                        T.C. Memo. 2009-291



                      UNITED STATES TAX COURT



            WEST COVINA MOTORS, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent*



     Docket No. 4802-04.               Filed December 16, 2009.



     Steven Ray Mather and Elliott Hugh Kajan, for petitioner.

     Alan H. Cooper, for respondent.



                  SUPPLEMENTAL MEMORANDUM OPINION


     KROUPA, Judge:   We previously issued an opinion determining,

among other things, that petitioner was not entitled to deduct

legal fees related to the acquisition of an automobile

dealership.   See West Covina Motors, Inc. v. Commissioner, T.C.


     *
      This opinion supplements our prior Memorandum Opinion, West
Covina Motors, Inc. v. Commissioner, T.C. Memo. 2008-237.
                                  -2-

Memo. 2008-237 (West Covina I).    Petitioner timely filed a motion

for reconsideration pursuant to Rule 161.1   We denied

petitioner’s motion except that we reopened the record for the

limited purpose of accepting evidence regarding the allocation of

the legal fees and their proper period of amortization or

deduction.

     The parties have stipulated all additional facts necessary

to address two issues regarding the legal fees.   The first issue

is whether any portion of the legal fees is related solely to

inventory and, if so, when those fees would be allowable as costs

of goods sold.   The second issue is whether any of the remaining

legal fees are allocable to the acquired assets and what the

period of amortization of such fees would be.   All other issues

have been resolved by the parties, are computational, or were

resolved by the Court in West Covina I.

                             Background

   We incorporate our findings in West Covina I for purposes of

this supplemental opinion.   We repeat here the facts necessary to

understand the discussion that follows, and we supplement those

facts with the additional stipulated facts of the parties.   The

supplemental facts have been stipulated under Rule 122, and the




     1
      All section references are to the Internal Revenue Code in
effect for 1999, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
                                 -3-

supplemental stipulation of facts and the accompanying exhibits

are incorporated by this reference.

     Petitioner is a corporation with its principal place of

business in California.    It is an accrual method taxpayer.    Zaid

Alhassen (Mr. Alhassen) is the sole shareholder of petitioner,

which operated a Dodge dealership during the years at issue.

     Mr. Alhassen entered into an agreement to purchase (purchase

agreement) the assets of Clippinger Chevrolet (Clippinger), an

established new car dealership in Covina, California.    Mr.

Alhassen assigned the purchase rights to petitioner, who

consummated the purchase agreement with Clippinger in November

1999.    The parties stipulated that petitioner paid $6,050,6012

for certain assets of Clippinger, including $250,001 for fixed

assets, $3.5 million for goodwill, and $2,300,600 for inventory

of used vehicles, parts, and miscellaneous items.    They further

stipulated that petitioner acquired Clippinger’s $6,258,074 new

and demonstrator vehicle inventory, which was subject to a

$6,421,047 floor plan line of credit.    Accordingly, the total

purchase price of the Clippinger assets was $12,308,675

($6,050,601 for assets under the purchase agreement + $6,258,074

for new and demonstrator vehicle inventory).

     Petitioner paid acquisition-related legal fees of $116,293

in 1999 to Clippinger’s counsel, Norman Hoffman.    Most, if not

all, of the fees paid to Mr. Hoffman were for drafting multiple


     2
        All dollar amounts are rounded to the nearest dollar.
                                -4-

loan documents and leases related to a seller-financing

arrangement for the assets purchased under the purchase

agreement.   Petitioner also paid $2,958 to Chrysler Financial in

1999 and $9,564 to Cooksey, Howard, Martin, & Toolen (Cooksey) in

2000.   These fees were paid primarily for document review and

other services related to inventory financing.    In addition,

petitioner paid $9,550 to Rogers, Clem, & Company (Rogers Clem)

in 2000 in connection with the Clippinger acquisition.    These

fees were related to the overall Clippinger acquisition as well

as physical inventory of the vehicles.    Approximately $6,675 of

the $9,550 paid to Rogers Clem was paid for physical inventory.

                            Discussion

     Petitioner argued in West Covina I that all of the legal

fees at issue were currently deductible because they either

related entirely to inventory financing or physical inventory or

because 80 to 90 percent of the Clippinger purchase price was

incurred for the purchase of inventory.    We found in West Covina

I that these fees were nondeductible capital expenditures because

they were incurred in connection with the purchase of a capital

asset and that petitioner did not provide proper substantiation

that any fees were allocable entirely to inventory.     West Covina

Motors, Inc. v. Commissioner, supra.     In addition, petitioner did

not provide necessary evidence concerning the total purchase

price or the amounts paid for inventory.    We must revisit the

treatment of legal fees attributable entirely to inventory given
                                - 5 -

the new stipulated facts and accompanying exhibits.    We then turn

to the proper allocation of any remaining acquisition-related

legal fees and their period of amortization.

I.   Legal Fees Attributable to Inventory

     We first address whether any of the $138,365 in legal fees

is attributable to inventory and therefore allowable as cost of

goods sold.    Petitioner did not properly substantiate at trial

the legal fees it claimed were associated entirely with

inventory.    The parties have stipulated, however, further

evidence regarding these fees, including itemized billing

statements from the respective attorneys.    We must determine

whether this evidence is sufficient to entitle petitioner to

treat any of the legal fees as cost of goods sold.

     We begin by noting the fundamental principle that the

Commissioner’s determinations are generally presumed correct, and

the taxpayer bears the burden of proving that these

determinations are erroneous. Rule 142(a); INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992); Welch v. Helvering, 290

U.S. 111 (1933).    This includes the burden of substantiation.

Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam

540 F.2d 821 (5th Cir. 1976).    Taxpayers must substantiate the

amount they report as cost of goods sold, and they must maintain

sufficient records for this purpose.    Sec. 6001; Nunn v.

Commissioner, T.C. Memo. 2002-250; Wright v. Commissioner, T.C.

Memo. 1993-27; sec. 1.6001-1(a), Income Tax Regs.
                               - 6 -

      We find that the legal fees paid to Chrysler Financial and

Cooksey were attributable to inventory financing.   We further

find that petitioner paid $6,675 to Rogers Clem for services

related to physical inventory of vehicle inventory.   Accordingly,

we hold that these fees are allowable as cost of goods sold.

See, e.g., Dowd v. Commissioner, 68 T.C. 294, 303-304 (1977)

(attorney’s fees held deductible to the extent that they related

to cost of goods sold).   The parties stipulated that any legal

fees attributable to cost of goods sold are deductible 40 percent

in 1999 and 60 percent in 2000, and we so hold.

II.   Allocation of Remaining Legal Fees

      We turn now to the allocation and amortization of the

$116,293 legal fees paid to Mr. Hoffman and the $2,875 balance

paid to Rogers Clem (remaining legal fees).   The remaining legal

fees are not specifically related to inventory but instead are

capital expenditures related to the Clippinger acquisition.

West Covina Motors, Inc. v. Commissioner, T.C. Memo. 2008-237.

The parties agree that these capital expenditures must be

amortized over the useful life of the assets to which they

relate.   See Commissioner v. Tellier, 383 U.S. 687, 689-690

(1966).   The remaining fees paid to Rogers Clem are related to

the overall Clippinger purchase.   We find that the legal fees

paid to Mr. Hoffman, however, were incurred in furtherance of the

seller-financing arrangement and are related only to the assets
                                 - 7 -

purchased under the purchase agreement.    We must first determine

how the legal fees are allocated to the purchased assets to then

determine the period over which those legal fees should be

recovered.

     The parties agree that the record in West Covina I lacked

sufficient evidence concerning the total cost of the Clippinger

acquisition and the breakdown of the amounts paid for the various

categories of assets.    The parties have now stipulated the

amounts paid for each category of assets.    The parties still do

not agree, however, as to how the legal fees should be allocated

among these assets.

     Respondent argues that the legal fees must be allocated in

accordance with the fair-market-value limitations of section

1060, which applies to applicable asset acquisitions.    He further

argues that all of the legal fees must be allocated under section

1060 to class V intangible assets, which include goodwill and

going concern value.    He therefore argues that the legal fees

must be amortized ratably over 15 years beginning with the month

of purchase under section 197.    Petitioner counters that section

1060 does not apply to the allocation of the legal fees.    We

agree with petitioner.

     A.   Operation of Section 1060

     Petitioner does not dispute that the Clippinger purchase

constitutes an “applicable asset acquisition” under section 1060.
                               - 8 -

An applicable asset acquisition is any transfer (whether direct

or indirect) of assets constituting a trade or business and in

which the transferee’s basis is determined wholly by reference to

the consideration paid for such assets.     Sec. 1060(c).

Generally, a written agreement is binding in such an acquisition

as to the allocation of the consideration or as to the fair

market value of any of the assets.     Sec. 1060(a).   Where the

parties do not allocate the consideration entirely, however, the

residual method of purchase price allocation may apply to

determine both the purchaser’s basis in, and the seller’s gain or

loss from, each of the transferred assets.     East Ford, Inc. v.

Commissioner, T.C. Memo. 1994-261; see also sec. 1060(a).

     A taxpayer generally allocates the consideration received to

the acquired assets, to the extent of their fair market values,

in descending order of priority by class under the residual

allocation method.   Sec. 1060(a); sec. 1.1060-1T(a), (d),

Temporary Income Tax Regs., 53 Fed. Reg. 27039, 27040 (July 18,

1988), amended by 62 Fed. Reg. 2272, 2273 (Jan. 16, 1997).

Consideration is first reduced by the amount of class I assets,

which include cash, bank accounts, and other similar items.        Sec.

1.1060-1T(d)(1), Temporary Income Tax Regs., supra.      Any

remaining consideration is allocated to the remaining classes of

assets in proportion to the assets’ fair market value.      Sec.

1.1060-1T(d)(2), Temporary Income Tax Regs., supra.      The
                                - 9 -

remaining consideration is first allocated among class II assets,

then among class III assets, then among class IV assets, and

finally to class V assets.    Id.   Class II assets include

certificates of deposits, U.S. Government securities, readily

marketable stock or securities, foreign currency, and other

similar items.   Sec. 1.1060-1T(d)(2)(ii), Temporary Income Tax

Regs., supra.    Class III assets are all assets other than class

I, II, IV, and V assets, generally, tangible property.    See sec.

1.1060-1T(d)(2)(iii), Temporary Income Tax Regs., supra.      Class

IV assets are all section 197 intangibles except those in the

nature of goodwill and going concern value.    Sec. 1.1060-

1T(d)(2)(iv), Temporary Income Tax Regs., supra.     Finally, class

V assets are section 197 intangibles in the nature of goodwill

and going concern value.   Sec. 1.1060-1T(d)(2)(v), Temporary

Income Tax Regs., supra.

     Allocation of consideration is subject to fair-market-value

limitations under the residual method.    Accordingly, the amount

of consideration allocated to an asset (other than Class V

assets) must not exceed the fair market value of that asset on

the purchase date.   Sec. 1.1060-1T(e)(1), Temporary Income Tax

Regs., 62 Fed. Reg. 2273 (Jan. 16, 1997).    Thus, any residual

consideration that is not allocated to other assets must be

allocated to the class V assets.    See East Ford, Inc. v.
                              - 10 -

Commissioner, supra;3 sec. 1.1060-1T(d), Temporary Income Tax

Regs., 62 Fed. Reg. 2267 (Jan. 16, 1997) (adding class V assets).

     We find that there were no class I, class II, or class IV

assets transferred in the Clippinger acquisition.     Therefore the

entire purchase price must be allocated between class III and

class V assets.   See East Ford, Inc. v. Commissioner, supra.     The

parties have stipulated that $8,808,6754 of the Clippinger

purchase price is properly allocated to class III assets,

including new, used, and demonstrator vehicle inventory, parts

inventory, and other fixed assets.     The parties have further

stipulated that $3.5 million is properly allocated to goodwill.

Thus, there is no controversy concerning the allocation of the

purchase price to these assets.

     B.   The Legal Fees Are Not Subject to Section 1060

     We must now decide whether the legal fees must be allocated

under section 1060.   Respondent cites no authority requiring

legal fees to be allocated under the fair-market-value

limitations of section 1060 where the parties have stipulated the

cost of each asset, and we find none.     Section 1060 is meant to

prevent abuse where there is no agreement between the parties



     3
      The residual class was Class IV assets for the years at
issue in East Ford, Inc. v. Commissioner, T.C. Memo. 1994-261.
     4
      ($250,000 for fixed assets + $2,300,600 for used vehicle
and parts inventory + $6,258,074 for new vehicle inventory + $1
for miscellaneous assets).
                                - 11 -

concerning how much of the purchase price is allocable to which

category of assets.     See S. Rept. 99-313, at 254 (1986), 1986-3

C.B. (Vol. 3) 1, 254.    The residual allocation method prevents

the parties from taking inconsistent positions for individual tax

advantages.   See id.

     Respondent equates the term “consideration” in section 1060

to the purchaser’s cost basis in the assets acquired.       We presume

respondent does so because section 1060 describes an applicable

asset acquisition as an acquisition in which the purchaser’s

basis in the transferred assets is determined wholly by reference

to the purchaser’s consideration.     Sec. 1060(c).   A taxpayer

generally has a basis in property equal to its cost, which is

defined as “the amount paid for such property in cash or other

property.”    Sec. 1012; sec. 1012-1(a), Income Tax Regs.    Legal

fees incurred in the acquisition or disposition of a capital

asset are to be treated as capital expenditures and are to be

“added to the basis of the capital asset with respect to which

they are incurred.”     Woodward v. Commissioner, 397 U.S. 572,

574-575 (1970); Berry Petroleum Co. & Subs. v. Commissioner, 104

T.C. 584, 618 (1995), affd. without published opinion 142 F.3d

442 (9th Cir. 1998).     Respondent therefore argues that

petitioner’s cost basis, including fees paid to third parties,

must be allocated under the fair-market-value limitations of
                                - 12 -

section 1060.    We disagree.   The parties have stipulated the cost

of each asset.    Accordingly, section 1060 does not apply.

     Respondent makes no alternative argument as to how the

acquisition-related legal fees should be allocated.     We therefore

agree with petitioner that the legal fees should be allocated

proportionately to the assets with which they are associated.

The parties have stipulated that petitioner paid Mr. Hoffman to

draft documents related to the seller-financing arrangement.      We

therefore conclude that the legal fees paid to Mr. Hoffman should

be allocated pro rata among the assets acquired under the

purchase agreement.    These assets include all assets except the

new and demonstrator car inventory.      Accordingly, the legal fees

paid to Mr. Hoffman will be allocated to fixed assets (4.1

percent), goodwill (57.9 percent), and used vehicles and parts

(38 percent).

     The balance of the legal fees paid to Rogers Clem, excluding

the amount paid for physical inventory, shall be allocated

proportionally among all assets purchased.     The parties have

stipulated the allocation of the Clippinger purchase price.

Accordingly, these fees will be allocated to fixed assets (2.03

percent), goodwill (28.44 percent), used vehicles and parts

(18.69 percent), and new and demonstrator vehicles (50.84

percent).
                              - 13 -

     The parties have also stipulated the period of amortization

or deduction for fees allocated to each category of assets.    We

therefore conclude that the legal fees allocated to fixed assets

are amortizable over seven years under section 168 and those

attributable to goodwill are amortizable over 15 years under

section 197.   We further hold that the legal fees allocated to

inventory (both new and used, including parts) are allowable as

cost of goods sold, 40 percent in 1999 and 60 percent in 2000.

     To reflect the foregoing,


                                         Decision will be entered

                                    under Rule 155.
