Definition
Purchase price allocation (Form 8594)
On this page5 sections
What it is
When a business changes hands as a going concern, the parties do not just agree one number. For tax purposes the price has to be spread across the categories of assets being transferred, because different assets are taxed differently and depreciate differently.
The IRS calls this an “applicable asset acquisition”: the transfer of a group of assets constituting a trade or business where goodwill or going-concern value attaches, and the purchaser’s basis is determined solely by the amount paid.[1]
The seven classes
Allocation uses the residual method, working down the classes in order:[1]
| Class | What it holds |
|---|---|
| Class I | Cash and general deposit accounts, excluding certificates of deposit |
| Class II | Actively traded personal property, certificates of deposit, and foreign currency |
| Class III | Assets marked to market annually, and debt instruments (with exclusions for certain related-party, contingent and convertible debt) |
| Class IV | Inventory and property held primarily for sale to customers |
| Class V | All other assets — typically furniture, fixtures, buildings, land, vehicles and equipment |
| Class VI | Section 197 intangibles other than goodwill and going-concern value — workforce, customer lists, licences, covenants not to compete, trademarks |
| Class VII | Goodwill and going-concern value |
“Residual” is the operative word: value is assigned up the classes and what is left over falls into Class VII. On most small-business deals, Class VII is the largest single number, because you are mostly buying goodwill.
Why the two sides pull in opposite directions
The same allocation produces different outcomes for buyer and seller, which is why it is a negotiation rather than an accounting exercise. Broadly, each side prefers value to sit where their own tax treatment is better — a buyer thinking about how quickly they can recover cost, a seller thinking about the character of their gain.
The specific consequences depend on entity type, holding period and the assets involved, and they are genuinely a question for your CPA rather than a rule of thumb. What is not in doubt is that the numbers matter and that the parties want different answers.
Both sides file, so both sides should agree
The IRS instructions are explicit that “generally, both the purchaser and seller must file Form 8594 and attach it to their income tax returns… when there is a transfer of a group of assets that makes up a trade or business.”[1] Each files for the year the sale occurred.
Two filings describing the same transaction differently is exactly the kind of inconsistency the form exists to surface. Agreeing the allocation in the purchase agreement is not administrative tidiness — it is the mechanism that stops both parties reporting incompatible positions.
Put it in the LOI
Allocation is routinely left to “to be agreed” and then negotiated in the final week, when the buyer has spent money on diligence and has the least leverage. Raise it in the letter of intent, at least in principle. It costs nothing to say the parties will agree an allocation and file consistently, and it prevents a late fight over a number with real cash consequences.
The full guide: Purchase price allocation and Form 8594.
Frequently asked questions
Can the buyer and seller file different allocations?
They can physically file different numbers, and it is a poor idea. The IRS instructions contemplate both parties filing Form 8594 for the same transaction, so inconsistent allocations are visible. Agree the allocation in the purchase agreement and have both CPAs work from the same schedule.
Which class does goodwill fall into?
Class VII, together with going-concern value. On most small-business acquisitions it is the largest class, because the majority of what a buyer pays for is the assembled, operating business rather than the equipment on the floor.
Does a non-compete get allocated separately?
A covenant not to compete is listed among the Section 197 intangibles in Class VI, separate from goodwill in Class VII. How much value is placed on it, and the consequences of that choice, is a question for your CPA — the two sides usually have opposing preferences.
When does this need to be settled?
In the purchase agreement, well before the filing deadline. The form is filed with the tax return for the year of sale, but the negotiation should happen while both sides still have something to trade — not in the week the returns are due.
Sources cited on this page
Every mutable number on this page — program caps, tax rules, thresholds, filing deadlines — traces to one of these primary sources. Rules change; check the source before you act on the number.
- 1 Internal Revenue Service. Instructions for Form 8594. https://www.irs.gov/instructions/i8594
Educational only — not legal, tax, lending, or investment advice. Confirm specific rules, rates, and forms with the relevant New York State agency, attorney, CPA, lender, or insurer before acting. See the editorial policy and methodology for how sourcing and review work.