Selling Your Business: How the Purchase Price Allocation Determines Your Tax Bill

By Yarik Yarosh, CPA ·September 5, 2026 ·6 min read

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

When a business is sold as a going concern (an asset sale rather than a stock sale), the total purchase price must be allocated among the individual assets of the business under IRC 1060 using the “residual method.” This allocation is critically important because different asset classes are taxed at different rates. The allocation follows a seven-class hierarchy established by Reg. 1.338-6, with the residual (remaining purchase price after allocating to identifiable assets) assigned to Class VII (goodwill and going concern value). Both the buyer and seller must file Form 8594 (Asset Acquisition Statement) reporting the allocation, and the IRS compares the two forms for consistency. If the allocations don’t match, both parties face scrutiny. The allocation is a negotiation point in every business sale, because the tax interests of the buyer and seller are directly opposed.

✓Key takeaway

IRC 1060 asset classes (residual method):

Class	Assets	Seller’s Tax Rate	Buyer’s Recovery
I	Cash and cash equivalents	N/A	N/A
II	Actively traded securities, CDs, deposits	Capital gains (15-20%)	N/A
III	Accounts receivable, inventory	Ordinary income (up to 37%)	Deducted when collected/sold
IV	Tangible personal property (equipment, vehicles)	Section 1245 recapture (ordinary) + capital gains	Depreciated (Section 179, bonus)
V	Real property, land	Section 1250 recapture (25%) + capital gains (15-20%)	Depreciated over 39 years (commercial)
VI	Intangibles (patents, licenses, customer lists, covenants not to compete)	Ordinary (covenant) or capital gains (patents)	Amortized over 15 years (IRC 197)
VII	Goodwill and going concern value (residual)	Long-term capital gains (15-20%)	Amortized over 15 years (IRC 197)

Buyer vs. seller preferences:

Asset Class	Seller Prefers	Buyer Prefers	Why
Inventory (Class III)	Less allocation	More allocation	Seller: ordinary income. Buyer: immediate COGS deduction.
Equipment (Class IV)	Less allocation	More allocation	Seller: 1245 recapture (ordinary). Buyer: Section 179 or bonus depreciation (immediate deduction).
Covenant not to compete (Class VI)	Less allocation	More allocation	Seller: ordinary income. Buyer: 15-year amortization.
Goodwill (Class VII)	More allocation	Less allocation	Seller: LTCG (15-20%). Buyer: 15-year amortization (slow recovery).

How does the allocation affect the tax bill?

Hypothetical example

Round numbers. A small business. S-Corp. Owner sells the business for $2,000,000 (asset sale).

Business assets at time of sale:

Asset	Fair Market Value	Adjusted Basis	Gain
Cash	$50,000	$50,000	$0
Accounts receivable	$100,000	$80,000	$20,000
Inventory	$150,000	$120,000	$30,000
Equipment	$200,000	$50,000 (depreciated)	$150,000
Real estate (building)	$400,000	$250,000	$150,000
Land	$100,000	$80,000	$20,000
Customer list	$200,000	$0	$200,000
Covenant not to compete	$100,000	$0	$100,000
Goodwill (residual)	$700,000	$0	$700,000
Total	$2,000,000	$630,000	$1,370,000

Seller’s tax on each asset:

Asset	Gain	Tax Character	Tax Rate	Tax
Cash	$0	N/A	N/A	$0
Accounts receivable	$20,000	Ordinary	32%	$6,400
Inventory	$30,000	Ordinary	32%	$9,600
Equipment ($150K depreciation recapture)	$150,000	Section 1245 (ordinary)	32%	$48,000
Building ($150K gain, $100K depreciation recapture)	$100,000 recapture + $50,000 LTCG	25% recapture + 15% LTCG	$25,000 + $7,500	$32,500
Land	$20,000	LTCG	15%	$3,000
Customer list	$200,000	LTCG (IRC 197 intangible)	15%	$30,000
Covenant not to compete	$100,000	Ordinary	32%	$32,000
Goodwill	$700,000	LTCG	15%	$105,000
Total	$1,370,000			$266,500
NIIT (3.8% on investment income above threshold)	~$1,370,000 x 3.8%			$52,060
Total tax				$318,560

Effective tax rate: $318,560 / $1,370,000 = 23.3%

Alternative allocation (seller-friendly, more to goodwill): If the seller negotiates $300,000 less to equipment and covenant not to compete, and $300,000 more to goodwill:

Changed Asset	Original Allocation	Seller-Friendly
Equipment	$200,000	$100,000
Covenant not to compete	$100,000	$0
Goodwill	$700,000	$1,000,000

Changed Tax Result	Original	Seller-Friendly
Equipment tax (ordinary)	$48,000	$16,000
Covenant tax (ordinary)	$32,000	$0
Goodwill tax (15% LTCG)	$105,000	$150,000
Total tax change	$185,000	$166,000
Tax savings		$19,000

Shifting $300,000 from ordinary income assets (32% rate) to goodwill (15% rate) saves the seller $19,000.

Buyer’s perspective on the same allocation:

Allocation	Buyer’s Deduction Timing
Equipment ($200,000)	Year 1 (Section 179 or 100% bonus depreciation)
Equipment ($100,000, seller-friendly)	Year 1 (Section 179, but $100,000 less)
Goodwill ($700,000)	15 years ($46,667/year)
Goodwill ($1,000,000, seller-friendly)	15 years ($66,667/year)

The buyer LOSES $100,000 in immediate deductions (from equipment to goodwill, which amortizes over 15 years). At a 24% tax rate, this costs the buyer $24,000 in Year 1 deductions, partially offset by higher amortization deductions in Years 2-15.

The negotiation: The $19,000 seller savings comes at a $24,000 buyer cost (Year 1 only; over 15 years the buyer catches up through amortization). This creates a negotiation point: the seller might lower the purchase price by $5,000-$10,000 to compensate the buyer for accepting a seller-friendly allocation.

Stock sale vs. asset sale:

Factor	Asset Sale	Stock Sale
Allocation required	Yes (IRC 1060, Form 8594)	No (buyer purchases stock, not assets)
Seller’s tax	Varies by asset class	LTCG on stock gain (generally lower)
Buyer’s basis	Stepped up to purchase price	Carries over from seller (no step-up)
Buyer preference	Asset sale (new basis, immediate deductions)	Stock sale (simpler, but no basis step-up)
Seller preference	Stock sale (all LTCG)	Asset sale (if buyer pays a premium)

S-Corp owners face double taxation on an asset sale: the S-Corp recognizes the gain on the asset sale, which flows through to the shareholder on the K-1. However, because S-Corps are pass-through entities, this is not truly “double” taxation (unlike C-Corps, where the corporation pays tax on the gain AND the shareholder pays tax on the distribution).

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

Want this checked against your own situation?

Start with a Diagnostic: a CPA licensed in the US and Canada reads your file and answers in writing, three to four business days after you finish the questions. $250 for cross-border, $195 for a second opinion on a filed return, and it comes straight off the bill if we do the work after. Or book a free 15-minute fit call first.

Start a Diagnostic →Book a free call

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. "Selling Your Business: How the Purchase Price Allocation Determines Your Tax Bill." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-tax-implications-selling-business-asset-allocation

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