Purchase Price Allocation: The Seven Asset Classes
How buyer and seller split the price of a business among assets, why each side pulls in a different direction, and the form both must file.
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
When a business is sold as assets, Section 1060 requires both buyer and seller to allocate the purchase price across seven asset classes using the residual method: cash first, then securities, receivables, inventory, equipment and real estate, identifiable intangibles, and finally goodwill. Both report the allocation on Form 8594, and it drives the seller's tax character and the buyer's depreciation.
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What are the seven classes?
| Class | Assets | Seller's tax on gain | Buyer's recovery |
|---|---|---|---|
| I | Cash and general deposit accounts such as checking and savings (not certificates of deposit) | None | None |
| II | Actively traded personal property such as U.S. government securities and publicly traded stock, plus certificates of deposit and foreign currency | Capital | Basis |
| III | Accounts receivable and other debt instruments, and assets marked to market at least annually | Ordinary | Collected tax-free up to allocation |
| IV | Inventory and other property held primarily for sale to customers | Ordinary | Cost of goods sold |
| V | All other assets, including equipment, vehicles, furniture and fixtures, buildings, and land | Ordinary to the extent of depreciation recapture; remainder Section 1231 gain, generally taxed as capital | Depreciation (often immediate for equipment) |
| VI | Section 197 intangibles other than goodwill and going concern value: customer lists, trade names, licenses, noncompete covenants | Mostly capital; noncompete is ordinary | 15-year amortization |
| VII | Goodwill and going-concern value | Capital | 15-year amortization |
Under the residual method, the price is assigned to Classes I through VI up to their fair market value, in order; whatever is left goes to goodwill.
Why do buyer and seller disagree?
The seller wants value in Classes VI and VII (capital gain) and away from Classes III, IV, and depreciation recapture in V (ordinary income). The buyer wants value in Class V, where equipment can be written off immediately, and less in goodwill, which takes 15 years. A noncompete covenant is bad for both: ordinary income to the seller, 15-year amortization for the buyer.
Is the allocation binding?
If the parties agree on an allocation in writing, each is bound to it for tax purposes unless one can show the agreement was unenforceable — for example, because of mistake, fraud, or duress. The IRS is not bound and can challenge an allocation that does not reflect fair market value. Allocations negotiated at arm's length between parties with opposing interests are the hardest to challenge, which is why the allocation belongs in the purchase agreement.
How and when is Form 8594 filed?
Both buyer and seller attach Form 8594 to their returns for the year of the sale. If the price changes in a later year — an earnout paid, a working-capital adjustment — whichever party is affected (usually both) attaches a supplemental Form 8594 to its return for the year the change is taken into account.
Frequently asked questions
Does this apply to a stock sale?
Not to an ordinary stock sale. When a stock purchase is treated as an asset purchase under a Section 338 election, the same seven-class residual method applies, but the allocation is reported on Form 8883 instead.
How is fair market value supported?
Appraisals for real estate and equipment, book values for receivables and inventory, and a valuation for intangibles. For small deals, a reasoned allocation agreed by both sides is often sufficient.
Can goodwill be allocated to the owner personally?
Personal goodwill can be sold by the owner separately from the company when it genuinely belongs to the individual, with its own agreement and valuation.
What if the parties never agreed on an allocation?
Each reports its own; mismatched forms invite IRS scrutiny of both.
Official sources
The IRS explains: “Allocate the remaining consideration to Class II assets, then to Class III, IV, V, and VI assets in that order.” — Internal Revenue Service, Instructions for Form 8594 (11/2021), https://www.irs.gov/instructions/i8594
The IRS explains: “Except for assets exchanged under any nontaxable exchange rules, both the buyer and seller of a business must use the residual method (explained later) to allocate the consideration to each business asset transferred.” — Internal Revenue Service, Publication 544 (2025), Sales and Other Dispositions of Assets, https://www.irs.gov/publications/p544
Next step
Fairlight Accounting handles U.S. domestic, cross-border (U.S.–Canada), and international tax returns, plus bookkeeping, payroll, and CFO advisory. Our U.S. Tax Desk negotiates the allocation before closing and prepares Form 8594 to match the agreement. See pricing or book a free fit call.
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