Peco Foods: Can Cost Segregation Override an Allocation?

Can a cost segregation study override a purchase-price allocation that a buyer and seller already agreed to in writing?

In Peco Foods, Inc. v. Commissioner, the answer was no. The Tax Court held that the taxpayer was bound by the clear and unambiguous allocation schedules in its acquisition agreements. A later cost segregation study could not change the agreed characterization of the acquired assets.

That does not mean cost segregation is unavailable for acquired commercial real estate. It means the acquisition agreement can establish legal constraints that engineering analysis cannot independently remove.

The 2025 IRS Cost Segregation Audit Technique Guide (ATG) discusses Peco Foods in two important places: its examination guidance for acquired properties and its discussion of changes in accounting method.

For commercial real estate investors, the decision raises a practical question that should be addressed before a transaction closes: Does the purchase agreement preserve the ability to identify and properly classify the assets being acquired?

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Key Takeaways

• Peco Foods establishes why a later cost segregation study could not override the taxpayer's agreed acquisition allocations.
• Section 1060 explains when written purchase-price allocations become binding on buyers and sellers.
• The IRS ATG directs examiners to review acquisition documents before accepting an acquired-property cost segregation study.
• Filing Form 3115 does not independently permit a taxpayer to disregard a binding purchase-price allocation.
• CostSegRx engineering analysis can identify and value assets, but it cannot independently rewrite an acquisition agreement.
• The ATG expressly recognizes uncertainty about applying Peco Foods beyond applicable asset acquisitions under § 1060.
• Investors should consider purchase-price allocation language before closing, not only after commissioning a study.

What Did the Tax Court Decide in Peco Foods?

Peco Foods, Inc. v. Commissioner, T.C. Memo. 2012-18, involved the acquisition of two poultry processing plants.

The acquisitions were applicable asset acquisitions under Internal Revenue Code § 1060.

As part of the transactions, Peco Foods entered into written agreements with the sellers allocating the purchase prices among the acquired assets.

After the acquisitions, the taxpayer hired an outside consulting firm to perform a cost segregation study.

The study sought to identify components that could receive depreciation treatment different from the original classifications. The taxpayer subsequently filed Form 3115 to change its accounting method and reclassify certain property from nonresidential real property to tangible personal property.

The IRS challenged the changes.

The dispute was not simply whether the taxpayer could physically identify components within the acquired plants. It was whether the taxpayer could subdivide and recharacterize assets in a manner inconsistent with the written allocation schedules it had already accepted.

The Tax Court held that Peco Foods was bound by the clear and unambiguous terms of those schedules.

The taxpayer could not depart from the agreed characterization of the assets through its subsequent cost segregation study.

The Eleventh Circuit affirmed the decision in Peco Foods, Inc. v. Commissioner, 522 F. App'x 840 (11th Cir. 2013).

What the Decision Actually Establishes

The important legal result is narrower than a general prohibition on cost segregation for acquired property.

Peco Foods involved written allocation schedules, applicable asset acquisitions under § 1060, and proposed reclassifications inconsistent with those agreements.

The court enforced the original allocations under those circumstances.

The case does not establish that every acquired building must remain entirely classified as real property or that every post-acquisition cost segregation study is ineffective.

Instead, it demonstrates that an otherwise detailed study cannot automatically overcome the legal consequences of an agreed acquisition allocation.

Why Does Section 1060 Matter to Purchase-Price Allocations?

Section 1060 addresses the allocation of consideration in certain acquisitions of business assets.

An applicable asset acquisition generally involves a transfer of assets constituting a trade or business where the purchaser's basis in those assets is determined wholly by reference to the consideration paid.

Under § 1060(a)(2), when the parties agree in writing to an allocation of consideration or to the fair market value of particular transferred assets, the agreement is binding on the parties unless the Commissioner determines that the allocation or valuation is inappropriate.

That rule is central to understanding Peco Foods.

A written acquisition allocation is not necessarily just an accounting worksheet that the buyer may freely revise after closing.

In an applicable asset acquisition, it can have binding federal income tax consequences.

What Is the Danielson Rule?

The ATG also discusses Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967).

Under the Danielson rule, a taxpayer generally cannot challenge the tax consequences of a written agreement without evidence of the type that would permit the agreement's construction to be altered or establish its unenforceability in a dispute between the contracting parties.

The ATG identifies circumstances such as mistake, undue influence, fraud, or duress in describing this standard.

The significance for an investor is that dissatisfaction with an agreed allocation after a cost segregation study is completed does not, by itself, establish a legal basis to disregard the agreement.

These are legal questions involving the actual transaction documents and applicable authorities. They are not questions that engineering estimates alone can resolve.

What Happens When There Is No Written Allocation?

The ATG distinguishes transactions with an agreed written allocation from those without one.

For applicable asset acquisitions without an agreed written allocation, the ATG discusses the residual allocation method under § 1060 and the related regulations.

The relevant rules include Treasury Regulation § 1.1060-1 and the residual-method provisions in Treasury Regulations §§ 1.338-6 and 1.338-7.

The absence of a binding written allocation does not mean the buyer may assign arbitrary values to the acquired assets.

The allocation still must follow the applicable tax rules and be supported by appropriate valuation evidence.

How Does the IRS ATG Tell Examiners to Review Acquired Property?

The ATG addresses Peco Foods in its guidance for examining cost segregation studies involving existing properties.

Chapter 5.B.3, within the discussion of other examination considerations, instructs examiners to review acquisition documents to determine what assets were purchased.

A central examination question is whether the buyer and seller agreed to a written purchase-price allocation.

Where a binding allocation exists, the examiner must consider its effect on the taxpayer's subsequent cost segregation positions.

The ATG states that an agreed allocation between personal and real property cannot be changed by a taxpayer's later cost segregation study in the circumstances described by its guidance.

The guide also directs examiners to consider the study when no written price allocation exists.

This distinction matters because the IRS examination does not begin and end with the engineering report.

The acquisition documents may determine what classifications or values the taxpayer is legally permitted to assert.

Other Acquisition Records the ATG Identifies

The ATG also directs attention to records that help establish the acquired property's basis and condition.

These include:

• Acquisition agreements and related schedules.
• Escrow documents and payment records supporting the purchase price.
• Appraisals addressing land and improvement values.
• Information about the physical and economic condition of acquired assets.
• Construction contracts and records of repairs or modifications.
• Available construction drawings and as-built information.

These records address different questions.

The purchase agreement may establish binding allocations. Payment records support the transaction amount. Appraisals and engineering evidence help establish values and identify the acquired assets.

A defensible study must account for all materially relevant evidence rather than relying on a single document or methodology.

Why This Is Different From Allocating Basis in General

Allocating an acquisition price among land, buildings, land improvements, and personal property is an important cost segregation task.

Peco Foods addresses a more specific problem: whether the taxpayer can later depart from a written allocation that already has binding legal effect.

Those questions are related, but they are not interchangeable.

An engineer may be able to develop a technically supported estimate of an asset's value. That estimate does not necessarily establish that the taxpayer is legally entitled to replace a previously agreed allocation.

Why Did Form 3115 Not Solve the Problem?

Peco Foods also appears in Chapter 6.B.4 of the ATG, under the broader subject of changes in accounting method.

This placement is significant.

Cost segregation studies are often performed after a property has already been placed in service.

Depending on the facts and applicable procedures, correcting depreciation classifications for property placed in service in an earlier tax year may involve a change in accounting method and the filing of Form 3115.

But Peco Foods demonstrates that the accounting-method process does not eliminate separate legal restrictions arising from the acquisition transaction.

The taxpayer filed Form 3115 to implement depreciation changes based on its subsequent study.

The IRS disputed the changes because they conflicted with the original allocation schedules.

The Tax Court's decision prevented the taxpayer from implementing those proposed reclassifications.

Two Different Questions Must Be Answered

For an acquired property, the taxpayer may need to address two separate issues:

1. Is the proposed depreciation treatment substantively permitted under the governing asset-classification and acquisition-allocation rules?
2. If a permissible depreciation correction is being made for an earlier year, what accounting-method procedures apply?

Form 3115 concerns the procedure for obtaining consent to certain accounting-method changes.

It does not independently establish that the underlying asset classifications or acquisition allocations are legally correct.

That is the distinction illustrated by Peco Foods.

A cost segregation study and a properly prepared accounting-method filing cannot substitute for analyzing the acquisition agreement itself.

What Is the CostSegRx Engineering Lesson From Peco Foods?

The engineering principle is straightforward: physical asset identification, valuation, and contractual allocation are related but distinct matters.

CostSegRx engineers can examine acquired property and identify assets that may require separate depreciation analysis.

That work may involve reviewing drawings, inspecting installed components, tracing building systems, assessing asset condition, and developing supportable costs or values.

However, engineering findings do not independently change the legal terms of a completed acquisition.

Identify What Was Actually Acquired

The first engineering question is what assets exist within the acquired property.

For commercial real estate, that may include:

• Building structures and structural components.
• Land improvements.
• Machinery and equipment.
• Specialized electrical, mechanical, or plumbing components.
• Other potentially qualifying tangible personal property.

Identifying these assets is essential to a meaningful cost segregation analysis.

But the inventory alone does not determine whether an agreed acquisition allocation can be changed.

Determine the Function and Classification of Each Asset

Once the assets are identified, CostSegRx engineers examine their functions, installation, and relationships to the building or business operations.

Those findings support the analysis of whether property may qualify for a particular depreciation class.

The applicable statutory, regulatory, and judicial authorities ultimately control the classification.

Peco Foods adds another consideration: the taxpayer's ability to assert that classification may be constrained by a binding allocation agreement.

Develop Values That Reflect Acquired-Property Conditions

The ATG recognizes that acquired assets may require valuation adjustments reflecting their actual physical and economic condition.

An asset in an existing building is not necessarily worth the cost of purchasing and installing an equivalent new asset.

Relevant considerations may include age, deterioration, obsolescence, and remaining economic usefulness.

CostSegRx engineers can develop and document those physical and functional observations.

But even a technically sound valuation must be evaluated alongside the transaction documents and applicable allocation rules.

Reconcile Engineering Findings With the Acquisition Documents

For acquired property, a defensible analysis should connect three sources of information:

1. The physical assets and their documented characteristics.
2. The supported acquisition values and total property basis.
3. The purchase agreement and any legally relevant allocation schedules.

When those sources appear inconsistent, the difference should be identified and evaluated.

The solution is not automatically to substitute the engineering estimate for the written agreement.

That distinction separates a supportable engineering interpretation from a legal conclusion about contractual enforceability.

Does Peco Foods Apply to Every Commercial Real Estate Acquisition?

No universal conclusion should be drawn from Peco Foods.

The ATG expressly states that it is unclear whether the holding applies to acquisitions other than applicable asset acquisitions under § 1060.

This is an important qualification.

The case involved two poultry processing plant acquisitions that fell within § 1060, along with written allocation agreements containing clear and unambiguous asset characterizations.

Those facts were central to the outcome.

A purchase of an individual rental building, a business acquisition, and another form of property transaction may involve different facts and potentially different allocation rules.

It would therefore be inaccurate to say that Peco Foods prohibits cost segregation following every real estate purchase.

It would also be inaccurate to say that a later engineering study always overrides an acquisition agreement whenever the study identifies additional components.

What Must Be Evaluated Before Applying the Case?

The analysis should consider:

• Whether the transaction is an applicable asset acquisition under § 1060.
• Whether the parties agreed in writing to particular allocations or values.
• Which assets and characterizations the agreement actually covers.
• Whether the agreement's relevant terms are clear and unambiguous.
• Whether the proposed cost segregation treatment conflicts with those terms.
• What legal authority governs any proposed departure from the agreement.

These are not questions that can be resolved by a generic cost segregation percentage or a standardized depreciation schedule.

They require the actual acquisition documents, applicable legal analysis, and supporting property evidence.

The ATG Is Examination Guidance, Not the Governing Law

The IRS ATG is useful because it explains how examiners are instructed to approach these issues.

However, the ATG does not create the underlying binding-allocation rule.

The relevant legal authority comes from § 1060, the applicable regulations, and judicial decisions such as Peco Foods and Danielson.

CostSegRx engineering interpretation focuses on how property identification, documentation, and valuation should be coordinated with those legal requirements.

Maintaining these distinctions prevents examination guidance from being mistaken for a universal statutory rule.

What Should Investors Do Before Buying Commercial Real Estate?

The most practical lesson from Peco Foods is that cost segregation planning can begin before an acquisition closes.

Waiting until after closing may limit the opportunity to address purchase-price allocation language that has already become binding.

Investors and their tax advisers should consider whether the proposed transaction documents adequately identify the assets being acquired and whether any agreed allocation is consistent with the intended tax treatment.

Before Closing

Review the purchase agreement and any allocation schedules.

Determine whether the transaction falls under § 1060 and whether the parties are agreeing to values or asset characterizations that may have binding tax consequences.

Where appropriate, consider involving qualified tax, valuation, and engineering professionals before the allocations are finalized.

The objective is not to manufacture favorable classifications. It is to ensure that the transaction documents and available property evidence are considered together.

After Closing

Provide the cost segregation team with the complete acquisition agreement and relevant allocation schedules, not only the closing statement or purchase price.

Also provide available appraisals, asset lists, construction records, and other documentation that may support the study.

If the engineering analysis suggests classifications that differ from an agreed allocation, the issue should be evaluated with the taxpayer's tax advisers before implementing a depreciation change.

When Reviewing a Completed Study

An investor should be able to determine whether the study considered the acquisition documents and explained how its asset classifications and values relate to those records.

A detailed engineering report may be valuable, but its conclusions must be consistent with the taxpayer's legal position.

The study should not assume that technical detail alone resolves a conflict with a binding agreement.

Final Takeaway: The Purchase Agreement Matters

Peco Foods, Inc. v. Commissioner illustrates an important limit on post-acquisition cost segregation.

The taxpayer acquired two processing plants, agreed to written purchase-price allocations, and later sought to change certain asset classifications through a cost segregation study and Form 3115.

The Tax Court held the taxpayer to the clear and unambiguous original allocations. The Eleventh Circuit affirmed.

The IRS ATG uses the decision to explain why examiners should review acquisition agreements and consider the legal effect of written allocations when evaluating studies of acquired property.

The ATG also recognizes that the decision's application beyond § 1060 applicable asset acquisitions remains uncertain.

For commercial real estate investors, the lesson is not to avoid cost segregation after an acquisition.

It is to recognize that engineering analysis, tax classification, valuation, and acquisition agreements must work together.

CostSegRx engineers can establish what the property contains, how its components function, and what supported values may be appropriate. They cannot independently erase the legal consequences of a binding purchase-price allocation.

That is why thoughtful acquisition planning and defensible engineering analysis belong in the same conversation.

Sources and Authorities

Primary IRS examination guidance: Internal Revenue Service, Cost Segregation Audit Technique Guide, Publication 5653, revised February 6, 2025. Chapter 5.B.3, examination considerations for existing properties, including acquisition documents and purchase-price allocations; Chapter 6.B.4, Peco Foods Case, page 81.

Central court authority: Peco Foods, Inc. v. Commissioner, T.C. Memo. 2012-18, affirmed, 522 F. App'x 840 (11th Cir. 2013).

Related judicial authority: Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967).

Underlying statutory and regulatory authority: Internal Revenue Code § 1060(a)(2); Treasury Regulation § 1.1060-1; Treasury Regulations §§ 1.338-6 and 1.338-7.

The IRS ATG provides examination guidance. The governing legal rules arise from the applicable statutes, regulations, and judicial decisions. Property-specific facts and transaction documents determine how those rules apply.