Mike Saxon is negotiating the purchase of a business. The final purchase has been agreed upon, but the allocation of the purchase price to the assets is still being discussed. Appraisals on a warehouse range from $1,200,000 to $1,500,000. If a value of $1,200,000 is used for the warehouse, the remainder of the purchase price, $800,000, will be allocated to goodwill. If $1,500,000 is allocated to the warehouse, goodwill will be $500,000. Mike wants to know what effect each alternative will have on cost recovery and amortization during the first year. Under the agreement, Mike will take over the business on January 1 of next year. Click here to access Exhibit 5.6 of the textbook. a. Complete the letter to Mike. If required, round your intermediate computations and final answers to the nearest dollar.

Dear Mr. Saxon: This letter is in response to your request concerning the tax consequences of allocating the purchase price of a business between the two assets purchased: a warehouse and goodwill. If the purchase price of $2,000,000 is allocated $1,200,000 to the warehouse and $800,000 to goodwill, the total recovery in the first year of operations will be (A) ?

Cost recovery on the warehouse will be $ (B) ?

and amortization of the goodwill will be $ (C)

If the purchase price is allocated $1,500,000 to the warehouse and $500,000 to goodwill, the total recovery in the first year of operations will be $(D) ?

The cost recovery on the warehouse will be $ (E)?

and amortization of the goodwill will be $ (F)?

Therefore, under the first option, your deductions in the first year will be $ (G)?

greater. The building is written off over years, whereas the goodwill is written off over years. Thus, the higher the allocation to goodwill, the faster the write-off will be. Should you need more information or clarification of calculations, please contact us. Sincerely yours, John J. Jones, CPA Partner