Exits & M&A · Brief · Working level
Negotiating the purchase price allocation: Form 8594, contested classes, and cost seg downstream
Buyer and seller must report the same Section 1060 allocation on Form 8594, but their interests collide on equipment, non-competes, and goodwill. How the allocation is fought, papered, and what it does to a later cost segregation study.
In an asset deal, price is only half the negotiation; how the price is allocated across the seven classes of Treas. Reg. §1.338-6 decides the seller's tax character and the buyer's deduction speed. Section 1060 requires both parties to use the residual method and report on Form 8594 — and a written allocation in the purchase agreement binds the parties, though never the IRS. The negotiation is zero-sum in character even when it is positive-sum in total tax, which is why sophisticated deals attach an allocation schedule or an agreed methodology before signing.
Where the classes fight
Classes I–IV (cash, securities, receivables, inventory) are usually mechanical — face or book value, with inventory occasionally contested where markup exists. The fights concentrate in three places:
Equipment (Class V). The buyer wants dollars here: MACRS recovery, and 100% bonus depreciation for property acquired after January 19, 2025, means much of the allocation deducts immediately (see Form 4562). The seller wants dollars out: allocation up to prior depreciation is Section 1245 ordinary recapture. An appraisal is the usual referee.
Non-competes and consulting (Class VI). Ordinary income to the seller, 15-year Section 197 amortization to the buyer regardless of the covenant's actual term — so a big non-compete allocation hurts the seller without much helping the buyer. Modern practice allocates a defensible token amount; the IRS challenges both zero (where the covenant plainly has value) and inflated figures (as disguised price or compensation).
Goodwill (Class VII). The seller's favorite: capital gain, and by the residual method it absorbs whatever the appraisals leave over. Buyers accept goodwill more readily than they once did — 15-year amortization is respectable — but every goodwill dollar is a dollar not in bonus-eligible equipment.
The character/recovery collision, class by class:
| Contested item | Seller wants | Buyer wants | Usual resolution |
|---|---|---|---|
| Equipment | Low (recapture) | High (bonus/MACRS) | Appraised FMV |
| Inventory | Book | Stepped to FMV | FMV, negotiated markup |
| Non-compete | Near zero | Modest | Small defensible figure |
| Goodwill | High (capital) | Residual | Residual after appraisals |
Consistency, reporting, and what the IRS does
Both sides file Form 8594 with their returns for the year of sale, and amend it when the price later changes — earnout payments and escrow adjustments flow through supplemental filings, usually landing in Class VII. Under Section 1060(a), a written agreement binds the parties unless they can disavow it under the exacting Danielson standard; the IRS remains free to challenge either side. Exam teams compare the two forms first. Consistent filings backed by a contemporaneous appraisal survive; a seller reporting all-goodwill against a buyer reporting heavy equipment is an invitation.
The cost segregation interaction
Buyers acquiring real estate should think one step ahead: a post-closing cost segregation study reclassifies building components into 5-, 7-, and 15-year property, but only within whatever the purchase agreement left open. In Peco Foods, Inc. v. Commissioner, the Tax Court (affirmed by the Eleventh Circuit) held a buyer to the detailed, itemized allocation it had agreed — no later carve-up of "processing plant building" line items it had specifically priced. The drafting lesson: describe real property in broad aggregates ("land and improvements — $X") and reserve the component detail for the study. The full interaction, including how the agreed Class V number seeds the study, is in purchase price allocation vs cost segregation, and the same class mechanics govern deemed asset sales under the elections covered in 338(h)(10) and 336(e).
Frequently asked questions
- Do buyer and seller have to file matching Form 8594 allocations?
- Both parties in an applicable asset acquisition must file Form 8594 reporting the allocation under Section 1060. A written allocation agreed in the purchase agreement is binding on the parties (though not on the IRS) under Section 1060(a). Mismatched filings are a recognized audit flag — the IRS can see both forms and pursue whichever party's position it prefers.
- Why do buyers and sellers fight over the equipment allocation?
- Every dollar allocated to Class V equipment gives the buyer fast depreciation — often immediate under 100% bonus — instead of 15-year goodwill amortization, but for the seller it typically produces ordinary depreciation recapture instead of capital gain. Non-competes cut the same way: ordinary income to the seller, 15-year amortization to the buyer, so buyers gain little and sellers lose a lot.
- Can a buyer do a cost segregation study after agreeing an allocation?
- Yes, but the agreed allocation constrains it. A cost seg study can reclassify components within the real property the buyer acquired, but Peco Foods v. Commissioner held that a buyer who agreed to a specific, itemized allocation in the purchase agreement could not later recharacterize those line items. Broad, aggregated classes in the agreement preserve cost seg flexibility.