Report the sale of goodwill on Form 4797 in the part that matches how the goodwill was treated during ownership. Self-created goodwill, which you never amortized, goes in Part I as a long-term Section 1231 gain. Purchased goodwill that you amortized under Section 197 goes first in Part III for Section 1245 recapture, and any gain above the recapture amount flows back to Part I. Before you fill out Form 4797, the sales price allocated to goodwill has to come off Form 8594.
Which Part of Form 4797 Applies
The sorting question is whether you took amortization deductions against the goodwill while you owned the business. Section 197 generally excludes self-created goodwill from amortization, so a founder-built business has no deductions to recapture on sale.1Office of the Law Revision Counsel. 26 USC 197 – Amortization of Goodwill and Certain Other Intangibles Goodwill you acquired when you bought a business is a Section 197 intangible amortized ratably over 15 years, and those deductions get recaptured as ordinary income when you sell.2Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property
Form 4797 covers sales of business property, including amortizable intangibles.3Internal Revenue Service. About Form 4797, Sales of Business Property The three parts split the reporting by character: Part I for Section 1231 property held more than one year, Part II for ordinary gains and losses on short-held property, and Part III for recapture calculations.
Self-Created Goodwill: Part I
If you built the business, put the sale in Part I. Enter the property description, the date acquired, the date sold, the gross sales price allocated to goodwill, and a cost basis of zero. Your basis is zero because you never capitalized founding costs into goodwill and never amortized any of it.4Internal Revenue Service. Publication 551, Basis of Assets – Section: Intangible Assets The whole allocated amount is gain, and it comes out of Part I as a Section 1231 gain that qualifies for long-term capital gains treatment.5Internal Revenue Service. Topic No. 409, Capital Gains and Losses Nothing goes in Part III, because there is no amortization to recapture.6Internal Revenue Service. Instructions for Form 4797
Purchased Goodwill: Part III, Then Part I
Start in Part III. Enter the gross sales price allocated to goodwill, your original cost, total amortization claimed to date, and your adjusted basis (cost minus amortization). Part III walks the recapture calculation: the portion of the gain up to the amount of amortization you claimed is ordinary income under Section 1245.6Internal Revenue Service. Instructions for Form 4797 Any gain above the recapture amount transfers back to Part I as a Section 1231 long-term capital gain.
A short example. You bought the goodwill for $300,000, claimed $100,000 of amortization, and sold it for $350,000. Adjusted basis is $200,000, so total gain is $150,000. The first $100,000 is Section 1245 ordinary income and stays in Part III. The remaining $50,000 moves to Part I as a Section 1231 gain.2Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property
Held One Year or Less: Part II
If your holding period was one year or less, the entire gain belongs in Part II and is taxed as ordinary income.6Internal Revenue Service. Instructions for Form 4797 This is unusual for goodwill but can come up on a quick resale of a recently purchased business. The holding period runs from the day after acquisition or founding through the date of sale.5Internal Revenue Service. Topic No. 409, Capital Gains and Losses
Get the Sales Price from Form 8594 First
The number you put on Form 4797 for goodwill has to come off Form 8594, the Asset Acquisition Statement required under Section 1060. Both buyer and seller file Form 8594 with their returns, and the IRS cross-references them for consistency.7Internal Revenue Service. About Form 8594, Asset Acquisition Statement Under Section 1060 When the two versions of the allocation don’t agree, both sides can expect follow-up.
Form 8594 breaks the total purchase price into seven asset classes using the residual method. Cash, receivables, inventory, and tangible assets absorb value first at fair market value; goodwill and going-concern value sit in Class VII and pick up whatever remains.8Reginfo.gov. Instructions for Form 8594 If you and the buyer signed a written allocation agreement, that agreement binds both parties unless the IRS determines it is not appropriate.9Office of the Law Revision Counsel. 26 USC 1060 – Special Allocation Rules for Certain Asset Acquisitions
The Class VII figure on Form 8594 is the gross sales price you enter on Form 4797. A mismatch between the two forms on your own return is the first thing an examiner would notice.
If the Sale Produced a Loss
Purchased goodwill can be sold at a loss when your adjusted basis exceeds the allocated sales price. A net Section 1231 loss for the year is treated as an ordinary loss rather than a capital loss, so it can offset wages and other ordinary income without running into the $3,000 annual capital-loss limitation. A five-year lookback rule then recharacterizes future Section 1231 gains as ordinary income up to the amount of any net Section 1231 losses you claimed in the previous five years that have not already been recaptured.
Installment Sales
If the buyer is paying over time, you can spread the Section 1231 goodwill gain across the payment years using Form 6252. You compute a gross profit percentage from total gain over contract price and apply it to each year’s principal payments.10Internal Revenue Service. Publication 537, Installment Sales
Section 1245 recapture is the exception. The ordinary-income portion from amortization recapture must be reported in full in the year of sale, even under an installment arrangement. Only gain above the recapture amount qualifies for installment reporting. Self-created goodwill has no recapture, so the entire gain is eligible for installment treatment.
Attaching the Forms to Your Return
File Form 4797 and Form 8594 with your income tax return for the year the sale closed. Sole proprietors and individuals attach them to Form 1040. Partnerships file them with Form 1065, and the gains and losses pass through to partners on Schedule K-1.11Internal Revenue Service. About Form 1065, U.S. Return of Partnership Income S corporations do the same with Form 1120-S. Before filing, check that the goodwill sales price on Form 8594 matches the gross sales price you entered on Form 4797.