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Florida Bar Journal

Allocation of the Purchase Price in Sales Transactions


As a transactional lawyer for over 30 years, I have encountered many tax and nontax issues that while extremely important to my client, the client may have no idea how these issues may affect them from a liability or tax standpoint. Thus, many of these issues are left to the experienced counsel to be an advocate for his client’s position even when the client is unaware of the various issues being debated. Some of these issues include topics, such as survival periods of representations and warranties, indemnification issues, including “baskets” and “caps,” knowledge qualifiers and nuances surrounding restrictive covenants. While “best practices” dictate that you send a comprehensive letter to your client explaining the multitude of legal and tax points you have negotiated on their behalf so that if a post-closing issue should arise, the attorney has “covered” himself, in practice, deals do not stand by while you write “CYA” letters. Further, clients are loathe to pay for such things, especially on Main Street deals and smaller middle-market deals.[1]

Many of the issues identified above are hot topics with counsel for the other party and end up being some of the most negotiated issues in a transaction. However, there is another significant tax issue that I have found gets little attention in many transactions and ends up being one of the last items to be completed; that issue being the allocation of the purchase price in transactions in which such an allocation is required pursuant to §1060 of the Internal Revenue Code of 1986, as amended (code). Accordingly, this article explains the what, when, why, and how of purchase price allocations so that you will be aware of these issues and perhaps be a better advocate for your client, even though they may not recognize your valuable contributions (unless you point it out to them). Finally, we will look at the impact of the recently passed Tax Cuts and Jobs Act of 2018 (TCJA).

The What

Pursuant to the Tax Reform Act of 1986, a new code §1060 was adopted that altered the face of a typical asset purchase transaction. The asset purchase was, and remains, a popular vehicle for a business purchase, at least for nonpublicly traded company transactions and Main Street deals. Purchasers of businesses tend to favor asset acquisitions over stock purchases or mergers for liability reasons (i.e., the purchaser does not want to be responsible for the liabilities, known and unknown, of the acquired business). Another benefit of the asset purchase is that the purchaser receives a new tax basis (or “step-up”) for the assets being purchased based on the purchase price.[2] Under the prior tax regime, although the purchaser receives a step-up in basis, with some exceptions, only the tangible assets could be depreciated or amortized, thereby generating a current tax benefit. The goodwill and going concern value were not amortizable. One exception to this rule was that noncompetition agreements entered into by the selling business or its owner(s) were amortizable over the term of the agreement.[3] Also, if a taxpayer could show that a specific intangible asset had a useful life that could be determined with reasonable accuracy, the taxpayer would be permitted to amortize that asset.[4] This paradigm led to exaggerated values being assigned to the seller’s tangible assets (which could be depreciated over relatively short periods of time), and also inflated values being allocated to the seller’s restrictive covenants, which were amortizable over the restricted period. In many transactions, the seller’s goodwill, including such valuable assets as client lists, licenses, franchises and permits, workforce, intellectual property, and going concern were allocated relatively small amounts.

Furthermore, except for depreciation recapture, the seller was generally indifferent to the proposed allocations and, thus, the purchaser generally got his way in such transactions. As a result, these allocations were frequently challenged by the IRS and resulted in frequent and costly litigation.[5] The adoption of code §197 pursuant to the Omnibus Budget Reconciliation Act of 1993 sought a compromise to this issue by permitting intangible assets acquired in certain transactions to be amortized for tax purposes by the purchaser over a 15-year period.[6] Noncompetition agreements also fell into this category of intangibles and, thus, in applicable transactions, noncompetes must also be amortized over 15 years despite their shorter legal duration. Now, some 25 years later, the basic tenants of §§1060 and 197 have been accepted in the M&A community as providing a reasonable tax benefit to the purchaser and, generally, certainty to the transaction, without fear of litigation with the IRS over the required allocations.

The When

Section 1060 of the code requires that in an “applicable asset acquisition,” the purchaser’s basis in the acquired assets and the seller’s consideration with respect to the acquisition must be allocated among the assets pursuant to the “residual method.”[7] An applicable asset acquisition (AAA) is defined as any transfer that involves a transfer of assets, which constitute a trade or business, and with respect to that, the purchaser’s basis in such assets is determined wholly by reference to the consideration paid for such assets.[8] This second component generally eliminates transactions in which the purchaser takes a “transferred” basis, such as a merger or stock purchase, except as described below regarding a §338(h)(10) election. The regulations under §1060 provide that a group of assets constitutes a trade or business if 1) the use of such assets would constitute an active trade or business under §355 (relating to corporate formations); or 2) its character is such that goodwill or going concern value could under any circumstances attach to such group.

It bears discussion that although not technically a transaction that comes within the definition of an AAA, the deemed asset sale pursuant to a §338(h)(10) election is treated similarly to an AAA under §1060 in that the residual method is dictated for determining the basis of the purchaser’s assets.[9] A §338(h)(10) election may be made with respect to a qualified stock purchase of at least 80 percent of the stock of a corporation that is a member of a selling consolidated group, a member of a selling affiliates’ group filing separate returns, or an S corporation.[10] In addition, the purchaser must be a corporation, and the purchaser and the seller (target) must jointly make the election.[11] Once made, the 338(h)(10) election treats the transaction for tax purposes as a purchase of all of target’s assets, and the consideration paid must be allocated pursuant to the residual method[12] similar to §1060.

There are some subtle differences between an AAA and a deemed asset sale under §338(h)(10). To qualify as an AAA, the transaction must involve assets involved in a trade or business. There is no such requirement under 338(h)(10). Under §1060, the seller’s noncompete clearly falls under the requirements of §1060, and the amount allocated to the noncompete will be amortized over 15 years under §197. This result is not clear under §338(h)(10).[13] Finally, the transaction costs incurred to the purchaser and seller under §1060 are treated as part of the consideration.[14] However, under §338(h)(10), such costs are not allocated to the assets.[15]

Real Estate Transactions

Section 1060 has generally been credited with providing tax certainty for the purchaser and seller, where the purchaser and seller agree on an allocation of the purchase price and report the transaction on a consistent basis. However, are there other transactions to which §1060 should apply such as the sale of real property? The regulations under §355 exclude from the definition of the conduct of a trade or business: 1) the holding of land or other property for investment; and 2) the ownership and operation (including leasing) of real property used in a trade or business, unless the owner performs significant services with respect to the operation and management of the property. Thus, the mere holding and leasing of real property (particularly pursuant to the ever-popular “triple net” lease) will not be considered a trade or business for purposes of §1060. Therefore, the typical sale of improved real property is not governed by §1060.

Notwithstanding that real property owned by itself may not constitute a trade or business (thus, the sale is not governed under §1060), the real property could be part of a trade or business being sold. Consider the following two scenarios: ABC Corp owns a trucking business, including several terminals at which their trucks are serviced and stored. ABC Corp enters into a purchase and sale agreement to sell all of its assets to BuyCo, Inc., for $10 million. The fair-market value of ABC’s tangible assets, including the improved real property is $6 million. This transaction clearly requires an allocation of the purchase price under §1060. If, however, the owner(s) of ABC Corp owned the terminals in separate LLCs, with each LLC owning a single terminal which is then leased to ABC Corp, then the transaction would typically involve multiple purchase and sale agreements wherein the tangible assets (and goodwill) of ABC Corp would be sold in one transaction (asset sale), and the real property (terminals) would be sold pursuant to one or more other purchase and sale agreements (property sale). The asset sale would clearly be governed by §1060 as the trucking business constitutes a trade or business and would require a purchase price allocation. The property sale, however, falls outside the ambit of §1060 since the LLC simply leases the real property. Therefore, ABC Corp and BuyCo, Inc. are left to assign potentially widely varying values to the real property, including its various improvements. This point becomes even more important when BuyCo, Inc. desires to obtain a cost segregation study to identify classes of assets within the terminals that would qualify for accelerated depreciation.

By adding some additional facts to our hypothetical transaction, you can clearly see the significant tax issues in such a transaction. Assume that appraisals were obtained by BuyCo, Inc. on the terminals, and that each terminal was valued at $1 million. The underlying land, which is not depreciable or amortizable, was valued at $250,000, and the building and improvements were valued at $750,000. Under our asset sale, the two parties would be required to further allocate the $750,000 among the “building” and the “improvements” as the building will be amortizable over 40 years, and the “improvements” can have depreciable lives ranging from five to 15 years. Further adding to the importance of this allocation is that the improvements may now also qualify for bonus depreciation (see the discussion below regarding the impact of the TCJA). These facts are very similar to the 2012 Tax Court ruling in Peco Foods, Inc. v. Commissioner (Peco Foods, Inc. v. Commissioner, TC Memo 2012-18 (Jan. 17, 2012), affirmed by No. 12-12169 (11th Cir. 2013), which denied allocations based on a cost-segregation study performed after the closing in which the allocations agreed upon at closing had been agreed to in writing and were unambiguous.[16]

Under the property-sale scenario, since the owning and leasing of real property does not constitute a trade or business, §1060 does not apply, and the parties are free to report the transaction for tax purposes as each deems appropriate. In this circumstance, it is likely that a wide variance may exist between how the purchaser and seller report the sale. The old dynamics that led to the adoption of §1060 to begin with are in play where the purchaser will desire to allocate a low value to land and a higher value to improvements while the seller will want to allocate more of the purchase price to the building that has not been depreciated as much as the other improvements.

The potential for widely varying tax reporting under the property sale scenarios raises the question of whether the parties could agree to apply the principles of §1060 to the transaction and, if so, whether such an agreement would be respected by the service. As this “negotiation method” was endorsed by the service[17] and the courts[18] prior to the adoption of §1060, it seems that the same tax principles would apply in this situation.

The How

An important and often overlooked provision of §1060 reads as follows:

If in connection with an applicable asset acquisition, the transferee and transferor agree in writing as to the allocation of any consideration, or as to the fair market value of any assets, such agreement shall be binding on both the transferee and transferor, unless the [s]ecretary determines that such allocation (or fair market value) is not appropriate.[19]

Significantly and to the surprise of many practitioners, §1060 does not mandate an agreed-upon allocation, but rather only speaks to those where an allocation has been agreed to in writing by the purchaser and seller. Section 1060 does, however, mandate what information must be furnished to the IRS.

Section 1060 dictates that in an AAA, the total sales price be allocated among seven classes of assets and that the allocation be done on the “residual method.”[20] The asset classifications are straightforward and generally noncontroversial as far as which class a particular asset will fall under. The classes can generally be described as follows:

• Class I: cash;

• Class II: marketable securities and government bonds;

• Class III: accounts receivable and certain debt instruments;

• Class IV: inventory;

• Class V: all other tangible assets (furniture, fixtures and equipment, land, buildings, vehicles, etc.);

• Class VI: all §197 intangibles, other than goodwill and going concern value (includes covenants not to compete, customer lists, trademarks, licenses); and

• Class VII: goodwill and going concern value.

The consideration in an AAA is then allocated among the classes in order beginning with the Class I assets, with the balance of the purchase price, if any, being allocated last to the Class VII assets.

One common misconception about §1060 is that the statute requires consistency in reporting by the purchaser and seller. Instead, the statute and the regulations require that the purchaser and the seller furnish to the secretary certain prescribed information regarding an AAA, which is accomplished by completing Form 8594. However, if the parties do agree in writing on the allocation of the purchase price, the agreement is binding on both parties, unless the IRS determines that the allocation is not appropriate. The unstated corollary to this statement is that if the parties do not agree on an allocation, or stated another way, if the parties file different allocations on Form 8594, the IRS may challenge one or more of the allocations. This challenge will, of course, come in the form of an audit.

In a typical transaction involving an AAA, the tax allocation section of a typical purchase agreement may read as follows:

The purchaser and seller hereby agree that the purchase price (including the assumption by purchaser of any of seller’s liabilities) shall be allocated among the assets in the manner set forth in Schedule 1.3. The parties agree to file all income tax returns and statements required by the Internal Revenue Code of 1986 as amended or the Regulations promulgated thereunder, in a manner consistent with such allocations.

Contrast this paragraph then to the purchaser or seller who desires to report the allocation using their own information.

Purchaser agrees to provide seller with a draft Form 8594 within ninety (90) days after closing for review and comment. Purchaser and seller shall make reasonable attempts to allocate the purchase price for tax purposes in a consistent manner. If the parties are unable to reach agreement with respect to such an allocation then the parties shall have no further obligation under this Section 1.6 and each party shall make its own determination of such allocation for financial and tax reporting purposes.

Thus, this paragraph not only allows for a post-closing allocation, but contemplates that the purchaser and seller may not agree. Be aware that if purchaser and seller do not agree on the allocation in writing, each party is advised to have good evidence to support their allocation.

Increases or Decreases in Purchase Price

Section 1060 and the applicable regulations also require that the purchaser and seller report an increase or decrease in consideration occurring either in the year of sale or after the close of the taxable year of the sale.[21] Such increases or decreases can occur from such things as working capital adjustments, indemnity claims, and earnouts. In the event of an increase occurring after the tax year of the purchase date, a “supplemental” asset acquisition statement must be filed by purchaser and seller on Form 8594.[22] According to the regulations, the increase should be allocated among the classes of assets in the same manner as the original allocation with the increase to be allocated to the assets in each class in proportion to their fair market value.[23] However, no allocation may be made to any asset in excess of fair market value.[24] This rule regarding fair market value leads to the general assumption that the increase will ultimately fall under the Class VI or Class VII (intangibles) category due to the residual method, unless the increase is due to a specific increase to a particular asset class. For example, if a sale takes place in December, but an adjustment (increase) to the purchase price occurs based upon a physical inventory that was not completed and agreed upon until January of the following year, such an increase would be allocated to Class IV (inventory). However, an increase in purchase price based on an earnout tied to profitability in the year following the sale would be allocated among the intangible assets since presumably the initial allocation to the Class I-Class V assets was based on their fair market values. A decrease in purchase price is more simply handled by reversing the allocation beginning with Class VII assets first and then to the other classes in reverse order.[25] One note in this regard is that if an asset has been disposed of or depleted, then no decrease can be allocated to such assets as no allocation is permitted that would decrease the amount allocated to an asset below zero.[26]

Another drafting note regarding the potential for increases or decreases in the purchase price or the payment of claims from escrow is to include language in the purchase agreement that states that any such payments shall be treated as adjustments to the purchase price. Further, the parties should agree to file a supplemental Form 8594 to reflect any such increase or decrease. A suggested clause would be:

In the event seller pays any claim for indemnification pursuant to this Article XI to the purchaser, then such payment shall be deemed to be a post-closing adjustment to the purchase price and the parties hereto shall, to the extent required under Section 1060 of the Code and the applicable Regulations thereunder, file amendments to Form 8594 which are consistent with the foregoing adjustment to the purchase price.

Impact of TCJA

The TCJA is likely to bring new focus to asset allocations due to the expansion of the bonus depreciation rules. The TCJA increased the deduction for bonus depreciation from 50 percent to 100 percent and extended the phase-out period until 2026. Also, the TCJA increased the maximum §179 deduction from $500,000 to $1 million for property placed in service in 2018 or after, while also expanding the definition of property qualifying as §179 property.[27] Similarly, the definition of property qualifying for the 100 percent bonus depreciation was broadened to include certain used qualified property.[28] Thus, well-advised purchasers will be looking for more opportunities to allocate the purchase price to tangible assets qualifying for this bonus depreciation. Sellers must be prepared to react knowledgeably or face larger-than-anticipated tax consequences.


Whether you represent the purchaser or seller in an applicable asset acquisition or a transaction in which a §338(h)(10) election will be made, do not leave the purchase price allocation to the last minute. Involve both your client and their CPAs in the discussion and let them know what is at stake. Being prepared to deal with this issue may bring additional tax benefits to your purchaser clients or help to avoid taxes for your seller clients.

[1] Divestopedia defines “Main Street” deals as companies having revenues of less than $5 million and “middle-market” as those companies having revenues of $5 million to $500 million.

[2] 26 U.S.C. §1012.

[3] Warsaw Photographic Assoc., Inc. v. Commissioner, 84 T.C. 21 (1985).

[4] See, e.g., Newark Morning Ledger Co. v. United States, 507 U.S. 546, 566 (Apr. 20, 1993), accord, Richard S. Miller & Sons, Inc. v. United States, 210 Ct. Cl. 431, 439, 537 F.2d 446, 452 (1976).

[5] The IRS estimated that $14.4 billion in proposed adjustments were in litigation in 1993. 93 Tax Notes Today 204-1 (Oct. 4, 1993).

[6] 26 U.S.C. §197 (1994); see also Omnibus Budget Reconciliation Act of 1993, Pub L. 103-66, Tit. XIII, §3261 (Aug. 10, 1993), 107 Stat. 532-533. Part XIII of the Omnibus Budget Reconciliation Act of 1993 is also called the “Revenue Reconciliation Act of 1993.”

[7] 26 U.S.C. §1060(a).

[8] 26 U.S.C. §1060(c).

[9] See 26 U.S.C. §338(h)(10) and 26 U.S.C. §338(b)(5); cf. 26 U.S.C. §1060(a).

[10] 26 U.S.C. §338(h)(10); 26 C.F.R. §1.338(h)(10)-1(c)(1).

[11] 26 U.S.C. §338(d)(3); 26 C.F.R. §1.338-3(b)(1); 26 C.F.R. §1.338(h)(10)-1(c)(3)

[12] 26 U.S.C. §338(a) and §338(b)(5).

[13] Cf. 26 U.S.C. §338(h)(10) and 26 U.S.C. §1060.

[14] BNA portfolio, 562 – 1st, see discussion at IV.B.(8).

[15] Id.

[16] Peco Foods v. Commissioner, TC Memo 2012-18 (Jan. 17, 2012), affirmed by Peco Foods v. Commissioner, No. 12-12169 (11th Cir. 2013).

[17] S. Rep. No 313, 99th Cong., 2d Secs. 251 (1986)

[18] Throndson v. Commissioner, 457 F.2d 1022 (9th Cir. 1972).

[19] 26 U.S.C. §1060(a) (emphasis added).

[20] See 26 U.S.C. §1060(a); see also T.D. 8940, 66 F.R. 9929 (Fed. 13, 2001); 26 C.F.R. §1.338-6.

[21] Treas. Reg. §1.1060-1(c)(2); Treas. Reg. §1.338-7.

[22] Treas. Reg. §1.1060-1(e)(1)(ii)B.

[23] Treas. Reg. §1.1060-1(c)(2).

[24] Id.; Treas. Reg. §1.338-7(e), Ex. 4.

[25] See generally Form 8594 Instructions.

[26] Treas. Reg. §1.338-7(d)(1).

[27] Tax Cuts and Jobs Act, Pub L. 115-97, Tit. I, §13101, Dec. 22, 2017, 131 Stat. 2101-2102. See also New Rules and Limitations for Depreciation and Expensing Under the Tax Cuts and Jobs Act, I.R.S. FS-2018-9 (Apr. 2018), available at

[28] Id. 131 Stat. 2105-2108.

Scott GlazierScott L. Glazier practices in the areas of corporate law, business transactions, and tax planning. He has a B.S. degree in accounting from the University of Florida (1981) and is a graduate of Stetson College of Law (1985). He is the managing partner of Glazier & Glazier, P.A., in Jacksonville.

This column is submitted on behalf of the Tax Law Section, Michael D. Minton, chair, and Benjamin A. Jablow, Christine Concepcion, and Charlotte Erdman, editors.