Form 8594 Classifications: The Seven Asset Classes and Residual Method

Form 8594 sorts every asset in a business sale into seven asset classes, numbered I through VII, and the purchase price is poured into those classes in strict order from most liquid to most abstract. Both the buyer and the seller file the form, and the class each dollar lands in decides how fast the buyer gets to deduct it and whether the seller pays ordinary-income or capital-gains rates on the gain.¹ The hierarchy is set by Section 1060 of the Internal Revenue Code and applies to any transfer of assets making up a trade or business where the buyer’s basis is determined by what was paid.²

Class I: Cash and General Deposit Accounts

Class I is cash and general deposit accounts, meaning checking and savings balances at banks or other depository institutions. Certificates of deposit do not belong here. The allocation always equals the face value of the cash transferred, and because there is nothing to depreciate or amortize, Class I carries no ongoing tax effect for either side.

Class II: Actively Traded Securities

Class II covers actively traded personal property: U.S. government securities, certificates of deposit, publicly traded stock, and foreign currency.³ These are instruments with a readily determinable market value, and the allocation to any single Class II asset is capped at its fair market value on the purchase date.

Class III: Debt Instruments and Receivables

Class III captures debt instruments, including accounts receivable, that the taxpayer marks to market at least annually for federal income tax purposes. The allocation uses fair market value, not face value. A pile of receivables is usually worth less than the balance on paper because some share will never be collected, so buyers apply a discount reflecting the expected collection rate and that discounted figure becomes the Class III number.³ For the seller, collections on these receivables generate ordinary income.

Class IV: Inventory and Stock in Trade

Class IV covers property the seller held primarily for sale to customers in the ordinary course of business. In most deals that means inventory. The allocation is capped at fair market value. The buyer’s cost basis in these goods is recovered immediately when the goods are resold, and any gain or loss on that resale is ordinary, just as it would be if the buyer had produced or purchased the inventory independently. For the seller, Class IV also produces ordinary income.

Class V: Tangible and Other Assets Not Elsewhere Classified

Class V is the catch-all for everything not placed in another class. In practice this is where the big operating assets sit: machinery, equipment, furniture, vehicles, buildings, and land. These assets are generally depreciated under MACRS, with recovery periods that vary by type. Office furniture and most equipment use seven years, computers and vehicles generally use five, and commercial buildings use 39.⁴

Class V often accounts for the largest share of the price in asset-heavy businesses. Qualifying personal property currently enjoys 100% bonus depreciation for assets acquired and placed in service after January 19, 2025, so a buyer who negotiates a higher Class V number can potentially write off the full amount in year one. Land is the exception. It is never depreciable, and any amount allocated to it sits on the balance sheet until the property is sold.

Class V is also where the seller’s pain tends to concentrate. Equipment and other depreciable personal property triggers depreciation recapture under Section 1245: gain attributable to prior depreciation deductions is taxed as ordinary income regardless of how long the seller held the asset.⁵ Depreciable real property such as commercial buildings follows Section 1250 instead, with gain attributable to straight-line depreciation taxed at a maximum 25% rate as unrecaptured Section 1250 gain.

Class VI: Section 197 Intangibles Other Than Goodwill

Class VI holds intangible assets defined under Section 197, excluding goodwill and going concern value. Common examples are patents, copyrights, customer lists, workforce agreements, covenants not to compete, franchises, trademarks, and trade names.⁶ The buyer amortizes these ratably over 15 years, beginning the month of acquisition.

Covenants not to compete deserve particular attention. The seller often treats non-compete payments as ordinary income, similar to compensation, while the buyer amortizes the cost over 15 years. That mismatch can push both sides to agree on a modest non-compete number, though the IRS expects the allocation to reflect genuine fair market value rather than whatever is convenient.

Class VII: Goodwill and Going Concern Value

Class VII is the residual bucket. Goodwill is the premium a buyer pays for reputation, customer loyalty, and brand recognition beyond the value of identifiable assets. Going concern value is the additional worth of an established, operating business compared to the same assets sitting unused. Class VII assets are amortized over 15 years, same as Class VI.⁶ In acquisitions of profitable businesses this is where most of the purchase price ends up, because whatever is left after funding Classes I through VI falls here by default.

How the Residual Method Fills Each Class

The IRS requires the residual method, and the sequence is fixed. You start at Class I and work down.³

Allocate the full face value of cash and deposits to Class I. Subtract that from the total consideration.
Allocate the remainder to Class II, then III, then IV, V, and VI, in that order. No single asset in these classes can receive an allocation above its fair market value on the purchase date.
Whatever is left after Classes I through VI are fully funded goes entirely to Class VII.

If the total price falls short of the combined fair market value of Classes I through VI, you allocate within each class proportionally based on the relative fair market values of the assets in it. Some assets then receive less than appraised value and Class VII gets nothing. The more common pattern runs the other way: the price exceeds the fair market value of all identifiable assets, and the surplus lands in Class VII as goodwill. A $5 million deal for a business with $3 million in identifiable assets pushes $2 million into goodwill, stretching that portion of the buyer’s deductions over 15 years instead of the shorter recovery periods available for equipment.

Why the Class Split Is Negotiated

The allocation is not just paperwork. It sets the character of the seller’s gain and the speed of the buyer’s deductions, and the two sides want different outcomes.

Buyers push for dollars in classes with short recovery lives. Machinery and equipment in Class V can be depreciated over five or seven years under MACRS, and qualifying property may be eligible for 100% bonus depreciation or Section 179 expensing in the year of purchase.⁴ Inventory in Class IV produces basis the buyer recovers immediately on resale. Every dollar pushed into Class VI or VII sits on a 15-year amortization schedule, so the buyer waits more than a decade to fully recover that portion of the investment.

Sellers generally want the reverse. Goodwill in Class VII typically qualifies for long-term capital gains treatment at lower rates than ordinary income. Inventory in Class IV and receivables in Class III generate ordinary income. And as noted above, Class V often triggers Section 1245 depreciation recapture, which claws prior deductions back as ordinary income regardless of holding period.⁵ Sellers who claimed heavy depreciation or bonus depreciation in prior years feel this most.

Buyer and Seller Must Report the Same Numbers

Both sides file a separate Form 8594 with their income tax return for the year the deal closed, and the allocations have to match.³ Because the IRS can cross-reference the two filings, a mismatch between buyer and seller is one of the clearest audit flags in the asset-acquisition space. The practical fix is to settle the class-by-class schedule inside the purchase agreement itself, often as an exhibit, and have both parties complete their forms from that single document. If the contract is silent and a dispute surfaces later, you have lost the strongest evidence an audit would have accepted.

1
Internal Revenue Service. About Form 8594, Asset Acquisition Statement Under Section 1060
2
Office of the Law Revision Counsel. 26 U.S. Code 1060 – Special Allocation Rules for Certain Asset Acquisitions
3
Internal Revenue Service. Instructions for Form 8594 (Rev. November 2021)
4
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
5
Office of the Law Revision Counsel. 26 U.S. Code 1245 – Gain From Dispositions of Certain Depreciable Property
6
Office of the Law Revision Counsel. 26 USC 197 – Amortization of Goodwill and Certain Other Intangibles