When a business changes hands as a set of assets rather than as shares, the price has to be spread across those assets, and both sides report the same spread.
That allocation is not administrative. It decides how the seller is taxed on the sale and what the buyer can write off afterwards, which means the two parties want different answers and have to agree one.
This covers when the form is required, the asset classes the price is allocated across, why both sides file, how contingent amounts are handled, and what happens when the two filings do not agree.
When a business is bought or sold and both parties agree on the purchase price allocation, both the buyer and the seller must independently file Form 8594 with the IRS. The allocation determines how each party treats the purchase, as capital gains or ordinary income for the seller, and as the tax basis for the buyer's assets.
When Form 8594 Is Required
Form 8594 is required when:
- There is an applicable asset acquisition: a transfer of assets that constitute a trade or business
- The buyer's basis in the assets is determined wholly by the amount paid
- Both parties agree (or the IRS presumes they agree) on the total purchase price
Common situations: buying or selling a business, including an asset sale (not a stock sale). Note: a stock sale does not trigger Form 8594, only asset sales do. However, elections under Section 338(h)(10) can treat a stock sale as an asset sale for tax purposes.
Both sides file the same information, so an allocation the parties never agreed is visible immediately and weakens each of them. Negotiate it into the purchase agreement, where it becomes a term of the deal, rather than leaving each side to decide alone after completion.
Ankit Sarawagi, CPA, CA, MBA · LinkedInThe Seven Asset Classes
The IRS requires the purchase price to be allocated across seven classes of assets. The order matters, each class is fully allocated before moving to the next:
| Class | Description |
|---|---|
| Class I | Cash and demand deposits, always valued at face value |
| Class II | Actively traded personal property, certificates of deposit, foreign currency |
| Class III | Debt instruments (including accounts receivable and mortgages), mark-to-market assets |
| Class IV | Stock in trade, inventory, property held primarily for sale to customers |
| Class V | All other tangible property not in Classes I-IV (equipment, furniture, real estate) |
| Class VI | Section 197 intangibles (covenants not to compete, customer lists, licenses, franchises) except goodwill and going concern |
| Class VII | Goodwill and going concern value, the residual class |
Pro Tip: From the buyer's perspective, Class VII (goodwill) is the most favorable allocation because Section 197 allows 15-year amortization. From the seller's perspective, Classes I-III produce capital gain while some Class VI assets produce ordinary income.
Why Both Parties Must File
Both buyer and seller are required to file Form 8594 for the same transaction, reporting the same allocations. The IRS cross-checks the two returns:
- If the allocations do not match, the IRS will investigate
- The IRS can reallocate if it determines the agreed allocation does not reflect fair market values
- Significant discrepancies between buyer and seller returns are a major audit red flag
For this reason, the allocation should be negotiated carefully and documented in the purchase and sale agreement, with specific allocation schedules attached.
Filing Instructions
| Item | Detail |
|---|---|
| Who files | Both buyer and seller |
| When to file | Attach to the tax return for the year in which the sale occurred |
| Amended returns | If the allocation changes after filing (e.g., due to contingent consideration), file an amended Form 8594 with the amended return |
| Multiple asset classes | Complete a separate Schedule A for each class with more than one asset |
Contingent Consideration
When part of the purchase price is contingent on future events (earnouts, performance milestones), the allocation becomes more complex:
- Buyer and seller report an initial Form 8594 based on the maximum price, or the price as determinable
- When contingent amounts are resolved, file a supplemental Form 8594 on an amended return
- The method for handling contingent consideration depends on whether the contingency is based on a fixed amount, a percentage, or other metrics
Tax Consequences by Asset Class
| Class | Seller's Treatment |
|---|---|
| Class I, Cash | No gain or loss |
| Class II, Securities | Capital gain or loss |
| Class III, Receivables | Ordinary income (to the extent of the face value) |
| Class IV, Inventory | Ordinary income |
| Class V, Tangible property | Section 1231 gain (long-term capital gain if net 1231 gain) or Section 1245/1250 recapture as ordinary income for depreciated amounts |
| Class VI, Section 197 intangibles (non-goodwill) | Ordinary income to the extent of amortization taken |
| Class VII, Goodwill | Capital gain (generally, may be subject to recapture if Section 197 amortization was taken) |
Common Mistakes
- Not filing at all, both parties are required to file regardless of whether they think the IRS will check
- Buyer and seller filing inconsistent allocations, triggers automatic scrutiny
- Treating the sale as a stock sale to avoid Form 8594 when the economic substance is an asset sale
- Misclassifying goodwill as equipment to get a stepped-up basis in a more favorable class
- Not filing a supplemental Form 8594 when earnouts are later resolved
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Frequently Asked Questions
Does Form 8594 apply to the purchase of a single asset?
No. Form 8594 is required only for applicable asset acquisitions, transactions that constitute a trade or business. Buying a single machine or piece of real estate does not trigger Form 8594.
Who prepares the allocation, buyer, seller, or both?
The allocation should be negotiated by both parties as part of the deal and documented in the purchase agreement. Each party then independently prepares their own Form 8594 based on the agreed allocations.
What if the buyer and seller cannot agree on the allocation?
The IRS generally defers to an arm's-length allocation between unrelated parties. However, if there is no agreed allocation or the parties are related, the IRS can impose its own allocation based on fair market values.
How long should I keep records related to the sale?
Keep records for at least as long as the statute of limitations remains open for the year of sale (typically 3 years from filing, 6 years if substantial omission). For assets with long depreciation lives, keep records until the asset is fully depreciated or sold, plus the applicable statute period.
What happens if the two sides report the allocation differently?
It is visible, because both file the same information and the returns can be compared. An inconsistency invites questions of both parties and weakens each side's position, since neither can point to an agreed treatment. That is why the allocation is better negotiated into the purchase agreement itself, where it becomes a term of the deal rather than something each side decides alone afterwards.
Written by
Ankit Sarawagi, CPA, CA, MBA
Ankit leads the finance team at Profitjets, where he has worked with 500+ businesses across the US on bookkeeping, tax and CFO-level strategy. He writes about the habits that keep small business books accurate all year. Connect on LinkedIn
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