Purchase Price Allocation: The Tax Negotiation That Starts After You Agree on Price
A founder I worked with sold a precision machining business in an asset sale for 18.5 million dollars. He had celebrated the number for three weeks. Then, nine days before closing, the buyer's counsel circulated a schedule allocating 6.2 million dollars of that price to machinery and equipment, 900,000 dollars to a five year non-compete, and 600,000 dollars to a consulting agreement, with the remainder to goodwill. His book value on that equipment was 1.3 million dollars, because he had written most of it down over eighteen years. The schedule had quietly moved roughly 4.9 million dollars of his proceeds from capital gain treatment into ordinary income, and another 1.5 million dollars into income that was also going to carry self-employment tax. His CPA ran it and came back with a difference of about 1.1 million dollars in federal tax on the same 18.5 million dollar price. Nobody had raised the topic once during four months of negotiation.
This is the part of a deal founders learn about last and pay for first. In an asset sale, the price is not a single number for tax purposes. Section 1060 of the tax code requires both the buyer and the seller to spread that price across seven classes of assets using the residual method, and to report the result to the IRS on Form 8594. Both sides file the form. The classes run from cash at the top through receivables and inventory, then tangible property, then intangibles, with goodwill and going concern value absorbing whatever is left. A plain walkthrough of the mechanics is in this guide to Form 8594 and the Section 1060 classes. I am not a CPA and none of this is tax advice. Your accountant has to run your actual numbers. What I can tell you is what I see happen on the deal side, which is that this schedule arrives late, arrives from the buyer, and arrives after the seller's leverage is gone.
The reason allocation matters is that the classes are taxed differently and the two sides want opposite things. Goodwill in the hands of a seller who has held the business for years is generally long term capital gain, taxed at a top federal rate of 20 percent plus the 3.8 percent net investment income tax. Hard assets are not. When equipment is sold above its depreciated tax basis, the gain up to the amount of depreciation previously taken comes back as ordinary income under the depreciation recapture rules, and the top federal ordinary rate is 37 percent. Amounts paid for a non-compete are ordinary income. Amounts paid under a consulting or employment agreement are ordinary income and generally carry payroll or self-employment tax on top. Same headline price, materially different net.
The buyer's incentives run the other way, and that is not villainy, it is arithmetic. A buyer recovers goodwill and most other purchased intangibles over fifteen years under Section 197. A buyer recovers equipment far faster. That gap has widened recently. The One Big Beautiful Bill Act, enacted in 2025, permanently restored 100 percent bonus depreciation for qualifying property acquired and placed in service after January 19, 2025, and the IRS issued interim guidance implementing it in Notice 2026-11, summarized in BDO's advisory on the interim bonus depreciation rules. Qualified property generally includes property with a recovery period of twenty years or less, and used property acquired from an unrelated party can qualify. In plain terms, a dollar the buyer can land on your equipment is often a dollar it writes off in year one instead of over fifteen. I have watched buyer allocation asks get noticeably more aggressive on equipment heavy businesses since that change took effect, and machine shops, fleets, and manufacturers are the ones feeling it.
So the first practical move is simple and almost nobody makes it: put allocation in the letter of intent. One paragraph. Either the allocation itself, or the principle that governs it, such as tangible assets allocated at their appraised fair market value with the residual to goodwill, and no amount allocated to a non-compete or consulting agreement in excess of a stated figure. You will not get a perfect answer at LOI stage because you do not yet have an appraisal. You do not need one. You need the subject to exist before exclusivity starts, because the day you sign the no shop is the day your ability to say no gets expensive. I wrote about that dynamic in the no shop clause, and allocation is the single clearest example of a term that costs nothing to fix before signing and seven figures to fix after.
Second, know your own recapture exposure before anyone asks. Ask your CPA for the tax basis of your fixed assets, not the book value on your financial statements, and not the insured replacement value. The number you want is the depreciated tax basis and the cumulative depreciation taken. If you have been aggressive with bonus depreciation and Section 179 for a decade, which most owner operators have been and should have been, your basis may be close to zero and nearly every dollar allocated to that equipment comes back at ordinary rates. That is not a reason to regret the deductions. It is a reason to know the number before you are negotiating against it. This belongs in the same pre market file as your quality of earnings preparation, which I described in what a quality of earnings provider actually tests first.
Third, treat the non-compete and the consulting agreement as price, not as paperwork. These two line items are where I see the most value moved with the least resistance, because they look like employment documents rather than money. A buyer that allocates 900,000 dollars to a five year non-compete gets a fifteen year amortizable intangible and you get ordinary income. A buyer that allocates 600,000 dollars to a consulting agreement gets a current deduction and you get ordinary income plus employment taxes. There is a real argument that some allocation to a non-compete is legitimate where the seller genuinely could compete, and I do not tell clients to insist on zero. I tell them to insist the number be defensible and small relative to the deal, and to negotiate it as part of the consideration rather than discovering it in a schedule. If you are being asked to stay on, the terms of that arrangement deserve the same scrutiny, and the personal side of it is worth thinking through separately.
Fourth, ask whether personal goodwill applies to you. Where a business has been genuinely built on an individual owner's relationships, reputation, and know how, and where that owner has never signed an employment agreement or non-compete assigning those to the company, a portion of the goodwill may belong to the individual rather than to the entity. In a C corporation asset sale, that distinction can be the difference between one layer of tax and two. It is fact specific, it is scrutinized, and it requires real substantiation and usually a valuation, so it is not a technique to invent in the final week. It is a question to put to your tax counsel in the preparation year, when the facts can still be documented properly.
Fifth, understand that the two sides do not have to agree, but they do have to live with disagreeing. Buyer and seller each file Form 8594. The form asks whether the allocation was agreed in the sale contract. Filing inconsistent allocations is legal but it is an invitation, and in practice it tends to surface in an examination of whichever party got the better of it. The clean answer is an allocation schedule attached to the purchase agreement, signed by both parties, with a covenant that both will file consistently with it. That is a one page exhibit. The number of deals I have seen close without one is higher than it should be.
Sixth, remember that allocation interacts with the rest of the structure and should be modeled alongside it, not after it. If the deal is a stock sale rather than an asset sale, most of this goes away for you, which is part of why the structure choice is worth so much, and I worked through that trade in asset sale or stock sale. If part of your price is contingent or deferred, the allocation question has a timing question stacked on top of it, and the same is true of escrow and earnout dollars, which I covered in the escrow holdback and who runs your earnout. The honest version of your proceeds is always after tax and after every deduction from the headline, which is the exercise I lay out in the equity value bridge.
A word on what a good outcome looks like, because I do not want to suggest you win this outright. You usually do not. The buyer has real economics on its side and a real need for a defensible allocation, and an appraisal will support a range rather than a point. What a prepared seller gets is the difference between the top and the bottom of that range, plus the difference between a defensible non-compete number and an invented one. On my machining client, the final schedule moved equipment to 3.4 million dollars against a supported appraisal, cut the non-compete to 250,000 dollars, and folded the consulting agreement into a shorter paid transition at a market rate. The recalculated federal difference against the original schedule was a little over 700,000 dollars. He did not get everything, and the fight cost him nine days of stress he should not have had at that point in a closing.
The reason he had any room at all was that his CPA already had the fixed asset basis schedule ready when the buyer's allocation arrived, so the counter went back in two days instead of two weeks. That is the whole lesson in a sentence. Allocation is not a technical footnote handled by accountants after the handshake. It is a live negotiation over several hundred thousand to several million dollars of your proceeds, it happens at the worst possible moment in the process, and the only real defense is having the numbers and the principle settled before you sign anything that removes your ability to walk. Building that file before a process starts, so that nothing about your own business surprises you at week nine, is a large part of what we do at Cordis Group.