Purchase Price Allocation
The allocation of total purchase price across asset categories (inventory, equipment, real estate, goodwill, etc.) for tax purposes under IRC Section 1060 — affecting seller's tax treatment and buyer's future depreciation deductions.
Full Definition
In asset sales (and 338(h)(10) elected stock sales), the total purchase price must be allocated across the acquired assets. This allocation determines how the seller's gain is characterized (capital gain vs. ordinary income) and how the buyer depreciates or amortizes the assets going forward. Section 1060 requires buyer and seller to use consistent allocations on IRS Form 8594.
How it actually works: Section 1060 prescribes a "residual method" allocation sequence: (1) Class I — cash and cash equivalents (full face value); (2) Class II — marketable securities (fair market value); (3) Class III — accounts receivable and similar items (fair market value); (4) Class IV — inventory (fair market value); (5) Class V — all other assets including equipment, real property (fair market value); (6) Class VI — intangibles other than goodwill (fair market value, including non-compete); (7) Class VII — goodwill and going concern value (residual).
Tax consequences differ by category: (1) inventory → ordinary income for seller, 1-year write-off for buyer; (2) depreciable equipment → depreciation recapture (ordinary income up to prior depreciation) plus capital gain on the excess, 5-7 year MACRS for buyer; (3) real property → 25% recapture on depreciation plus capital gain, 39-year depreciation for buyer; (4) goodwill → capital gain for seller, 15-year amortization for buyer (Section 197); (5) non-compete → ordinary income for seller, 15-year amortization for buyer.
Buyer and seller have opposing preferences: buyer wants more allocated to faster-depreciating assets (equipment, inventory); seller wants more to goodwill (long-term capital gain). These tensions are negotiated as part of deal structure.
Seller vs. Buyer Perspective
Allocations affect your tax bill meaningfully. Preferences: (1) maximize goodwill (capital gain); (2) minimize inventory and equipment (ordinary income from depreciation recapture); (3) minimize non-compete allocation (ordinary income). For every $100K shifted from equipment to goodwill, you save roughly $15-20K in taxes. Fight for reasonable allocations in the definitive agreement; Form 8594 filings should match.
Allocations affect your future tax savings. Preferences: (1) maximize equipment and inventory (fast depreciation/write-off); (2) maximize real property if applicable; (3) minimize goodwill (15-year amortization is slower). Every $100K shifted to equipment vs. goodwill accelerates tax benefits by 10+ years. The PV benefit of faster deductions is meaningful. Appraisal-supported allocations work; aggressive allocations invite IRS scrutiny.
Real-World Example
A $12M asset sale with the following book values: inventory $400K, AR $800K, equipment $1.2M, real estate $2M, other tangible $300K. Remaining purchase price to allocate: $12M - $4.7M already at cost = $7.3M to goodwill and intangibles. Negotiation: seller proposes inventory at $400K (book), equipment at $1.5M (up from book), real estate $2.5M (up from book), non-compete $50K, goodwill $6.75M. Buyer counters: inventory $500K, equipment $2M, real estate $3M, non-compete $250K, goodwill $5.55M. Negotiated outcome: inventory $450K, equipment $1.8M, real estate $2.75M, non-compete $150K, goodwill $6.05M. Seller's tax bill: inventory ordinary income $50K over book, equipment ordinary income (recapture) $600K, real estate recapture $200K, non-compete ordinary $150K, goodwill capital gain $6.05M, real estate remaining gain $550K capital. Different from seller's original position but within market range.
Why It Matters & Common Pitfalls
- !Both sides must file consistent 8594. Inconsistency invites IRS audit.
- !Appraisal support. Documented valuations (equipment, real estate appraisals) support aggressive allocations.
- !Non-compete allocation. Seller wants minimal ($10-50K); buyer wants more for amortization. Typically modest unless genuinely material.
- !Goodwill residual. Whatever's left after other classes becomes goodwill. Sellers benefit from high goodwill.
- !State tax implications. Some states have different allocation rules. Check state-level.
- !Installment method. With installment treatment, allocation affects year-by-year gain recognition.
Frequently Asked Questions
What is purchase price allocation in M&A?↓
Who fills out Form 8594?↓
Why do buyers and sellers disagree on purchase price allocation?↓
Related Terms
Asset Sale
A transaction in which the buyer purchases specific assets and assumes specific liabilities of a business, while the seller retains the legal entity — contrast with a stock sale, where the entity itself changes hands.
Capital Gains (Short vs Long Term)
The tax treatment of gain from selling a capital asset (like a business). Long-term capital gains (asset held >1 year) are taxed at preferential federal rates (typically 20%); short-term gains and ordinary income can be taxed at up to 37%.
Goodwill
The excess of purchase price paid over the fair value of identifiable assets and liabilities in an acquisition. Goodwill represents value not captured by tangible or specifically identifiable intangible assets — brand reputation, customer loyalty, assembled workforce, and going-concern value. In purchase price allocation (IRC Section 1060), goodwill is the residual "Class VII" category. For buyers, goodwill is amortized over 15 years for tax purposes. For sellers, goodwill gain is typically long-term capital gain — a significant benefit in asset sales.
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Disclaimer: The information provided on this page is for educational and informational purposes only. It should not be considered financial, legal, or investment advice. Business valuations depend on many factors specific to each situation. Always consult with qualified professionals — including business brokers, CPAs, and M&A attorneys — before making acquisition or sale decisions. LegacyVector is not a licensed broker, financial advisor, or attorney. Data shown may be based on limited samples and may not reflect current market conditions.
LegacyVector Research Team
Reviewed by M&A professionals · Updated April 2026