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Allocation of the sale price when buying or selling a business

Steve Sink is the founder and managing partner of Phoenix Affiliates Ltd.

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Most businesses are made up of different types of assets, and those assets get different treatment for tax purposes. How those items are identified at the time of the sale/purchase can have a significant tax impact on both the buyer and the seller. A seller will, of course, want to designate items into classes that will yield a long-term capital gain on sale and thus provide the best tax result from the sale. Whereas the buyer will generally want to designate the purchased items into classes that provide the biggest up front write-offs.

The IRS generally does not care how the class allocations are made so long as both the buyer and the seller use consistent treatment and use GAAP as a guide. That is where IRS Form 8594 comes in. The form allocates the entire purchase/sale price of the business into the various classes of assets; both the buyer and the seller are required to file the form with their tax returns. It is also very important that allocations be spelled out in the sale/purchase agreement and the treatment must be consistent between the buyer and seller.

Generally, assets are divided into the seven categories very briefly described below:

> Cash and Bank Deposits
> Actively Traded Personal Property & Certificates of Deposit
> Debt Instruments
> Stock in Trade (Inventory)
> Furniture, Fixtures, Vehicles, etc.
> Intangibles (Including Covenant Not to Compete)
> Goodwill of a Going Concern
 
A seller would prefer to designate the major portion of the sales price to goodwill and minimize any allocation to furnishings and equipment. Why, you ask? Because goodwill is a capital asset, which for federal purposes will be taxed at a maximum rate of 15%, while the furnishings and equipment can be taxed as high as 35%. On the other hand, the buyer would prefer to have as much as possible designated as furnishings and equipment, since they can be expensed or written off over a short period of time (usually 5 or 7 years) as opposed to a 15-year amortized write-off of the goodwill. 

Whether you are the buyer or the seller, don’t leave the asset allocations to chance. Negotiate the allocation as part of the sales agreement. If you don’t, you could easily end up with inconsistent treatment and potential adjustments by the IRS. 

If you are anticipating a sale, please contact your CPA to assist you in structuring the transaction to your best benefit.

Feel free to contact me if you have questions.

Steve Sink

Certified Business Intermediary

ss@phxaffiliates.com

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