A Frederick County manufacturing business sells for two million dollars. The purchase agreement took three months to negotiate. The representations were fought over line by line, the indemnity cap went back and forth four times, and the earnout mechanics consumed two calls.

At the closing table, the buyer’s counsel hands across a one-page allocation schedule. It assigns $700,000 to equipment and $900,000 to goodwill, with the rest spread across receivables and inventory. Nobody negotiated it. The seller’s broker says it looks standard. The seller signs.

Ten months later the seller’s accountant explains that the equipment was almost fully depreciated, that the $700,000 allocated to it is largely ordinary income rather than capital gain, and that the tax bill is roughly $150,000 higher than the seller expected.

That schedule was not a formality. It was a term with a dollar value, and it was the only significant term in the deal that went unnegotiated.

This guide explains how purchase price allocation works under Internal Revenue Code Section 1060, why buyer and seller have structurally opposed interests, where the real money moves, a Maryland-specific interaction that national guidance overlooks entirely, and when in the deal timeline the allocation should actually be settled. It sits alongside our guides on asset sale versus stock sale and how to sell a business in Maryland.

Internal Revenue Code Section 1060 governs allocation in an applicable asset acquisition, which is generally a transfer of a group of assets constituting a trade or business where the purchaser’s basis in the assets is determined wholly by the amount paid for them.

Under Treasury Regulation Section 1.1060-1, the seller and the purchaser each must file asset acquisition statements on Form 8594 with their income tax returns for the taxable year that includes the first date assets are sold pursuant to an applicable asset acquisition. Both parties file. Neither files on the other’s behalf.

Where it applies and where it does not:

• Asset sales: yes, where the assets constitute a trade or business.
• Stock sales: generally no, because the buyer acquires shares rather than assets. This is one of the practical differences between the two structures.
• Section 338 elections: a stock purchase for which a Section 338 election is made is treated as a deemed asset sale and uses the same allocation methodology, though the reporting mechanics differ.
• Partnership interests: an ordinary transfer of a partnership interest generally does not require Form 8594, although separate reporting requirements may apply under Treasury Regulation Section 1.755-1. If the transaction is treated for federal income tax purposes as a purchase of partnership assets constituting a trade or business, as can occur under Revenue Ruling 99-6, the purchase is subject to Section 1060 and the purchaser must file Form 8594. The seller may nevertheless be treated as selling a partnership interest rather than the underlying assets.
• Partial sales: the transferred assets do not have to be the entire company. If the group transferred functions as a trade or business, Section 1060 can apply to a division or product line.

Later adjustments matter too. The instructions to Form 8594 provide that if the amount allocated to any asset is increased or decreased after the year in which the sale occurs, the affected party must complete Parts I and III of Form 8594 and attach the form to the income tax return for the year in which the increase or decrease is taken into account. That is directly relevant where a deal includes an earnout or a post-closing purchase price adjustment, since additional consideration paid later has to be allocated and reported.

The statute does not let the parties simply divide the price however they like. It prescribes a residual method: consideration is assigned to each class in order, up to the fair market value of the assets in that class, and whatever is left over lands in the final class. Under the Section 1060 residual method, the portion of consideration remaining after Classes I through VI have been allocated up to their permitted values is assigned to Class VII goodwill and going concern value. The tax allocation to Class VII is therefore residual, although goodwill may also be valued directly for negotiation, financial-reporting, or appraisal purposes and to support the reasonableness of the parties’ agreed allocation.

Here is the core of it. The same dollar produces a different tax outcome depending on which class it lands in, and because the total price is fixed, every dollar moved toward one party’s preference is a dollar moved away from the other’s.

What the buyer wants

The buyer wants deductions sooner. Value allocated to Class V tangible property is recovered through depreciation over relatively short recovery periods. Value allocated to Classes VI and VII is amortized under Section 197 over fifteen years on a straight-line basis. A dollar in equipment is worth materially more in present value terms to a buyer than a dollar in goodwill.

What the seller wants

The seller wants capital gain rather than ordinary income. Gain attributable to Class VII goodwill is generally long-term capital gain, taxed at preferential federal rates. Value allocated to Class IV inventory produces ordinary income. Value allocated to Class V equipment can produce ordinary income through depreciation recapture, discussed in the next section.

Look at the non-compete row carefully. It is the only line where both parties do worse than they would with goodwill: the seller takes ordinary income and the buyer still amortizes over fifteen years. That is worth remembering the next time a large non-compete allocation appears in a draft schedule.

This is the provision that produces the unpleasant surprise described at the start of this post, and it is the single most under-modeled item in small business sales.

Section 1245 applies to depreciable personal property such as machinery, equipment, and vehicles. On a sale, gain is treated as ordinary income to the extent of depreciation previously allowed or allowable. The character of that income does not depend on how long the seller owned the business. A seller who bought a machine for $200,000, depreciated it fully, and allocates $150,000 of the purchase price to it recognizes $150,000 of ordinary income, not capital gain.

Section 1250 applies to depreciable real property, but its ordinary-income recapture rules differ materially from Section 1245. For property held longer than one year, Section 1250 generally treats as ordinary income only the gain attributable to depreciation exceeding straight-line depreciation. Consequently, modern real property depreciated solely under the straight-line method often produces no ordinary-income recapture under Section 1250. The depreciation-related gain that is not treated as ordinary income may instead constitute unrecaptured Section 1250 gain, a category of long-term capital gain generally subject to a maximum 25% federal rate for individual taxpayers. Different rules, including Section 291, apply to C corporations.

Two consequences follow that sellers should understand before signing anything:

• Heavily depreciated equipment is the most expensive place to put value. The more depreciation previously taken, the larger the ordinary income component. Businesses that took bonus depreciation or expensing elections on equipment have essentially pre-committed to recapture on sale.
• Recapture generally cannot be deferred through an installment sale. Recapture income under Sections 1245 and 1250 is generally recognized in the year of the sale even where the seller is receiving payments over time. A seller taking a note can therefore owe tax on recapture before receiving the cash to pay it.

Section 1060(a) contains a provision, added by Congress in 1990, that gives the parties real power over the outcome. 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 of the assets, that agreement is binding on both the transferee and the transferor, unless the Secretary determines that the allocation or fair market value is not appropriate.

Read that carefully, because it has two halves.

The first half is a gift to careful parties. A written allocation negotiated in the purchase agreement generally controls how both sides report. Neither can quietly take a more favorable position on its own return later. That is why the allocation schedule belongs in the definitive agreement rather than being left to whichever accountant prepares the return first.

The second half is the limit. The IRS is not bound by an allocation it determines is inappropriate. An allocation that both parties signed but that has no relationship to fair market value is not protected simply because it was agreed. That is why the schedule should be supported by something: an appraisal, a broker’s valuation, equipment listings, a book value analysis, or at minimum a documented methodology.

Consistency between the two filings

The purchaser and seller generally must each file Form 8594 for the same transaction and should report the agreed allocation consistently. Their forms, however, are not necessarily identical in every number. For Section 1060 purposes, the seller allocates its amount realized, while the purchaser allocates its cost, and transaction costs or other tax-law adjustments can cause those amounts to differ legitimately. The IRS instructions state that a party that fails to file a correct Form 8594 by the due date of its return, without reasonable cause, may be subject to penalties under Sections 6721 through 6724. The instructions do not impose a separate penalty merely because the parties’ forms contain different numbers.

The purchase agreement should include a covenant requiring both parties to file consistently with the agreed schedule, to refrain from taking inconsistent positions in any examination or proceeding, and to notify each other promptly if the allocation is challenged. That is standard contract drafting work and it costs nothing to include.

This is the part that national guidance on Form 8594 almost universally omits, and it matters to every Maryland asset deal involving meaningful tangible property.

Maryland does not follow the federal capital gain preference

Maryland does not generally give long-term capital gain the preferential rate available under federal law. Moreover, beginning with tax year 2025, an individual whose federal adjusted gross income exceeds $350,000 generally owes an additional Maryland tax equal to 2% of the net capital gain included in Maryland adjusted gross income, subject to statutory exclusions. Those exclusions include, among other items, certain qualifying principal-residence sales, retirement-plan assets, preservation land, qualifying agricultural assets, and property used in a trade or business whose cost is deductible under Section 179. Accordingly, a seller’s preference for goodwill ordinarily remains a federal tax benefit, while the resulting net capital gain may actually carry an additional Maryland tax cost for a high-income individual seller. The precise result depends on the seller’s entity structure, income, the character of the gain, and the statutory exclusions.

The allocation can drive Maryland sales and use tax on the transfer itself

The other Maryland obligations that travel with an asset deal

Purchase price allocation does not sit in isolation from the rest of the Maryland transaction analysis. An asset buyer in Maryland should also be attending to the bulk transfer notice obligations and the personal liability that attaches to a buyer who fails to notify the Comptroller of Maryland of the transfer, which we cover in detail in our guide on successor liability in Maryland business acquisitions. The same closing checklist should cover both.

Covenants not to compete

An amount allocated to a covenant not to compete entered into in connection with the acquisition of a trade or business is a Section 197 intangible. Two consequences follow, and both are unfavorable:

• For the seller, the allocated amount is generally ordinary income rather than capital gain.
• For the buyer, it is amortized over fifteen years, even if the covenant itself runs for only two or three years. The buyer does not get to match the deduction to the term of the restriction.

Compared with allocating the same dollars to goodwill, the non-compete allocation makes the seller worse off and leaves the buyer no better off. Where a covenant is genuinely necessary, our guide on non-compete enforceability in Maryland covers the drafting side, but the allocated dollar amount is a separate decision that deserves its own analysis.

Consulting and employment agreements

Payments to a departing owner under a separate consulting or employment agreement sit outside the Section 1060 allocation, but they are frequently used to move value, so they belong in the same conversation. Those payments are ordinary income to the seller and may carry self-employment or payroll tax, while the buyer generally deducts them currently rather than amortizing. The buyer’s preference for this treatment is strong, which is exactly why a seller should price it rather than accept it as a leftover.

Personal goodwill

Where the target is a C corporation, an asset sale can produce tax at the corporate level and again when the proceeds reach the shareholder. If a portion of the enterprise value is genuinely personal goodwill, meaning goodwill attributable to an individual’s own relationships, reputation, and skill rather than to the entity, that portion may be sold by the individual directly and taxed once.

Courts have recognized the concept in appropriate circumstances, and it is most defensible in professional services and relationship-driven businesses where the individual never transferred those relationships to the entity through an employment agreement or a covenant not to compete. It is heavily fact-dependent and frequently challenged. It requires genuine substance, contemporaneous documentation, and often a valuation, not a label applied in the closing binder. Our post on LLC versus corporation tax implications covers the entity-level backdrop.

Installment sales

Where the seller carries a note for part of the price, the allocation interacts with the installment method in a way that can create a cash timing problem.

• Gain on goodwill and other capital assets generally can be reported under the installment method as payments are received.
• Inventory and dealer dispositions generally do not qualify for installment reporting.
• Depreciation recapture under Sections 1245 and 1250 is generally recognized in the year of sale, regardless of when the cash arrives.

Combine those and a seller with a heavy equipment allocation and a seller note can owe substantial tax in year one on money not yet received. That is a modeling exercise to run before agreeing to either the allocation or the payment terms, not after.

Section 338 elections and deemed asset sales

A qualified stock purchase for which a Section 338 election is made is treated for federal income tax purposes as a deemed sale of the target’s assets by the old target followed by a deemed purchase of those assets by the new target. The residual allocation methodology applies, but the transaction is reported on Form 8883 rather than Form 8594. Both the old target and the new target generally must file Form 8883 with the returns on which the deemed asset sale and purchase are reported. Form 8023 is separately used to make the Section 338 election, with the parties required to join in that election depending on whether it is made under Section 338(g) or Section 338(h)(10).

The threshold structural question, asset sale or stock sale, is covered in our guide on asset sale versus stock sale for Maryland business sellers, and the diligence that surrounds it in our guide on buying a business in Maryland.

The allocation should be settled at the letter of intent stage. That is not a stylistic preference. It follows from where leverage exists.

By the time a schedule appears with the closing documents, the price is agreed, both sides have spent money on diligence and legal fees, and the disadvantaged party has nothing left to trade for an adjustment. Refusing to sign at that point means threatening a deal that everyone has already committed to. Our guide on letters of intent in Maryland makes the general point that the letter of intent is where a deal’s leverage is spent; the allocation is a clear illustration.

A workable sequence:

1. Raise allocation in the letter of intent. Either agree a framework or state expressly that the allocation will be negotiated and that the price assumes a stated approach.
2. Model the after-tax result before agreeing to the price. For a seller, the relevant number is what you keep. For a buyer, it is the present value of the deductions plus any state transfer tax cost.
3. Support the numbers. Equipment lists with book values, an appraisal where the amounts justify it, or a documented valuation methodology. This is what protects the allocation if it is examined.
4. Run the Maryland analysis alongside the federal one, including sales and use tax on the transfer and who bears it.
5. Attach the agreed schedule to the definitive agreement and include the consistency covenant described above.
6. Address later adjustments. Specify how earnout payments, working capital true-ups, and indemnity payments will be allocated and reported when they occur.
7. Have the tax and deal analysis done by people who talk to each other. An allocation negotiated by counsel who has not modeled the tax, or modeled by an accountant who was not in the negotiation, is how the schedule ends up unexamined.

• Treating the allocation as an accounting formality. It is a negotiated term with a dollar value, and it is often the last one anybody negotiates.
• Agreeing to a price without modeling the after-tax result. What the business sold for and what the seller keeps are different numbers.
• Ignoring depreciation recapture. Heavily depreciated equipment is the most expensive place to put value, and the recapture generally cannot be deferred through an installment note.
• Accepting a large non-compete allocation. Ordinary income to the seller and fifteen-year amortization to the buyer; worse than goodwill for both.
• Signing an allocation with no valuation support. A written agreement binds the parties, but the IRS is not bound by an allocation it determines is not appropriate.
• Failing to agree on and consistently report the allocation itself. Legitimate differences can exist between the seller’s amount-realized figures and the buyer’s cost figures, but an unexplained inconsistency about the agreed value or allocation of assets invites scrutiny.
• Overlooking Maryland sales and use tax on the transfer. The buyer’s federal preference for tangible property can increase the state tax on the deal, and the agreement should say who pays it.
• Assuming the federal capital gain preference carries to Maryland. Maryland does not generally provide the federal preferential rate for long-term capital gain, and a high-income individual may also owe Maryland’s additional 2% tax on net capital gain, subject to statutory exclusions.
• Forgetting later adjustments. Earnouts and post-closing true-ups have to be allocated and reported when paid.
• Waiting until closing. By then the leverage to trade the allocation against the price is gone.

Purchase price allocation is the division of the total consideration in a business sale across the individual assets transferred. It is governed by Internal Revenue Code Section 1060, which applies to an applicable asset acquisition, meaning a transfer of a group of assets that constitutes a trade or business where the buyer’s basis is determined wholly by the amount paid. Under Treasury Regulation Section 1.1060-1, the seller and the purchaser each must file Form 8594, Asset Acquisition Statement, with their income tax returns for the taxable year that includes the first date assets are sold. It applies to asset sales rather than stock sales, although a stock purchase for which a Section 338 election is made is treated as a deemed asset sale using the same allocation methodology. An ordinary partnership-interest transfer generally does not require Form 8594. If the transaction is treated for federal income tax purposes as a purchase of partnership assets constituting a trade or business, however, Section 1060 may apply and the purchaser must file Form 8594.

Section 1060 uses a residual method that assigns consideration to seven classes in order, up to the fair market value of each class, with whatever remains falling into the last class. Class I is cash and general deposit accounts, including checking and savings but excluding certificates of deposit. Class II is actively traded personal property, including certificates of deposit, government securities, publicly traded stock, and foreign currency. Class III is assets marked to market at least annually and certain debt instruments, including accounts receivable. Class IV is inventory and property held primarily for sale to customers. Class V is all other assets not in another class, which is where equipment, furniture, fixtures, vehicles, land, and buildings fall. Class VI is Section 197 intangibles other than goodwill and going concern value, such as customer lists and covenants not to compete. Class VII is goodwill and going concern value.

Because the same dollar produces a different tax result depending on which class it lands in, and the total price is fixed, so more value in one class necessarily means less in another. The buyer generally prefers value in Class V tangible assets, because equipment and similar property are recovered through depreciation over relatively short periods, which accelerates deductions. The seller generally prefers value in Class VII goodwill, because that gain is typically long-term capital gain taxed at preferential federal rates. Value placed in equipment can trigger depreciation recapture taxed to the seller as ordinary income, and value placed in inventory produces ordinary income as well. Intangibles in Classes VI and VII are amortized by the buyer over fifteen years under Section 197, which is far slower than equipment depreciation. That is the structural conflict, and it is why the allocation schedule is a negotiated term rather than an accounting exercise.

Depreciation recapture is the rule that claws back, as ordinary income, the benefit of depreciation deductions the seller previously took. Under Section 1245, gain on the sale of depreciable personal property such as equipment is treated as ordinary income to the extent of prior depreciation, regardless of how long the seller held the business. Section 1250 applies to depreciable real property but generally recaptures as ordinary income only depreciation exceeding straight-line depreciation for property held longer than one year. The remaining depreciation-related gain may be unrecaptured Section 1250 gain, a category of long-term capital gain generally subject to a maximum 25% federal rate for individuals. The practical consequence is that a seller who has fully depreciated equipment and then allocates a meaningful amount of the purchase price to that equipment can face ordinary income tax on that entire allocated amount. Sellers frequently do not model this before agreeing to a schedule, and it is a common source of unpleasant surprises when the return is prepared months after closing.

Generally yes, as between the parties and with respect to the IRS, subject to an important qualification. Section 1060(a) provides that 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 of the assets, that agreement is binding on both the transferee and the transferor unless the Secretary determines that the allocation or fair market value is not appropriate. So a written allocation negotiated in the purchase agreement generally controls how both parties report, and neither can unilaterally take a different position later. But the IRS is not bound by an allocation it determines is inappropriate, which means an allocation unsupported by fair market value evidence is vulnerable even when both parties signed it.

The purchaser and seller generally should report the agreed purchase-price allocation consistently, but their Forms 8594 are not required to be numerically identical in every respect. The seller allocates its amount realized, while the purchaser allocates its cost, and transaction costs or other tax-law adjustments may create legitimate differences. An unexplained inconsistency concerning the agreed value or allocation of the assets can create audit risk or a contractual dispute, but a numerical difference is not automatically an incorrect filing. The IRS instructions state that failure to file a correct Form 8594 by the return’s due date, without reasonable cause, may result in penalties under Sections 6721 through 6724; they do not prescribe a separate penalty merely for a mismatch. The purchase agreement should require consistent reporting of the agreed allocation except to the extent applicable tax law requires a difference.

In two ways that pull in different directions, and this is the part national guidance misses. First, Maryland does not generally give long-term capital gain the preferential rate available under federal law. Beginning with tax year 2025, an individual whose federal adjusted gross income exceeds $350,000 also generally owes an additional Maryland tax equal to 2% of net capital gain included in Maryland adjusted gross income, subject to statutory exclusions. Consequently, goodwill treatment may produce a federal rate benefit while also increasing the Maryland tax imposed on a high-income individual seller. Second, the acquisition itself may be subject to Maryland sales and use tax on the portion of the purchase price allocated to taxable tangible personal property and digital products, unless an exemption applies, and Maryland taxability does not track the Form 8594 classes exactly. Allocating more value to depreciable equipment and other taxable tangible personal property can improve federal deductions while increasing Maryland sales and use tax, but Class V also includes nontaxable land and buildings, and some Class VI intangibles such as certain software, business records, and customer lists may themselves be taxable digital products. The parties should analyze the Maryland tax status of each transferred asset and determine before closing who bears any resulting tax.

Both deserve careful attention because they are often the worst outcome available for a seller. An amount allocated to a covenant not to compete entered into in connection with the acquisition of a trade or business is generally ordinary income to the seller, and it is a Section 197 intangible that the buyer amortizes over fifteen years, even where the covenant itself runs for only two or three years. So the seller gets ordinary income treatment and the buyer gets slow amortization, which makes it inefficient for both compared with goodwill. Payments under a separate consulting or employment agreement are ordinary income to the seller and may carry self-employment or payroll tax as well, although the buyer generally deducts them currently. Because these amounts are frequently used to move value around, both parties should price them deliberately rather than treating them as leftover line items.

Personal goodwill is goodwill that belongs to an individual owner rather than to the business entity, typically arising from that person’s own relationships, reputation, and skill. It matters most where the target is a C corporation, because a sale of corporate assets can produce tax at the corporate level and again when proceeds reach the shareholder. If a portion of the value is genuinely personal goodwill owned by the individual, that portion may be sold directly by the individual and taxed once. Courts have recognized the concept in appropriate circumstances, and it is most defensible in professional services and other relationship-driven businesses where the owner never transferred those relationships to the entity through an employment or non-compete agreement. It is heavily fact-dependent and frequently challenged, so it requires genuine substance and contemporaneous documentation rather than a label applied at closing.

At the letter of intent stage, not at closing. By the time a draft Form 8594 or an allocation schedule appears with the closing documents, the price is settled, both sides have spent money, and the party disadvantaged by the allocation has no leverage left to trade for an adjustment. Because the allocation moves real money between the parties, it belongs alongside the price itself as a term to be negotiated when leverage still exists. The practical approach is to include an allocation framework in the letter of intent, model the after-tax result before agreeing to the total price, attach the agreed schedule to the definitive purchase agreement, and include a covenant requiring both parties to file consistently and to notify each other of any examination. Where the parties genuinely cannot agree, the disagreement is usually a signal that the price itself needs adjusting.