In 'Deseret' IRS uses DCF to prove goodwill and loses its argument

Deseret Management Corp. v. United States, 2013 U.S. Claims LEXIS 987 (July 31, 2013)

Win the battle, but lose the war. In a taxpayer refund action that centered on a like-kind exchange, the Court of Claims was receptive to the IRS's argument that the taxpayer's swapped radio station had goodwill. The issue was how to prove the goodwill was appreciable, such that the taxpayer could not benefit from the Internal Revenue Code's section 1031, which allows for the deferral of taxes on the gain.

The taxpayer, claiming the station had no goodwill, simply subtracted the value of the station's tangible and intangible assets from the $185 million exchange value and assigned the entire difference (the residual) to the value of the station's FCC license. The IRS expert performed a discounted cash flow (DCF) analysis of the station to show that the license was worth only $131.4 million, which left a residual value of goodwill of $45.4 million. But the taxpayer's rebuttal experts successfully argued the analysis contained multiple mistakes related to the value, the useful life, and the starting date of the license, as well as the discount rate. The court agreed that if one corrected for these errors, the DCF, the very analytical tool the IRS chose to  support its claim of substantial goodwill, in fact disproved it.