How is a business purchase price allocated for tax purposes?
Required in asset acquisitions; the values inside the classes are negotiated
In an asset acquisition of a trade or business, IRC §1060 requires the buyer and seller to allocate the price among the assets using the residual method of Treas. Reg. §1.338-6. The seven classes run from cash (Class I) to goodwill and going concern value (Class VII). If both sides agree on the allocation in writing, the agreement generally binds both. Each party reports the allocation on its own Form 8594.
Reviewed by Ebot Mbi, CPA, EA · Last reviewed · Law and figures current as of September 17, 2026
Key takeaways
- The residual method allocates price to Classes I through VI up to fair market value, and the rest goes to goodwill (Class VII).
- A written allocation agreement binds both parties unless the IRS finds it inappropriate (§1060(a)).
- Each side files its own Form 8594 with its own return.
- Equipment gain is often ordinary recapture for the seller, while goodwill gain is generally capital gain.
- Buyers amortize goodwill and most other intangibles, including noncompetes, over 15 years (§197).
What it is
When a business is sold as assets, the purchase price is one number, but for tax purposes it must be divided among the assets acquired. That division determines the buyer's basis in each asset and the character and amount of the seller's gain on each asset.
Because the same allocation affects both sides differently, it is one of the most negotiated tax terms in an asset purchase agreement.
What the law says
IRC §1060(a) requires the consideration in an applicable asset acquisition to be allocated among the assets in the same manner as under §338(b)(5). If the transferee and transferor agree in writing on the allocation or on the fair market value of any asset, the agreement binds both of them unless the IRS determines that it is not appropriate.
Treas. Reg. §1.1060-1 applies the residual method of Treas. Reg. §1.338-6. Class I is cash and general deposit accounts. Class II includes actively traded personal property, certificates of deposit, and foreign currency. Class III includes assets marked to market at least annually and debt instruments, including accounts receivable. Class IV is inventory. Class V is all assets not in another class, such as equipment, furniture, buildings, and land. Class VI is all §197 intangibles except goodwill and going concern value. Class VII is goodwill and going concern value.
Under §197, goodwill, customer-based intangibles, and covenants not to compete entered into in connection with an acquisition are amortized over 15 years. Under §168(k), as amended by the One Big Beautiful Bill Act, qualified property acquired after January 19, 2025 is eligible for 100% bonus depreciation.
Requirements and tests
An allocation should satisfy these points:
- The transaction is an applicable asset acquisition: a transfer of assets that make up a trade or business, where goodwill or going concern value could attach.
- Price is allocated to Classes I through VI in order, each up to its fair market value, with any remainder in Class VII.
- The fair market values are supportable, ideally by an independent appraisal.
- The allocation, or the method for determining it, is written into the purchase agreement.
- Both parties file Form 8594 with their returns for the year of sale and file supplemental statements if the price changes later.
- Payments to the owners personally, such as for a noncompete or consulting, are identified separately.
How it works
For the buyer, dollars allocated to equipment may be deducted quickly through bonus depreciation, while dollars allocated to goodwill or a noncompete are deducted over 15 years, and dollars allocated to land are not deducted at all. For the seller, gain on equipment is generally ordinary income to the extent of prior depreciation under §1245, a noncompete payment is ordinary income, and gain on self-created goodwill is generally capital gain.
The two sides' preferences therefore diverge. A buyer usually prefers more allocation to short-lived assets. A seller, especially an individual or a pass-through owner, usually prefers more allocation to goodwill. The allocation still has to reflect fair market value; moving dollars without support invites an IRS challenge.
If the price later changes, for example through an earnout or a working capital adjustment, the increase or decrease is allocated under the same residual method, and both parties report it on a supplemental Form 8594.
Liabilities matter too. Liabilities the buyer assumes are part of the consideration allocated among the classes, and they increase the seller's amount realized. Real estate is often split between land, which is not depreciable, and buildings or improvements, which are; a cost segregation study can support shorter recovery periods for some building components. State sales tax on transferred equipment and local property tax reassessments can also depend on the allocation, so the schedule should be reviewed for state effects before it is final.
Assumptions: Tax year 2026; calendar-year buyer and seller; the acquisition closes and the assets are placed in service in January 2026; no cash, receivables, inventory, or liabilities are included.; Appraised fair market values: equipment $4,000,000 (Class V) and a noncompete from the owner $1,000,000 (Class VI); the $5,000,000 residual is goodwill (Class VII).; The equipment qualifies for 100% bonus depreciation. The seller's equipment has an adjusted basis of $1,000,000 and an original cost of $5,000,000; goodwill is self-created with zero basis.; The seller is an S corporation whose sole owner is married filing jointly, lives in Texas, materially participates (no NIIT), and has other income above $768,700 of joint taxable income; ordinary income is taxed at 37% and capital gain at 20%; any §199A deduction is ignored.
| Buyer: 2026 bonus depreciation on equipment | $4,000,000 |
|---|---|
| Buyer: annual §197 amortization (($1,000,000 + $5,000,000) ÷ 15) | $400,000 |
| Seller: §1245 recapture on equipment ($4,000,000 − $1,000,000), ordinary | $3,000,000 |
| Seller: noncompete, ordinary | $1,000,000 |
| Seller: goodwill gain, capital | $5,000,000 |
| Seller: tax on ordinary income ($4,000,000 × 37%) | $1,480,000 |
| Seller: tax on capital gain ($5,000,000 × 20%) | $1,000,000 |
| Seller: total federal tax | $2,480,000 |
The same allocation gives the buyer $4,400,000 of first-year deductions and the seller $4,000,000 of ordinary income, which is why the schedule should be negotiated before signing.
Illustration only; not a projection of your results.
Risks and IRS scrutiny
The IRS compares the buyer's and seller's Forms 8594. Allocations that ignore fair market value, a noncompete priced far above its economic value, and inconsistent reporting between the parties are common audit issues. Without a written agreement, each side may take its own position, which makes a dispute more likely.
Who it is not for
This page describes a required method rather than an optional strategy, so it applies to every applicable asset acquisition. It is not a tool for each side to claim the most favorable allocation separately. And it is not something to leave until after closing, because the purchase agreement is where the allocation is fixed.
How ebotCPA helps
We model the allocation's effect on both sides, coordinate with the appraiser, draft the allocation schedule for the agreement, and prepare Form 8594 and any supplemental statements. We coordinate with your attorney, who drafts the legal documents.
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.
We coordinate with your attorney, who drafts the legal documents.
Frequently asked questions
What are the seven asset classes?
Class I cash; Class II actively traded property, certificates of deposit, and foreign currency; Class III mark-to-market assets and debt instruments, including receivables; Class IV inventory; Class V other assets such as equipment and real estate; Class VI §197 intangibles other than goodwill; Class VII goodwill and going concern value.
Do the buyer and seller file one Form 8594 together?
No. Each files its own Form 8594 with its own return. If they agreed on the allocation in writing, IRC §1060(a) generally binds both to it.
Why does the seller care about the allocation?
Because it changes the character of the gain. Equipment gain is often ordinary recapture income, a noncompete is ordinary income, and goodwill gain is generally capital gain.
How is a noncompete deducted by the buyer?
A covenant not to compete entered into in connection with the acquisition of a business is a §197 intangible amortized over 15 years.
Have facts like these?
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.