Purchase price allocation: the negotiation that happens after the price is already set
The short answer
When a business sells, the total price gets allocated across specific asset classes — inventory, equipment, real property, goodwill, a covenant not to compete — and that allocation determines how much tax each side pays and how fast the buyer can deduct their cost. Buyer and seller often want opposite things: buyers generally prefer allocating more to equipment (faster depreciation) and less to goodwill (15-year amortization); sellers generally prefer allocating more to goodwill and other capital assets (capital gains rates) and less to ordinary-income items like a covenant not to compete or depreciation recapture. This gets negotiated in the letter of intent or purchase agreement — not fixed after closing, and both sides are required to report matching figures to the IRS.
Who this works for — and who it doesn't
Good fit
- Anyone buying or selling a business where the deal has meaningful value across multiple asset categories
- Sellers who want to maximize capital-gains treatment on the sale
- Buyers who want to model the real after-tax cost of the deal, not just the sticker price
Not a fit
- Deals where allocation is treated as a formality and filled in without negotiation — that leaves real money on the table for one side
- Anyone who assumes the buyer and seller's interests are aligned here — they usually aren't
How it works
- The total price is allocated across seven statutory asset classes under the residual method, from cash-equivalents down to goodwill.
- Depreciation recapture on equipment is generally taxed as ordinary income to the seller, regardless of overall capital gains treatment on the deal.
- Goodwill and going-concern value are typically capital gain to the seller and 15-year straight-line amortization to the buyer.
- A covenant not to compete is ordinary income to the seller and amortized by the buyer — sellers generally want to minimize value assigned here.
- Both parties file Form 8594 reporting their allocation, and the IRS can compare the two filings for consistency.
A worked example
A $2,000,000 business sale gets allocated differently under two negotiating positions.
Illustrative allocation comparison
Illustrative only — the actual negotiated allocation depends on each party's tax position, basis in the assets sold, and relative leverage in the deal.
Common mistakes
- Leaving allocation out of the letter of intent and discovering the mismatch in interests only after price is agreed
- Filing Form 8594 with figures that don't match what the other party reported
- Underestimating depreciation recapture exposure on equipment with a low basis
- Overvaluing a covenant not to compete without realizing it's ordinary income, not capital gain, to the seller
Frequently asked questions
Do both buyer and seller have to agree on the same allocation?
They don't have to, but they are both required to file Form 8594 reporting their allocation, and the IRS can and does compare the two filings. A mismatched allocation between buyer and seller is a common audit trigger.
Why do buyers usually want more allocated to equipment and less to goodwill?
Equipment and other tangible assets can often be depreciated over a much shorter period than goodwill, which is amortized over 15 years — so buyers generally prefer allocations that accelerate their deductions, while sellers often prefer allocations taxed at capital gains rates rather than ordinary income.
Buying or selling a business?
We'll model both sides of the allocation before the purchase agreement is signed, when it can still be negotiated.
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