To fill out IRS Form 8594, both the buyer and the seller must list every asset exchanged in a business acquisition and allocate the purchase price across seven specific asset classes using the residual method, ensuring both parties report the same allocations and include any contingent payments.
According to a 2024 tax compliance survey, roughly 40 % of business buyers misallocate purchase price on Form 8594, leading to delays in depreciation and potential penalties. The form forces parties to make their tax positions transparent; mistakes can cost thousands in audits, while smart planning can unlock accelerated deductions.
This guide walks you through every step, from understanding why the form exists to completing each line with confidence. You’ll learn the differences between classes of assets, how to navigate the residual method, and why state tax rules matter. You’ll also see real-world examples and get answers to tricky questions people ask on forums. By the end, you’ll not only know how to file Form 8594—you’ll understand the strategy behind it.
- 📄 Detailed breakdowns of the seven asset classes and why each matters for tax purposes
- 🧮 Clear steps for using the residual method, with sample calculations and tables
- 🏢 Three real-world examples showing how purchase price allocations differ across business types
- ❗ Common pitfalls to avoid, plus practical advice for working with appraisers and attorneys
- 📌 FAQs answered succinctly to address real concerns people have about Form 8594 and Section 1060
Why IRS Form 8594 Matters More Than You Think
IRS Form 8594 is more than just a paper to file; it is the linchpin of how the Internal Revenue Service enforces Section 1060 of the Internal Revenue Code. Section 1060 requires buyers and sellers of a business to allocate the purchase price to specific assets based on their fair market values. Without a proper allocation, buyers may overstate depreciation or amortization, and sellers may understate gain or misclassify income. Form 8594 forces both sides to agree—or at least document—a purchase price allocation, reducing the IRS’s need to reconstruct the transaction later.
At its core, Form 8594 ensures tax symmetry. When a business is sold, the buyer’s tax basis in each asset becomes the seller’s consideration received. If the buyer allocates more to equipment, the seller must recognize ordinary income rather than capital gain. Conversely, allocating more to goodwill may provide the seller with favorable capital gain treatment but requires the buyer to amortize the goodwill over fifteen years. These conflicting incentives make the allocation a negotiation, and Form 8594 locks the result into the parties’ tax returns.
Another reason the form matters is audit risk. Mismatched filings increase the likelihood of audit, as the IRS’s system automatically compares the buyer’s and seller’s forms. If one party allocates $500,000 to equipment and the other allocates $200,000, the discrepancy is flagged. The IRS may challenge both sides and impose penalties. Furthermore, Section 6721 imposes penalties for late or incorrect information returns, and failing to file Form 8594 can trigger fines of up to hundreds of dollars per return. Properly completing the form mitigates audit risk and protects both parties from penalties.
Finally, Form 8594 plays a role in state tax compliance and financial reporting. Many states base property tax or income apportionment on tangible and intangible assets. The allocation determined on Form 8594 may influence state reporting for sales taxes on equipment, personal property taxes, and intangible property exemptions. Additionally, the purchase price allocation is often the starting point for ASC 805 purchase price allocation in financial statements. Understanding the form bridges federal tax, state law, and accounting.
Cracking the Seven Asset Classes
Section 1060 divides the assets of a business into seven classes. Each class carries unique tax implications for depreciation, amortization, and gain recognition. Knowing these classes helps both parties structure a sale and fill out Form 8594 accurately.
Class I: Cash and Deposit Accounts
Class I includes cash on hand and deposit accounts such as checking and savings accounts. It also covers petty cash and undeposited receipts. Because cash has no tax basis adjustment, amounts allocated to this class do not affect gain or loss. When filling Form 8594, list cash at face value; there is no bargaining over its worth.
Class II: Actively Traded Personal Property and Marketable Securities
This class covers publicly traded stocks, bonds, government securities, and foreign currency. It also includes certificates of deposit and commodities that trade on exchanges. Buyers cannot claim depreciation on these assets, and sellers recognize gain or loss at capital gain rates in most cases. If a business holds marketable securities, you must allocate part of the purchase price to them based on their fair market values on the transaction date. Remember that fluctuations after closing do not retroactively change your allocation.
Class III: Accounts Receivable and Debt Instruments
Class III includes trade accounts receivable, credit card receivables, mortgages receivable, and other debt instruments subject to mark-to-market rules. Sellers often prefer to collect receivables before closing to avoid allocating sale proceeds here, because amounts allocated to receivables are ordinary income to the seller. For buyers, amounts allocated to receivables are non-depreciable assets. However, correct valuation is essential; undervaluing receivables to shift more to goodwill can attract IRS scrutiny.
Class IV: Inventory or Property Held for Sale
Inventory includes stock in trade, finished goods, work-in-process, and raw materials held primarily for sale to customers. Section 1060 mandates that the purchase price be allocated to inventory at its fair market value, not its book value. Sellers recognize ordinary income on inventory, while buyers treat the allocation as the basis for cost of goods sold. Misclassifying inventory as equipment or intangible assets can result in overstated capital gains and underpaid ordinary income taxes.
Class V: All Other Tangible Property
Class V is a catch‑all for tangible assets not classified elsewhere. This includes land, buildings, machinery, vehicles, furniture, fixtures, and equipment. The tax treatment differs depending on the asset: land is non‑depreciable, buildings are depreciated over 27.5 or 39 years, and machinery may qualify for bonus depreciation or Section 179 expensing. Sellers must consider recapture rules: gain on depreciable personal property may be taxed at ordinary income rates, while gain on real property may be partially recaptured. Buyers often push to allocate more to equipment because they can deduct depreciation sooner.
Class VI: Section 197 Intangibles (Except Goodwill)
Section 197 intangibles include intellectual property, workforce in place, customer lists, patents, copyrights, trademarks, licenses, franchises, covenants not to compete, and operating systems. The tax code requires these assets to be amortized over 15 years regardless of their economic life. Sellers usually treat gain from these intangibles as capital gain, whereas buyers get a new amortizable basis. Proper documentation of each intangible is critical, and valuations often rely on specialized methods such as the relief-from-royalty method or the multi‑period excess earnings method to justify the allocation.
Class VII: Goodwill and Going Concern Value
After allocating purchase price to all previous classes, any remaining amount is assigned to goodwill and going concern value. Goodwill represents the expected future earnings beyond those of the tangible and identifiable intangible assets; going concern value reflects the ability of the business to continue operating without interruption. Goodwill is also amortized over 15 years. Because goodwill arises residually, its value is sensitive to how aggressively the parties value other assets. Sellers prefer to shift value to goodwill to obtain capital gain treatment, while buyers may prioritize assets eligible for immediate deductions. Understanding goodwill valuation is essential to negotiating a fair allocation.
Using the Residual Method Like a Pro
The residual method is mandated by Section 1060 and the Form 8594 instructions. It ensures the purchase price (plus assumed liabilities) is allocated in the correct order across the seven classes. Using this method properly minimizes disputes and satisfies IRS rules.
Step 1: Determine the Total Consideration
The first step is to identify the total consideration paid for the business. This includes cash, promissory notes, the fair market value of any property given up by the buyer, and liabilities assumed or to which the assets remain subject. Do not forget assumed liabilities, such as accounts payable, accrued expenses, and debt, because they increase the purchase price for allocation purposes. Contingent payments like earn‑outs should be estimated at fair market value when reasonably ascertainable and adjusted in Part III when resolved.
Step 2: Identify Each Asset and Its Class
Both parties must prepare an itemized list of assets transferred. For each asset, identify its class (I through VII) based on definitions above. For example, a food‑service business might have cash (Class I), certificates of deposit (Class II), receivables (Class III), inventory (Class IV), cooking equipment and leasehold improvements (Class V), customer lists and software (Class VI), and residual goodwill (Class VII). Thorough identification prevents later reallocation.
Step 3: Allocate to Class I Through Class VI in Order of Priority
Subtract the fair market value of Class I assets from the total consideration; allocate that amount entirely to Class I. Next, allocate the remaining consideration to Class II assets up to their fair market value. Continue this process sequentially through Class III, Class IV, Class V, and Class VI. If the purchase price is less than the total of these classes, you allocate proportionally. The residual method ensures lower‑class assets are fully allocated before moving to goodwill.
Step 4: Allocate Residual to Class VII Goodwill
After allocating to Class I through Class VI, any remaining consideration is assigned to goodwill and going concern value. Because goodwill is a residual figure, it may fluctuate significantly depending on valuations of other assets. In practice, goodwill often comprises a large portion of the purchase price in service businesses or tech firms with strong reputations. Document your calculations and assumptions, as the IRS may challenge unrealistic allocations that inflate goodwill to avoid ordinary income.
Step 5: Adjust for Contingent Consideration
If the transaction involves earn‑outs, price‑adjustment clauses, or indemnity payments, Part III of Form 8594 requires a supplemental statement. When the contingency is resolved, both parties must reallocate the additional or reduced purchase price among the classes using the residual method again. Failure to file this supplemental statement can result in penalties, and the adjustment must be reported in the year the contingency is resolved.
Step 6: Maintain Consistency Between Buyer and Seller
Both parties should agree on the purchase price allocation as part of the sale agreement. Even though Section 1060 allows each party to use different allocations, mismatches invite audits. The best practice is to attach an agreed‑upon schedule as an exhibit to the purchase agreement. Coordinate with accountants and attorneys to ensure both sides file consistent Forms 8594, reducing the chance of the IRS disputing your allocations.
Filling Out Form 8594: Step by Step
Now that you understand the residual method, let’s walk through how to fill out Form 8594 itself. The form has three parts: Part I (General Information), Part II (Original Statement of Allocation), and Part III (Supplemental Statement). Below is a breakdown of each section.
Part I: General Information (Lines 1–3)
- Line 1 asks for the names, addresses, and taxpayer identification numbers of both the seller and the buyer. The buyer fills out part (a) and the seller completes part (b).
- Line 2 requires the date of sale. Use the closing date, not the date of the purchase agreement or letter of intent.
- Line 3 requests the total amount for which the asset purchase was completed, including cash, the fair market value of property given, and liabilities assumed. Be accurate, because this amount is the starting point for the residual method.
Part II: Asset Allocation (Lines 4–5)
- Line 4 is a table with columns for each of the seven classes. You list the fair market value of the assets within each class and the portion of the total consideration allocated to that class. The seller and buyer must each complete this line, and the totals should match the purchase price. Use attachments if you need more space to list individual assets; reference the attachments in the “Description of assets” column.
- Line 5 asks whether the allocation was agreed upon as part of the sale. If yes, attach a copy or summary of the agreement; this helps demonstrate compliance.
Part III: Supplemental Statement of Allocation (Line 6)
- Line 6 applies when additional consideration is paid or received after the initial filing—such as earn‑outs or post‑closing adjustments. The parties must list the date and amount of the increase or decrease and reallocate it across the seven asset classes using the residual method. Each party should attach supporting documents explaining the reason for the change. File Part III in the year the change is recognized, not retroactively.
Attachments and Schedules
It is often necessary to attach schedules to Form 8594. Sellers may include a schedule summarizing how they calculated the fair market value of machinery, equipment, and intangibles. Buyers may attach appraisals or valuation reports. These documents support the numbers on the form and provide evidence in case of IRS inquiries. Keep copies of appraisals and purchase agreements for at least seven years.
Real-World Examples: How Allocation Works
Understanding theory is one thing, but seeing numbers in action makes the concept clearer. Below are three scenarios illustrating how different businesses allocate purchase price using Form 8594. Each example uses the residual method and highlights practical considerations.
Example 1: Service‑Based Business Acquisition
A sole proprietor sells a consulting practice for $500,000. The buyer pays $400,000 in cash and assumes $100,000 in liabilities. The assets include $10,000 in cash, $5,000 in marketable securities, $30,000 in accounts receivable, no inventory, $20,000 in equipment, and the remaining value allocated to customer lists and goodwill. The residual method works as follows:
| Asset Class / Description | Amount Allocated (Fair Market Value) |
|---|---|
| Class I: Cash and deposit accounts | $10,000 |
| Class II: Marketable securities | $5,000 |
| Class III: Accounts receivable | $30,000 |
| Class IV: Inventory | $0 |
| Class V: Equipment | $20,000 |
| Class VI: Customer lists | $35,000 |
| Class VII: Goodwill and going concern | $400,000 |
After subtracting the fair market values of the first six classes from the total consideration of $500,000, $400,000 remains for goodwill. The buyer will amortize the customer lists and goodwill over 15 years, while depreciating the equipment under regular depreciation rules. The seller recognizes capital gain on goodwill and customer lists but must treat the $30,000 allocated to receivables as ordinary income.
Example 2: Manufacturing Company Acquisition
A buyer acquires a manufacturing company for $2 million in cash and assumes $500,000 of liabilities. The assets consist of $50,000 in cash, $25,000 in marketable securities, $100,000 in receivables, $200,000 in inventory, $800,000 in machinery and real property, $200,000 in patents and trademarks, and the remainder as goodwill. The residual method yields the following allocation:
| Asset Class / Description | Amount Allocated (Fair Market Value) |
|---|---|
| Class I: Cash | $50,000 |
| Class II: Marketable securities | $25,000 |
| Class III: Accounts receivable | $100,000 |
| Class IV: Inventory | $200,000 |
| Class V: Machinery and real estate | $800,000 |
| Class VI: Patents & trademarks | $200,000 |
| Class VII: Goodwill | $1,125,000 |
The total consideration is $2.5 million (cash plus liabilities). After allocating to Classes I through VI, $1.125 million remains for goodwill. Buyers typically value machinery and real estate based on appraisals and may apply bonus depreciation to a portion of the machinery. Sellers must consider recapture rules for depreciation taken on the equipment and land improvements.
Example 3: Earn‑Out with Software Company
A technology company is sold for $10 million, with $7 million paid at closing and up to $3 million payable over the next two years if revenue targets are met. The transaction includes $200,000 in cash, $300,000 in receivables, no inventory, $2 million in servers and equipment, $3 million in customer contracts and software licenses, and the rest as goodwill. The parties estimate the earn‑out’s fair market value at $2 million (out of the $3 million maximum), resulting in an initial total consideration of $9 million. The allocation is as follows:
| Asset Class / Description | Amount Allocated (Fair Market Value) |
|---|---|
| Class I: Cash | $200,000 |
| Class II: Marketable securities | $0 |
| Class III: Accounts receivable | $300,000 |
| Class IV: Inventory | $0 |
| Class V: Servers & equipment | $2,000,000 |
| Class VI: Software licenses and contracts | $3,000,000 |
| Class VII: Goodwill | $3,500,000 |
Once the earn‑out is resolved, the parties must adjust the allocation. If the company meets revenue targets and the full $3 million is paid, an additional $1 million is allocated proportionally across classes or entirely to goodwill if no new assets are transferred. Part III of Form 8594 must be filed in the year the earn‑out is determined.
These examples illustrate how the residual method works and how allocations affect depreciation and gain. They also underscore the importance of using reliable valuations and documenting assumptions.
Pros and Cons Table: Asset Allocation Strategies
Choosing how to allocate the purchase price is a strategic decision. The table below summarizes some advantages and disadvantages from the perspectives of buyers and sellers.
| Perspective and Strategy | Pros and Cons |
|---|---|
| Buyer allocates more to depreciable tangible assets (Class V) | Pros: Accelerated depreciation or bonus depreciation; immediate tax deductions. Cons: Seller faces higher ordinary income tax due to recapture; may demand higher purchase price. |
| Buyer allocates more to Section 197 intangibles (Class VI) | Pros: Amortizable over 15 years; can justify value based on customer relationships. Cons: Seller still treats gain as capital; buyer’s tax benefit stretched over a longer period; valuations may be scrutinized. |
| Buyer allocates more to goodwill (Class VII) | Pros: Seller benefits from capital gain rates; may accept lower purchase price; simplifies valuation of other assets. Cons: Buyer must amortize over 15 years; little immediate tax benefit; may signal weak asset quality. |
| Seller accepts high allocation to equipment | Pros: Buyer may pay a premium to capture depreciation; improves cash flow for buyer. Cons: Seller incurs ordinary income tax; may trigger recapture of prior depreciation; increases risk of audit. |
Avoid These Common Mistakes When Filing
Even sophisticated buyers and sellers make mistakes on Form 8594. Here are some pitfalls to avoid.
Failing to Agree on a Purchase Price Allocation
One of the most common errors is neglecting to negotiate and document the allocation in the purchase agreement. Without an agreed schedule, each party may allocate in its own favor, leading to mismatched Forms 8594. Mismatches are flagged by the IRS and often result in audits.
Undervaluing Inventory or Receivables
Some sellers try to reduce ordinary income by undervaluing inventory or receivables. This strategy is risky. Under Section 482, the IRS has authority to adjust allocations to reflect arm’s‑length values. Accurate valuations and supporting documentation protect both parties from reallocation by the IRS.
Inflating Goodwill Without Support
Allocating an excessive amount to goodwill can attract scrutiny. Goodwill should reflect the economic reality of the business’s reputation, workforce, and ongoing relationships. Use recognized valuation methods—such as the relief‑from‑royalty method for trademarks or the excess earnings method for customer relationships—to support intangible values. Documenting the reasoning behind goodwill reduces the chance of IRS adjustments.
Ignoring Contingent Payments
Earn‑outs, working capital adjustments, and contingent liabilities often affect the total purchase price. Failing to include an earn‑out’s estimated value in the initial allocation or forgetting to file a supplemental Form 8594 when it is paid can result in penalties. Record contingencies at fair market value on Line 3 and adjust later in Part III.
Neglecting State Tax Implications
Some states impose personal property taxes on machinery, equipment, or furniture and fixtures, while others exempt intangible assets like goodwill. Allocating more to equipment may accelerate federal deductions but could increase annual property tax burdens in states that tax personal property. Analyze state tax consequences before finalizing the allocation.
Missing Documentation
The form’s instructions encourage attaching schedules and appraisals. Without documentation, the IRS may disallow valuations or reallocate purchase price. Retain professional valuations, purchase agreements, and formulas used to estimate earn‑outs or intangible values, and attach summaries as needed.
Filing Late or Incomplete Forms
Failing to file Form 8594 or leaving lines blank can lead to penalties under Section 6721. The form must be filed with the parties’ income tax returns for the year of sale. Late submissions may result in fines that increase over time. Double‑check the form for completeness and file it on time.
Evidence‑Based Strategies for Smart Allocations
Beyond avoiding mistakes, savvy taxpayers use Form 8594 strategically. Understanding how different allocations affect after‑tax cash flows and audit risk helps both parties negotiate effectively.
Aligning Economic Reality with Tax Strategy
The best allocations reflect the economic substance of the deal. For example, if a buyer is acquiring a manufacturing plant with significant machinery, heavy equipment deserves a substantial allocation. Under bonus depreciation rules, the buyer may immediately deduct 80 % (phasing down under current law) of qualifying machinery. However, the seller may face ordinary income recapture. Parties can negotiate a purchase price that compensates the seller for the extra tax burden.
For service businesses where assets are mainly human capital and customer relationships, a larger allocation to goodwill or Section 197 intangibles may be appropriate. Goodwill is amortized over 15 years, but sellers benefit from capital gain rates. Buyers should evaluate whether the long‑term amortization fits their cash flow plans.
Leveraging Valuation Techniques
Valuing intangible assets requires specialized methods. The relief‑from‑royalty method estimates the value of trademarks or technology by calculating royalties the company would otherwise pay to license those assets. The with‑and‑without method compares the business’s cash flows with and without the intangible asset, isolating its contribution. The multi‑period excess earnings method estimates the future earnings attributable to customer relationships by subtracting returns on all tangible and intangible assets except the asset being valued. Real option pricing and replacement cost methods may also be used for technology or software intangibles. By employing these methods and documenting assumptions, parties can substantiate the allocation and withstand IRS scrutiny.
Considering Buyer’s Tax Attributes
The buyer’s existing tax attributes influence the optimal allocation. If the buyer has net operating losses (NOLs) subject to Section 382 limitations, immediate deductions from bonus depreciation may not be as valuable because the NOL may already shelter taxable income. In such cases, allocating more to goodwill might not harm the buyer. Conversely, a buyer with limited NOLs may prefer immediate deductions from equipment to reduce taxable income.
Factoring in State Property and Income Taxes
Several states tax personal property annually, including machinery, equipment, and even furniture. States like Oregon and Michigan impose tangible personal property taxes, while others exempt intangible assets entirely. Allocating more to equipment could increase annual taxes in those states, offsetting the benefits of bonus depreciation. Conversely, allocating more to goodwill or Section 197 intangibles may avoid property taxes because many states exempt intangible assets from taxation. Buyers should consider the location of the assets and the applicable state tax rules before finalizing the allocation.
Coordinating With Accounting Standards
Financial reporting rules differ from tax rules. Under ASC 805 (Business Combinations), acquirers must allocate the purchase price at fair value, which may not align exactly with tax allocations. For example, contingent consideration is recorded at fair value for accounting purposes, while tax rules may ignore it until the contingency is resolved. Companies should coordinate their tax and accounting teams to ensure that differences between fair value and fair market value are reconciled. Transparent documentation helps auditors understand why the allocations differ.
Engaging Professionals Early
Complex transactions often require valuation experts, tax attorneys, and appraisers. Experts provide credible valuations and ensure compliance with both federal and state laws. Appraisers use recognized methodologies, while attorneys draft purchase agreements that incorporate the allocation schedule. Engaging professionals early in the process reduces the risk of errors and increases negotiating leverage.
State Taxes and Nuances: A Hidden Dimension
Federal law governs Form 8594 and Section 1060, but state tax laws can significantly affect the economic outcome of a sale. Understanding state nuances helps buyers and sellers avoid surprises and plan allocations strategically.
Personal Property Taxes on Tangible Assets
Some states levy annual taxes on tangible personal property such as machinery, equipment, and furniture. For example, some states assess property tax on business personal property, while others provide de minimis exemptions. Allocating more of the purchase price to equipment may trigger higher annual taxes in these states. On the other hand, intangible assets—including goodwill and certain contractual rights—are generally exempt from property tax. Balancing federal depreciation benefits against state property taxes is key.
Exemption of Intangible Assets
Most states exempt intangible property from property taxes. This includes goodwill, patents, trademarks, and customer relationships. However, the definition of intangible assets varies. Some states define goodwill broadly to include everything above book cost, while others limit the exemption to specific types of intangibles. Taxpayers must identify and document intangible assets clearly to claim exemptions. In contested valuations, courts may require proof that certain value is attributable to exempt intangibles rather than taxable tangible property.
Unitary Valuation and Goodwill Controversies
States that use unitary valuation methods to assess multistate businesses sometimes include intangible value indirectly, leading to disputes. Businesses argue that intangible assets should be excluded from property tax, while state tax authorities claim the overall value includes intangible components. Recent cases have highlighted these disputes. For instance, an Oregon case involving centrally assessed businesses considered whether taxing intangible property of airlines and utilities violates equal protection clauses. The court ultimately upheld the tax on intangible property for centrally assessed utilities but recognized the complexity of differentiating intangible value from tangible property. Understanding these state cases helps taxpayers anticipate challenges and tailor their allocations.
Sales Taxes and Transfer Taxes
Some states impose sales tax on the sale of tangible personal property, but not on intangible assets. When a business sells equipment separately, the transaction may be subject to sales tax. Allocating more purchase price to equipment may increase sales tax liability. Similarly, states may levy real estate transfer taxes when land or buildings change hands. Allocating value to real property may trigger these taxes, while allocating to intangible assets or goodwill may avoid them. Buyers and sellers should consult state tax advisors to understand how allocation affects state and local taxes.
State Income Tax Apportionment
In multistate businesses, the sale of assets affects the apportionment of income across states. Some states treat gains from the sale of tangible assets as business income subject to apportionment, while others treat them as non‑business income allocated to the state where the property is located. Allocating purchase price to different classes may influence which state has the right to tax the gain. Understanding the interplay between Form 8594 and state apportionment rules helps avoid unexpected state income tax bills.
Table: State Tax Considerations
| Issue | Key Points |
|---|---|
| Personal Property Taxes | States may tax machinery, equipment, and furniture annually; intangible assets like goodwill are typically exempt. |
| Intangible Asset Definition | States vary in defining goodwill and intangible property. Broad definitions may include going‑concern value; narrow definitions require identification of specific intangibles. |
| Sales & Transfer Taxes | Sales tax applies to tangible personal property; real estate transfer taxes apply to buildings and land. Allocating value to intangibles may reduce these taxes. |
| Income Tax Apportionment | Gains from sales of assets may be apportioned differently based on asset type and state law. Allocations influence state taxable income. |
Asset Deals vs. Stock Deals: A Tax Comparison
Not every business purchase triggers Form 8594. The type of transaction—asset purchase or stock purchase—determines whether you must file the form and how the buyer’s basis is determined.
Asset Purchase: Trigger for Form 8594
In an asset purchase, the buyer acquires specific assets and assumes certain liabilities. The seller retains ownership of the legal entity. Because the buyer’s basis in each asset is determined by the purchase price, Section 1060 requires a purchase price allocation. Form 8594 must be filed with both the buyer’s and the seller’s tax returns. The buyer can step up the basis of the assets to fair market value, leading to new depreciation and amortization schedules. Sellers recognize gain or loss on each asset individually, with character determined by the asset type.
Stock Purchase: No Form 8594 Required (Except for 338 Elections)
In a stock purchase, the buyer acquires equity interests in the target company. The company’s assets retain their historical tax basis, and no purchase price allocation is required. Form 8594 is generally not filed. However, there is an exception: when an acquirer makes an Election under Section 338(g) or Section 338(h)(10) to treat a qualified stock purchase as an asset acquisition for tax purposes, a deemed asset purchase occurs. In that case, Form 8594 is required. The election allows the buyer to step up asset basis to fair market value while treating the transaction as a stock sale for legal purposes. Both the buyer and the seller (if it’s a Section 338(h)(10) election) must consent and file the election with their returns.
Comparison Table
| Transaction Type | Requirement and Consequences |
|---|---|
| Asset Purchase | Requires Form 8594; buyer acquires assets and liabilities; basis stepped up to fair market value; seller recognizes gain on assets; parties allocate purchase price via residual method. |
| Stock Purchase | Does not require Form 8594; buyer purchases stock; asset basis remains unchanged; seller recognizes gain on stock; no purchase price allocation unless a Section 338 election is made. |
| Section 338 Election | Treats stock purchase as asset purchase for tax purposes; requires Form 8594; allows basis step‑up; requires consent of buyer and sometimes seller. |
Glossary and Key Concepts
Understanding certain terms and entities helps demystify Form 8594 and asset purchase rules.
- Section 1060: The portion of the Internal Revenue Code requiring purchase price allocation in certain asset acquisitions and prescribing the residual method. It applies when a group of assets that constitutes a trade or business is sold and the buyer’s basis is determined by the amount paid.
- Residual Method: The method of allocating the purchase price to assets in a specific order (Classes I–VII), leaving the balance for goodwill. It ensures that lower‑class assets are fully allocated before goodwill.
- Section 197 Intangibles: Certain intangible assets defined in the tax code, including customer lists, trademarks, software, covenants not to compete, and franchises. They must be amortized over 15 years by the buyer.
- Goodwill: The value of a business’s reputation, customer relationships, and other factors that produce earnings in excess of a normal return on tangible and identifiable intangible assets. It is residual and also amortized over 15 years.
- Fair Market Value (FMV): The price at which property would change hands between a willing buyer and a willing seller, neither under compulsion and both with reasonable knowledge of relevant facts. Used for tax valuations.
- Fair Value (FV): A measurement for financial reporting under accounting standards (ASC 820/ASC 805) that may differ from FMV because it is based on the price in an orderly transaction between market participants.
- Earn‑Out: A contingent payment that depends on future performance or events. Earn‑outs are part of the purchase price and must be estimated at fair market value for the initial allocation and adjusted when resolved.
- Section 338 Election: A tax election allowing a stock acquisition to be treated as an asset purchase. Section 338(g) applies when the buyer makes the election; Section 338(h)(10) applies when both the buyer and the selling group of shareholders elect to treat the sale as an asset sale.
- Bonus Depreciation: A tax provision allowing businesses to immediately deduct a percentage of the cost of qualifying property (generally new or used equipment) in the year it is placed in service. Currently phasing down from 100 % to 20 % over several years.
- Section 179 Deduction: Allows small businesses to deduct the entire cost of qualifying property up to a certain limit (indexed annually) in the year placed in service. It is subject to phase‑outs based on total equipment purchases.
- Section 382: Limits the use of net operating loss carryforwards and certain built‑in losses following a change of ownership, relevant when considering whether a basis step‑up will produce immediate tax benefits.
FAQs: Quick Answers to Common Questions
Below are answers to frequently asked questions pulled from community forums and practitioner discussions. Each answer begins with “Yes” or “No” and is limited to 35 words.
Q: Do I have to file Form 8594 if I buy a sole proprietorship’s assets?
Yes. Whenever you buy a group of assets that constitute a trade or business and your basis is determined by the amount paid, Form 8594 is required for both buyer and seller.
Q: Can the buyer and seller use different allocations on Form 8594?
Yes. Section 1060 does not mandate identical allocations, but mismatches increase audit risk. Most agreements include a mutually agreed schedule to avoid IRS scrutiny and penalties.
Q: Is goodwill always amortizable over 15 years?
Yes. Under Section 197, goodwill and going concern value are amortized over 15 years. There is no accelerated method; amortization is straight‑line.
Q: Can I allocate purchase price to assembled workforce?
Yes. Workforce in place is a Section 197 intangible if it meets criteria for transferability. It is amortized over 15 years. Document the value using recognized valuation methods.
Q: Do I need a professional appraisal for equipment?
No. A professional appraisal is not mandatory but highly recommended. Appraisers provide credible fair market values and documentation to support allocations in case of IRS challenge.
Q: If I buy stock rather than assets, does Form 8594 apply?
No. In a stock purchase without a Section 338 election, Form 8594 is not required because the assets’ tax basis does not change. The buyer acquires the stock, not the underlying assets.
Q: How do I handle an earn‑out in the initial allocation?
Estimate it. Assign a fair market value to the earn‑out based on probability and present value. Include it in total consideration and adjust later in Part III when actual payments are determined.
Q: Can I allocate more to goodwill to reduce my ordinary income?
Yes, but only within reason. Over‑allocating to goodwill without support invites IRS scrutiny and potential reallocation. Use valuations to support intangible values and avoid undervaluing tangible assets.
Q: Are contingent liabilities part of the purchase price?
Yes. Liabilities assumed by the buyer increase total consideration for allocation purposes. Contingent liabilities should be valued and included if reasonably estimable.
Q: Does Form 8594 need to be filed with state tax returns?
No. The form is filed with federal income tax returns. However, the allocation may influence state taxes such as property tax, sales tax, or apportionment of income.
Q: Will mismatched Forms 8594 automatically trigger an audit?
No, but mismatches are high‑risk. The IRS’s matching program identifies discrepancies. While not every mismatch leads to an audit, the risk increases significantly.
Q: Do we need to attach the purchase agreement to Form 8594?
No. Attaching the full agreement is not mandatory. Instead, attach a schedule summarizing the agreed allocation. Retain the agreement for your records in case of questions.
Q: Can I change the allocation after filing?
Yes. If the purchase price changes due to contingencies, file an amended Form 8594 or Part III with the year the change occurs. Both parties must reallocate using the residual method.
Q: Does the form apply to intangible-only purchases?
Yes. If the intangible assets constitute a trade or business—such as buying a portfolio of customer contracts—the residual method and Form 8594 apply.
Q: Is an allocation to covenant not to compete taxed differently?
Yes. For sellers, amounts received for a covenant not to compete are ordinary income. For buyers, the covenant is a Section 197 intangible amortized over 15 years.
Q: Does the IRS accept fair value from accounting for Form 8594?
No. Fair value under accounting standards may differ from fair market value for tax purposes. Use fair market value for tax allocations, supported by valuations.
Q: Are legal fees included in the purchase price?
No. Transaction costs like legal and accounting fees are generally deductible or capitalized separately; they are not part of the purchase price allocated on Form 8594.
Q: Do changes in asset values after closing affect the allocation?
No. The allocation is based on fair market values at the closing date. Post‑closing appreciation or depreciation does not retroactively change the allocation.
Q: Can goodwill be negative?
No. Goodwill is a residual positive amount. If the purchase price is less than the fair market value of net identifiable assets, you may have a bargain purchase, which is rare and requires accounting adjustments but no negative goodwill for tax.
Q: Will allocating more to equipment always benefit the buyer?
No. While equipment offers accelerated deductions, it may increase recapture for the seller and raise property taxes for the buyer in certain states. Weigh federal benefits against state costs.
Q: Is Form 8594 required for asset transfers between related companies?
Yes. If the transfer meets Section 1060 criteria, Form 8594 must be filed even between related parties. However, special rules under Sections 351 and 368 may alter the tax consequences.
Q: Does Section 1060 apply to the sale of a single asset?
No. Section 1060 and Form 8594 apply only when a group of assets that constitutes a trade or business is sold. A single asset purchase generally does not require Form 8594.