In an asset purchase structure, how do we negotiate the Section 1060 purchase price allocation between tangible equipment, non-competes, and Class VII goodwill to avoid turning our capital gains into ordinary income tax?

Question

Tyler Smith · Accepted Answer

In an asset purchase, the buyer and seller must agree on the purchase price allocation across asset classes under Internal Revenue Code Section 1060 and file matching IRS Form 8594 documents. A failure to negotiate this allocation during the letter of intent phase allows the buyer to dictate asset valuations that maximize their immediate depreciation deductions while creating an unexpected tax burden for you.

The primary battleground is Class VI and VII goodwill versus Class IV inventory, Class V depreciable equipment, and covenants not to compete. Buyers aggressively push purchase price into equipment to take advantage of bonus depreciation under Section 168(k). However, any purchase price allocated to fully depreciated machinery triggers Section 1245 depreciation recapture, taxing those proceeds at ordinary income tax rates up to thirty-seven percent rather than the preferential twenty percent federal capital gains rate. Similarly, allocations to non-compete agreements are treated as ordinary income.

To protect your net walkaway proceeds, negotiate a preliminary allocation schedule as an explicit binding exhibit to your letter of intent. Insist that tangible equipment be valued at orderly liquidation value or net book value rather than elevated replacement cost, backed by an independent third-party appraisal.

Channel the vast majority of enterprise premium into Class VII goodwill, which qualifies for long-term capital gains treatment for individual owners while still providing the buyer with fifteen-year tax amortization under Section 197. Establishing these allocation caps before granting exclusivity ensures you do not surrender hundreds of thousands of dollars in tax recapture when the definitive purchase agreement is finalized.