule supplies the enforcement mechanism: the government may look behind a contract, but the parties who wrote it may not, absent reformation-grade proof. Notably, the court did not question cost segregation methodology at all — the studies' engineering was irrelevant, because the threshold legal question of what Peco bought had already been answered by Peco's own signature.

What it means for claims today

Peco Foods is a diligence rule masquerading as a depreciation case. Before any study on acquired property, counsel should pull the purchase agreement and the Section 1060 statements and ask three questions. Did the parties agree to a written allocation? How granular are its categories? Is there room to subdivide within a category without contradicting it? Where the agreement allocates only between broad classes — or is silent — a study retains its full force under Hospital Corp of America v. Commissioner, 109 T.C. 21 (1997), and the classification framework in Pub 946. Where the agreement is specific, the fix belongs in the negotiation, not the study: sophisticated buyers now draft allocation schedules with cost segregation in mind, or expressly reserve component-level detail. The IRS's Cost Segregation Audit Techniques Guide directs examiners to request acquisition documents for exactly this reason, and a retroactive study implemented on Form 3115 will not cure a contractual bar.

Related reading

• How cost segregation became law — Peco as the contractual boundary of the doctrine
• What is cost segregation? — where acquisition studies fit
• Audit readiness and documentation — keeping the deal file and the study consistent