What happens if you write up assets for book purposes but not for cash tax purposes?
A deferred tax liability is created equal to the difference between the higher book basis and the lower tax basis multiplied by the tax rate, since future tax deductions will be smaller than book depreciation.
Intuition
If you write up assets only on the books, you'll record higher depreciation expense on the books than on the tax return. That means in future years, book pre-tax income is lower than taxable income, so you'll pay more cash tax than your book tax expense would otherwise imply. That's the classic setup for a deferred tax liability, because the higher book basis creates future taxable amounts when the temporary difference reverses.
Watch
Interviewers often follow up with: 'What if this write-up occurs in a stock acquisition with purchase price allocation?' In that case, the DTL created by the book-tax basis difference affects purchase accounting and increases goodwill rather than flowing through the income statement, because it's part of the acquisition accounting.
Deep Dive
Determine the balance sheet and tax implications when assets are written up for book (GAAP) purposes but their tax basis remains unchanged.
Core Setup: Book basis of asset increases (write-up), but tax basis stays at the old, lower value. This creates a temporary difference between book and tax.
Step 1: Identify the Temporary Difference
- Book basis of asset > Tax basis of asset
- This means in future periods, book depreciation/amortization will be higher than tax depreciation (larger expense on books), OR upon sale, taxable gain will exceed book gain.
- But the key economic fact: you have an asset on the books worth more than the IRS recognizes. Eventually, when that asset generates deductions (depreciation) or is sold, you will owe more tax than your books suggest — because tax won't let you deduct the written-up portion.
Step 2: Create a Deferred Tax Liability (DTL)
- This DTL sits on the balance sheet as a non-current liability.
- It represents taxes you will owe in the future that you have not yet paid, because the book write-up created income/value that tax has not yet recognized.
Step 3: Ongoing Impact — Higher Book Depreciation, No Tax Benefit
- Each period, book D&A is computed on the higher written-up value → larger book expense.
- Tax D&A is computed on the original, lower basis → smaller tax deduction.
- Result: Book pre-tax income < Tax pre-tax income in each period (temporarily), and the DTL unwinds over the asset's remaining life as the basis difference reverses.
Step 4: Numerical Illustration
| Item | Book | Tax |
|---|---|---|
| Asset FMV / Written-Up Value | 100 | — |
| Original (Tax) Basis | — | 60 |
| Temporary Difference | 40 | — |
| Tax Rate | 25% | 25% |
| DTL Created | 10 | — |
Over the asset's life, book depreciation exceeds tax depreciation by a cumulative 40. Each year, a portion of the DTL reverses as the gap narrows.
Step 5: Where This Shows Up in Practice
- Purchase Price Allocation (PPA) in M&A: Asset write-ups to fair value on the acquirer's consolidated books. If the deal is structured as a stock deal (no Section 338(h)(10) election), the target's tax basis carries over unchanged → DTL is created.
- Goodwill: If goodwill is created for book but is not tax-deductible, a DTL is generally NOT recorded for the book-tax goodwill difference (ASC 805 exception). But for identifiable intangibles and fixed assets, the DTL is recorded.
Net Effect on Equity at Inception:
The write-up increases assets but is partially offset by the DTL, so net assets (and in an acquisition context, goodwill) are affected on a tax-effected basis.