Quick answer: Purchase price allocation divides the price of an asset sale among the assets bought. The IRS form sorts them into seven classes, from cash in Class I to goodwill and going concern value in Class VII.[1] Under the residual method the price generally fills the classes in order, and goodwill receives what is left. Buyer and seller each generally file Form 8594.[1] Because the classes are taxed and recovered differently, the split moves the seller’s tax and the buyer’s deductions in opposite directions, so it is negotiated.
Key points
- The total price is fixed, so the allocation only moves price between classes, and each class is taxed and recovered differently.
- The residual method generally fills the classes in order, so goodwill and going concern value are a remainder, and every dollar placed in an earlier class comes out of them.
- Buyers generally want price on assets they can recover quickly, and sellers generally want it on assets taxed more lightly, so the schedule is a negotiation and not a formality.
- Agree the principles in the letter of intent and attach the schedule to the purchase agreement. A schedule left to be agreed after closing leaves the seller with little leverage.
The residual method works through the classes in order
In an asset sale the purchase agreement states one total price, and the allocation says how much of it is paid for each asset. Buyers and sellers of a group of assets that make up a trade or business, where goodwill or going concern value could attach, report the allocation on Form 8594.[2] Both the purchaser and the seller generally file it, and the form divides assets into seven classes.[1] The instructions describe the residual method in the Treasury regulations under sections 1.338-6 and 1.338-7.[1] Generally, the method assigns price to Class I first, lets each later class take up to the fair market value of its assets, and places whatever remains after Class VI in Class VII. Goodwill is therefore a remainder and not a number anyone appraises directly.
The instructions define the classes as shown below, and the right-hand column is general explanation and not IRS guidance.[1]
| Class | What the IRS form places in it | What it means in the negotiation |
|---|---|---|
| I | Cash and deposit accounts | Usually outside the sale, because the seller keeps cash in a cash-free, debt-free deal |
| II | Actively traded personal property | Rarely present in an operating business |
| III | Assets marked to market at least annually and certain debt instruments, such as most receivables | Valued near face value, and a cash-method seller may owe regular income tax as they are collected |
| IV | Stock in trade or inventory | The buyer recovers the cost as the goods are sold, and the seller’s gain over cost is generally taxed at regular rates |
| V | All assets not in another class, such as equipment, vehicles, furniture, land and buildings | The most contested class: faster cost recovery for the buyer, and recapture of earlier depreciation for the seller |
| VI | Section 197 intangibles other than goodwill and going concern value, such as customer lists, trade names, licenses and covenants not to compete | Recovered on the same slow schedule as goodwill, so the dispute is mostly over the covenant not to compete, which is often regular income to the seller |
| VII | Goodwill and going concern value | The remainder, and the seller’s preferred home for value, because self-built goodwill usually has no basis and is generally taxed as capital gain |
Following the residual method through a sample price
Illustrative example: The same price, two allocations
A buyer acquires the assets of a business for total consideration of $9,000,000. The seller keeps its cash, and the seller’s draft values the equipment at $1,700,000. The buyer’s appraiser values the same equipment at $2,100,000. The classes are filled in order and Class VII takes what remains.
| Class | Assets in this example | Seller’s draft | Buyer’s draft |
|---|---|---|---|
| I | None, the seller keeps its cash | $0 | $0 |
| II | None | $0 | $0 |
| III | Receivables | $1,100,000 | $1,100,000 |
| IV | Inventory | $1,400,000 | $1,400,000 |
| V | Equipment | $1,700,000 | $2,100,000 |
| VI | Customer relationships and a non-compete | $500,000 | $500,000 |
| VII | Goodwill and going concern value (remainder) | $4,300,000 | $3,900,000 |
| Total price | $9,000,000 | $9,000,000 |
The total does not move. The extra $400,000 the buyer finds in the equipment comes out of Class VII dollar for dollar, and to the extent it reverses depreciation the seller already deducted, it is recapture and not goodwill. The amounts are invented to show the mechanics and are not benchmarks.
Why buyer and seller want different splits
Because the total is fixed, the allocation moves price between classes, and each class is taxed and recovered differently. The buyer wants price on assets whose cost it recovers soonest. Inventory comes back through cost of goods sold as it is sold, equipment is generally recovered faster than intangibles, and goodwill is recovered slowly on a fixed schedule. The seller wants price on assets taxed most lightly. Capital gain on property held more than one year is long-term,[3] while inventory, recaptured depreciation and some other items are generally taxed at regular rates. The federal tax guide covers each layer.
The seller’s stake depends on the entity. Owners of pass-through companies see each class on their personal returns, while a corporation that pays tax on the sale itself may care less about the character of each dollar. The seller’s CPA says which applies. The comparison of asset and stock sales explains why a buyer may insist on an asset purchase and how a seller can ask to be compensated for the extra tax.
Where schedules get contested
- Equipment values. Book value, appraised value and auction value are different numbers. An independent appraisal gives both sides a common anchor, and the gap between the buyer’s and the seller’s figures shows the recapture at stake.
- The covenant not to compete. An amount allocated to it is often regular income to the seller and is recovered by the buyer over time, so the seller usually prefers a modest figure. The guide to non-competes and non-solicits covers the restriction itself.
- Real estate. Land and buildings sit in Class V and need their own appraisal. The guide to selling a business that owns its real estate covers the options.
- Inventory. Finished goods, work in process, raw materials and slow-moving stock are valued differently, and the buyer’s diligence usually tests them.
- Deferred payments. Where part of the price is a seller note, the allocation decides how much of the gain can be spread, as the installment sale guide explains.
How the schedule gets negotiated
- Letter of intent. State that the allocation will follow agreed principles, such as fair market value supported by independent appraisals, and not a figure set by the buyer alone. The guide to reading a letter of intent shows where such terms sit.
- Purchase agreement. Prefer a schedule attached at signing, while the seller still has leverage. If the schedule is to be agreed after closing, require a buyer draft by a stated date, a review period for the seller and a dispute process that sends disagreements to an independent accountant. The guide to purchase agreement terms covers the rest of the contract.
- Consistent reporting. Each side reports the same schedule on Form 8594 and on its return, and does not take a different position unless a final determination requires it.
- Later adjustments. A working capital true-up, earnout payment or indemnity payment changes the total, so the agreement says which classes absorb the change and the CPA confirms what must be updated.
The guide to pre-sale tax and entity planning lists the questions to settle before the structure is fixed, and the guide to how to sell a business shows where the allocation fits among the stages of a sale. This guide is general education and not tax advice.
Frequently asked questions
What is Form 8594?
Form 8594 is the asset acquisition statement. Buyers and sellers of a group of assets that make up a trade or business, where goodwill or going concern value could attach, report the allocation of the price on it.[2] Both the purchaser and the seller generally file it.[1] The two forms should therefore show the same allocation.
What are the seven asset classes on Form 8594?
Class I is cash and deposit accounts. Class II is actively traded personal property. Class III is assets marked to market at least annually and certain debt instruments. Class IV is stock in trade or inventory. Class V is all assets not in another class. Class VI is section 197 intangibles other than goodwill and going concern value. Class VII is goodwill and going concern value.[1]
Who decides how the price is allocated?
The buyer and seller agree it, either in a schedule attached to the purchase agreement or in a process after closing. Because their tax interests differ, the seller tests the buyer’s draft against appraisals and the principles in the letter of intent. Each side then reports consistently, and an independent accountant often resolves disputes.
Why does the allocation matter to the seller?
The total price is fixed, so the allocation decides how much of it falls on assets taxed at regular income rates, such as inventory and depreciated equipment, and how much falls on goodwill, which for many sellers receives the lower long-term rates. The same headline price can leave different after-tax proceeds, so the seller’s CPA should model each draft.
What happens to the allocation if the price changes after closing?
A working capital adjustment, an earnout payment or an indemnity payment changes the total consideration, so the agreement should say which classes absorb the change. The seller’s CPA confirms whether the parties must update what they report, and the instructions for Form 8594 are the place to check the current filing rules.
Thinking about a sale or an acquisition?
The Impetus Group provides sell-side and buy-side M&A advisory, from preparation and buyer outreach to negotiation and closing. A transactional valuation is often the first step, scoped and priced separately.
Related guides
- Asset Sale vs. Stock Sale: How Structure Changes Your Proceeds: In an asset sale the buyer picks the assets and liabilities it takes. In a stock sale it buys the owner’s shares. See how each affects taxes, risk and proceeds.
- Federal Taxes When You Sell a Business: Capital Gain, Ordinary Income and Recapture: Federal tax on a business sale comes in layers: capital gain, depreciation recapture, ordinary income and the net investment income tax. See how they stack.
- The Purchase Agreement: Key Terms Sellers Should Understand Before Signing: The purchase agreement is the binding contract in a business sale. See its key terms, from price adjustments to indemnification, and the questions to ask counsel.
- Installment Sale of a Business: How Seller Financing Defers Tax and Adds Risk: The installment method reports gain as a seller note is paid. See how deferral works, which parts of a sale qualify and the default risk the seller takes on.
- Non-Competes and Non-Solicits in a Business Sale: Scope, Duration and Negotiation: A buyer’s non-compete and non-solicit protect the goodwill it pays for. See how scope, duration and geography are set, what to negotiate and what to ask counsel.
- How Long Does It Take to Sell a Business? Phase by Phase: How long a business sale takes depends on its slowest phase. See what controls each stage, where delays occur and what shortens the path.
Sources
- Instructions for Form 8594, Asset Acquisition Statement Under Section 1060. Internal Revenue Service. Accessed October 13, 2026.
- About Form 8594, Asset Acquisition Statement Under Section 1060. Internal Revenue Service. Accessed October 8, 2026.
- Topic no. 409, Capital gains and losses. Internal Revenue Service. Accessed October 13, 2026.
This guide is general education. It is not a valuation opinion, appraisal, investment advice, or legal or tax advice. How these guides are made.