Under IRC Section 1060, purchase price allocation in a business asset sale works one way: both the buyer and seller must divide the total price among seven asset classes using the residual method, and both must report the result on IRS Form 8594. The split drives the buyer’s future depreciation and amortization deductions and the character and amount of the seller’s gain, which is why the two sides usually negotiate it hard before closing. A written allocation agreement is binding on both parties for tax purposes unless the IRS finds the values unreasonable.
When Section 1060 Applies
Section 1060 covers what the statute calls an “applicable asset acquisition.” Two conditions have to be met. The transferred assets must constitute a trade or business in the hands of either the buyer or the seller, meaning the group of assets is enough to run an ongoing commercial activity rather than a random collection sold together. And the buyer’s tax basis in those assets must be determined entirely by what the buyer paid.
That second condition rules out deals where basis carries over from a prior owner, such as tax-free corporate reorganizations and certain liquidations. When both conditions are satisfied, the allocation rules and the Form 8594 filing requirement kick in automatically. There is no election to opt out.
The Seven Asset Classes and the Residual Method
The residual method fills the seven classes in order, from most liquid to hardest to value. Each class is allocated up to the fair market value of the assets in it before any remaining purchase price flows into the next class. Whatever is left after Classes I through VI drops into Class VII by default.
- Class I: Cash and general deposit accounts such as checking and savings (but not certificates of deposit).
- Class II: Actively traded personal property, including U.S. government securities, publicly traded stock, and certificates of deposit.
- Class III: Debt instruments, accounts receivable, and assets the taxpayer marks to market annually.
- Class IV: Inventory and other property held primarily for sale to customers.
- Class V: All tangible and intangible assets not in another class. Most physical business property lands here: equipment, furniture, vehicles, buildings, and land.
- Class VI: Section 197 intangibles other than goodwill and going concern value. Covenants not to compete, customer lists, workforce in place, trademarks, trade names, patents, and copyrights fall here when acquired as part of a business purchase.
- Class VII: Goodwill and going concern value. Because this is the final bucket, any purchase price above the combined fair market value of Classes I through VI ends up here.
The order is deliberate. Requiring liquid, easily valued assets to be filled first stops either party from inflating the value of depreciable property to accelerate deductions. Extra purchase price cannot simply be assigned to equipment when the math forces the excess into goodwill.
Why the Split Matters to Each Side
Buyers and sellers want opposite results, and that tension is the reason Section 1060 exists in the first place.
The buyer wants value pushed toward assets that write off quickly. Class V equipment and furniture depreciate over 5 to 7 years under MACRS. Commercial buildings take 39 years. Class VI and VII intangibles, including goodwill, are amortized over a fixed 15-year period under Section 197. Every dollar assigned to short-lived depreciable property is worth more in present-value tax savings than a dollar sitting in goodwill.
The seller pulls the other way. Gain on goodwill and other long-term capital assets is usually taxed at lower long-term capital gains rates, so a heavy Class VII allocation is attractive. But amounts allocated to inventory, accounts receivable, and depreciation recapture on equipment are taxed as ordinary income. Under Section 1245, when a seller disposes of depreciable personal property such as machinery or office furniture, gain attributable to prior depreciation deductions is recaptured as ordinary income regardless of holding period. Amounts allocated to a covenant not to compete are also ordinary income to the seller.
Because of this pull in opposite directions, the allocation is often one of the most contested items in a deal even after the total price is settled.
Locking In the Allocation With a Written Agreement
Section 1060 gives written allocation agreements real teeth. If the buyer and seller agree in writing on the allocation or on the fair market value of specific assets, that agreement binds both parties for tax purposes. Neither side can later file using different numbers to grab a tax advantage.
The only escape is an IRS determination that the agreed allocation is “not appropriate,” which in practice means the values are so far from reality that they look like manipulation. Short of that, the agreement holds. Negotiate the allocation carefully before closing, because reopening it afterward is generally not an option. Independent appraisals of major asset categories, particularly intangibles and real property, make the agreed numbers easier to defend.
Reporting on Form 8594
Both parties file IRS Form 8594, the Asset Acquisition Statement, with their federal income tax returns for the year of sale. Each side files a separate copy identifying the other party by name, address, and taxpayer identification number. The form requires the sale date, the total purchase price, and the dollar amount allocated to each of the seven classes.
The IRS receives a copy from each side, so mismatched allocations stand out. If the buyer reports $2 million to equipment and the seller reports $800,000, both returns draw scrutiny. This is exactly the scenario the binding-agreement rule is meant to prevent, and skipping a written allocation is asking for an audit.
Price Changes After Closing
Earnouts, escrow holdbacks, and other contingent payments often change the total purchase price after the year of sale. When that happens, the affected party files a supplemental Form 8594 (completing Parts I and III) with the return for the year of the change.
Increases follow the same order as the original allocation: start with Class I and fill each class up to fair market value, with any excess flowing to the next. Decreases run in reverse. The reduction comes first out of Class VII, then Class VI, and downward through Class II. Within each class, the change is spread among assets in proportion to their original fair market values on the purchase date. An asset’s allocation cannot go below zero, and if an asset has already been depreciated, amortized, or sold, the adjustment is handled under general tax accounting principles.
Stock Deals and the Section 338(h)(10) Election
Not every acquisition is a direct asset purchase. When a corporation buys the stock of a target, the parties may jointly elect under Section 338(h)(10) to treat the stock purchase as a deemed asset sale for tax purposes. The allocation mechanics are similar, but the transaction is not technically an applicable asset acquisition under Section 1060, and it is reported on Form 8883 instead of Form 8594. Both the old target and the new target must file Form 8883. The election itself is made on Form 8023, is irrevocable, and must be filed by the 15th day of the 9th month after the month of acquisition.
Penalties for Getting It Wrong
Form 8594 is an information return, and the penalties for late or incorrect filing follow the general information return schedule. For 2026, the per-return amounts are:
- $60 if corrected within 30 days of the due date.
- $130 if corrected after 30 days but by August 1.
- $340 if not corrected by August 1 or never filed.
- $680 for intentional disregard.
Annual caps apply based on the filer’s gross receipts, reaching $3 million or more for larger businesses with uncorrected failures.
Deliberately filing a false Form 8594 is a different problem. Willfully making a false statement on a federal tax return is a felony punishable by a fine of up to $100,000 ($500,000 for a corporation) and up to three years in prison. Keep the purchase agreement, any appraisals, and the filed forms in your records so you can support the reported allocation if the IRS raises questions later.