Tax Treatment of Goodwill and IRC 197 Intangible Assets in Business Acquisitions

By Yarik Yarosh, CPA ·September 5, 2026 ·Updated October 19, 2026 ·8 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

In virtually every business acquisition, a portion of the purchase price exceeds the fair market value of the tangible assets (equipment, inventory, real estate) being acquired. This excess is allocated to intangible assets, with goodwill typically being the largest component. Under IRC 197, purchased goodwill and certain other intangible assets must be amortized ratably over 15 years, producing a deduction of 1/15 of the cost each year. This amortization period applies regardless of the actual useful life of the intangible: a 3-year customer contract, a 5-year non-compete agreement, and perpetual goodwill are all amortized over the same 15 years. IRC 197 was enacted in 1993 to simplify the tax treatment of intangibles (previously, the deductibility and useful life of different intangibles were frequently litigated). For buyers, the 15-year amortization provides a valuable and predictable deduction stream. For sellers, the allocation of the purchase price between goodwill (capital gain), covenants not to compete (generally ordinary income), and tangible assets (mixed treatment) significantly affects their tax liability on the sale.

✓Key takeaway

Section 197 intangible assets (amortized over 15 years):

Intangible Asset	Notes
Goodwill	The excess of purchase price over FMV of identifiable assets
Going concern value	Value attributable to the business as an ongoing enterprise
Workforce in place	Value of the existing trained workforce
Customer lists and relationships	Value of existing customer base
Know-how and trade secrets	Proprietary processes and technical knowledge
Patents and copyrights (purchased)	If acquired as part of a business purchase
Trademarks and trade names	Brand names and marks
Covenants not to compete	Agreements limiting the seller’s competitive activity
Franchises, licenses, permits	Government or private
Computer software (purchased)	Can be 3-year or 15-year depending on how acquired

Not Section 197 intangibles (different treatment):

Asset	Treatment
Self-created goodwill	$0 basis; not amortizable; capital gain on sale
Self-created patents/copyrights	Not amortizable under IRC 197; costs are recovered under other rules (such as IRC 167), not the 15-year period
Separately acquired software	3-year straight-line (36 months), or bonus depreciation if it qualifies
Interest in a corporation, partnership, or trust	Not a Section 197 intangible
Financial instruments	Not a Section 197 intangible
Professional sports franchises acquired before October 23, 2004	Not a Section 197 intangible (sports franchises acquired later are)

How does purchase price allocation work?

Hypothetical example

Round numbers. Buyer acquires a business for $3,000,000 in an asset acquisition. The identifiable tangible and intangible assets:

Purchase price allocation (Form 8594):

Asset Class	Allocation	Recovery	Year 1 Deduction
Class I: Cash and equivalents	$50,000	N/A	$0
Class II: Actively traded securities	$0	N/A	$0
Class III and IV: Accounts receivable (III), inventory (IV)	$200,000	Collected or sold	$200,000 (as sold/consumed)
Class V: Equipment, furniture, vehicles	$400,000	5-7 year MACRS	$400,000 (100% bonus)
Class V: Land, buildings	$500,000	39 years (building) / N/A (land)	$10,256 (building portion, full year)
Class VI: Covenant not to compete	$200,000	15 years (IRC 197)	$13,333
Class VI: Customer lists	$300,000	15 years (IRC 197)	$20,000
Class VII: Goodwill	$1,350,000	15 years (IRC 197)	$90,000
Total	$3,000,000

Year 1 total deductions for the buyer:

Component	Deduction
Inventory/receivables (as consumed/collected)	$200,000
Equipment (100% bonus depreciation)	$400,000
Building depreciation	$10,256
Covenant not to compete amortization	$13,333
Customer lists amortization	$20,000
Goodwill amortization	$90,000
Total Year 1	$733,589
Tax savings (37%)	$271,428

Seller’s perspective (same allocation):

Asset Class	Allocation	Seller’s Basis	Gain	Character
Inventory	$200,000	$150,000	$50,000	Ordinary income
Equipment	$400,000	$100,000	$300,000	Ordinary income (to extent of depreciation recapture) + capital gain
Building	$400,000	$300,000	$100,000	25% unrecaptured 1250 gain + capital gain
Land	$100,000	$80,000	$20,000	Capital gain
Covenant not to compete	$200,000	$0	$200,000	Ordinary income (generally)
Customer lists	$300,000	$0	$300,000	Capital gain (Section 197, long-term if held over 1 year)
Goodwill	$1,350,000	$0	$1,350,000	Capital gain
Total (excluding the $50,000 of cash, which has no gain)	$2,950,000	$630,000	$2,320,000

Why the allocation matters:

Seller’s Preference	Buyer’s Preference
More allocated to goodwill (capital gain at 20%)	More allocated to equipment (100% bonus depreciation in Year 1)
Less allocated to covenant not to compete (generally ordinary income, taxed up to 37%)	More allocated to covenant not to compete (15-year amortization, same as goodwill, but generally ordinary to seller)
More allocated to long-term capital gain assets	More allocated to shorter-lived depreciable assets

In practice, buyer and seller negotiate the allocation because their tax interests often conflict. Both generally file Form 8594, and a written allocation agreement binds both sides (IRC 1060(a)).

Residual method (IRC 1060): When the total purchase price exceeds the FMV of all identifiable assets, the excess is allocated to goodwill under the residual method:

Step	Action
1	Allocate to Class I (cash) at face value
2	Allocate to Class II (securities) at FMV
3	Allocate to Class III (accounts receivable and other debt instruments, mark-to-market assets) at FMV
4	Allocate to Class IV (inventory and stock in trade) at FMV
5	Allocate to Class V (all other assets, including equipment, furniture, vehicles, land and buildings) at FMV
6	Allocate to Class VI (Section 197 intangibles other than goodwill) at FMV
7	Remaining amount = Class VII (goodwill and going concern value)

Anti-churning rules (IRC 197(f)(9)): The anti-churning rules stop taxpayers from turning goodwill and going concern value that they or a related person held or used between July 25, 1991 and August 10, 1993 into amortizable 197 intangibles through related-party or same-user transactions.

Transaction	197 Amortization Available?
Purchase from unrelated party	Yes
Purchase from related party (same goodwill)	No (if the goodwill was held before August 10, 1993)
Conversion of non-amortizable intangible to amortizable through related-party sale	No
Step-up in basis through partnership distribution	May trigger anti-churning rules

Stock acquisition vs. asset acquisition (impact on goodwill):

Transaction Type	Buyer Gets Goodwill Amortization?
Asset acquisition	Yes (buyer gets FMV basis in all assets including goodwill)
Stock acquisition (no 338(h)(10) election)	No (buyer’s basis is in the stock, not the underlying assets; no step-up)
Stock acquisition with 338(h)(10) election	Yes (treated as asset acquisition for tax purposes; buyer gets step-up and goodwill amortization)
Stock acquisition with 338(g) election	Yes (but the deemed sale at the target level creates immediate tax; rarely beneficial)

The 338(h)(10) election is a powerful planning tool: it converts a stock acquisition into a deemed asset acquisition for tax purposes, giving the buyer amortizable goodwill and stepped-up asset basis. The buyer must be a corporation making a qualified stock purchase, the target must be an S corporation or a member of a selling consolidated (or affiliated) group, and the buyer and seller (for an S target, all of its shareholders) make the election jointly on Form 8023.

Illustrative numbers only, not a real client and not advice for your facts.

Can a business buyer use 179 or bonus on acquired equipment?

Yes, on the tangible equipment in an asset purchase, as long as you buy from an unrelated seller and didn’t use the equipment before. Both Section 179 and bonus depreciation cover used property bought that way. Goodwill, customer lists and noncompetes don’t qualify for either, and they stay on the 15-year amortization described above.

The seller relationship matters. Section 179 excludes property acquired from a related party, by gift or inheritance, or with a carryover basis, and bonus applies the same purchase rules to used property. The Class V building gets neither, since it’s 39-year property. For equipment acquired after January 19, 2025, bonus is 100% and applies by default. Section 179 is optional and can’t exceed your taxable income from active trades or businesses, which matters in a year when the deal itself squeezes profit.

Want this checked against your own situation?

Start with a Diagnostic: a CPA licensed in the US and Canada reads your file and tells you in writing what's wrong and how to fix it, three to four business days after you finish the questions. The report is $250. If you hire us for any work after that, you get the $250 back as a discount on that work. Or send us your return or your letter and get a fixed price, free.

Start a Diagnostic →See prices

Get a fixed price, free

Get the next cross-border guide by email

One or two plain-English guides a week on US-Canada tax. No spam, unsubscribe anytime.

Cite this page

Yarik Yarosh, CPA. "Tax Treatment of Goodwill and IRC 197 Intangible Assets in Business Acquisitions." Blue Cloud CPA, September 5, 2026, updated October 19, 2026. https://bluecloudcpa.com/guides/small-business-tax-implications-goodwill-irc-197-intangibles

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.

Tax Treatment of Goodwill and IRC 197 Intangible Assets in Business Acquisitions

How does purchase price allocation work?

Can a business buyer use 179 or bonus on acquired equipment?

Related guides