Tax
Selling a Small Business: How Form 8594 Splits the Price
Buying or selling a small business? See how the price splits across the seven asset classes on Form 8594, who each split favors, and what must back it.
By 409.AI Team - 2026-10-10
# Selling a Small Business: How Form 8594 Splits the Price
If you are buying or selling a small business as an asset deal, the purchase price is not one number to the IRS. It is a stack of smaller numbers, one for each kind of asset, and both sides report the same stack on Form 8594. For an owner, a CPA, a broker or a lender, that split can move the tax bill by tens of thousands of dollars.
This article walks through how the split works, with one worked example, and where a valuation fits.
Why the split exists
Say a buyer pays $900,000 for the assets of a small HVAC company. The buyer gets trucks, tools, receivables, a parts inventory, a customer base and the owner's promise not to compete. The tax law treats each of those differently.
For the seller, some of the price becomes ordinary income and some becomes long-term capital gain. The IRS says gains on assets held more than a year are long-term, taxed at 0%, 15% or 20% depending on taxable income, while short-term gains are taxed as ordinary income ([IRS Topic 409](https://www.irs.gov/taxtopics/tc409)). For the buyer, each dollar of price is recovered through a different schedule: inventory when it is sold, equipment through depreciation, goodwill through amortization.
So the buyer and the seller have opposite interests in the same table. Congress anticipated that, and wrote a rule for it.
The rule: section 1060 and the residual method
IRC section 1060 covers the sale of a group of assets that makes up a trade or business. If the buyer and seller agree in writing on how to allocate the price, that agreement binds both of them, unless the Treasury decides the allocation is not appropriate ([26 U.S.C. 1060](https://www.law.cornell.edu/uscode/text/26/1060)).
The allocation follows the residual method. Assets are sorted into seven classes, and the price is poured into them in order. Each class takes up to its fair market value, and what is left flows to the next. The classes are defined in the Treasury regulations ([26 CFR 1.338-6](https://www.law.cornell.edu/cfr/text/26/1.338-6)) and repeated in the [Form 8594 instructions](https://www.irs.gov/instructions/i8594):
| Class | What it holds | |---|---| | I | Cash and bank accounts | | II | Actively traded personal property, certificates of deposit, foreign currency | | III | Accounts receivable and other debt instruments, assets marked to market | | IV | Inventory | | V | Everything not in another class: equipment, vehicles, furniture, land, buildings | | VI | Section 197 intangibles other than goodwill: customer lists, trademarks, workforce in place, covenants not to compete | | VII | Goodwill and going concern value |
Two features matter most. First, the amount placed on any asset in Classes II through VI cannot exceed that asset's fair market value. Second, Class VII is the leftover. Whatever the price is after the other classes are filled goes to goodwill.
That second point is why the real work is not in goodwill at all. It is in the values you put on everything above it.
A worked example
This is an illustration, not a real deal. The seller is an HVAC company owner who sells the assets, with the seller keeping its cash. The buyer pays $900,000.
| Class | Asset | Allocated value | |---|---|---| | III | Accounts receivable | $120,000 | | IV | Parts inventory | $80,000 | | V | Trucks and equipment | $250,000 | | VI | Covenant not to compete | $40,000 | | VII | Goodwill (the residual) | $410,000 | | | Total | $900,000 |
Goodwill is $900,000 minus the $490,000 placed on Classes III to VI. Nobody negotiated it directly.
What the seller sees
Assume the trucks and equipment cost $300,000 and have been depreciated down to a tax basis of $60,000. Selling them at $250,000 produces $190,000 of gain. Section 1245 treats gain on depreciable property as ordinary income up to the depreciation already taken, which here is $240,000, so the full $190,000 is ordinary ([26 U.S.C. 1245](https://www.law.cornell.edu/uscode/text/26/1245)).
The $410,000 of goodwill is the part that can produce long-term capital gain if the seller held the business for more than a year. The 0%, 15% and 20% brackets in Topic 409 apply to that portion.
Now suppose an appraisal showed the equipment was really worth $300,000. The table would shift $50,000 from goodwill to equipment, and the seller's ordinary income would rise by $50,000 in this example, because the equipment gain is ordinary and the goodwill gain is not. The seller's CPA decides how each line is treated on the seller's own facts. The point is that the table has consequences.
What the buyer sees
The buyer wants the opposite. Section 197 says goodwill, going concern value, workforce in place, customer-based intangibles and covenants not to compete are all amortized ratably over 15 years, beginning in the month acquired ([26 U.S.C. 197](https://www.law.cornell.edu/uscode/text/26/197)).
Here the goodwill and the noncompete together are $450,000. Over 15 years that is $30,000 a year of deduction. The $250,000 of equipment is recovered on its own depreciation schedule, and the inventory and receivables come back as the buyer sells and collects. A dollar placed on equipment is generally a dollar the buyer deducts sooner than a dollar placed on goodwill.
So the seller leans toward goodwill and the buyer leans toward equipment and inventory. The written allocation is where they settle it.
Form 8594: who files, when, and what happens after
Both the seller and the buyer of a group of assets that makes up a trade or business file Form 8594. The form is attached to the income tax return for the year the sale took place ([Form 8594 instructions](https://www.irs.gov/instructions/i8594)).
Three practical points:
- **The two forms should match.** The IRS gets one from each side. If the buyer reports $250,000 on equipment and the seller reports $200,000, someone will be asked why.
- **Later changes get a new form.** The instructions say that when the consideration goes up or down in a later year, the party files a new Form 8594 for each year in which the change occurs. An earnout paid in year three is the usual case.
- **Penalties are real.** Failing to file a correct form on time, without reasonable cause, can trigger penalties under sections 6721 through 6724.
A stock sale is a different animal. The seven-class allocation governs a purchase of assets that make up a business. If the buyer is acquiring the shares of a company, your CPA should tell you whether any allocation form applies.
Where a valuation fits
Notice what the table needs. A fair market value for the receivables, the inventory, the equipment and each intangible. The IRS can challenge an allocation that is not appropriate, and the Class II to VI cap means a number with nothing behind it is a weak number.
Three places this shows up in small deals:
1. Equipment. An appraisal or a documented market comparison supports the Class V figure. A sale at $250,000 backed only by "that seems right" is hard to defend. 2. The noncompete. Buyers often want a large value on the covenant because they get to amortize it. The covenant must be worth what is assigned to it, and it must be a real restriction on a person who could compete. 3. The price itself. The total comes from the earnings of the business after normalizing the owner's pay and add-backs, which is a different exercise covered in [how owner pay is normalized in a small business valuation](https://www.409.ai/articles/owner-compensation-add-backs-small-business-valuation-sde-ebitda). An SBA lender may also require an appraisal on a change of ownership, as [the current SOP 50 10 8.1 change](https://www.409.ai/articles/sba-sop-50-10-8-1-business-valuation-change-of-ownership) explains.
If the business is an S corporation or another pass-through, [tax-affecting](https://www.409.ai/articles/tax-affecting-pass-through-entity-s-corp-valuation) can change the total before you ever reach the table. And if the sale is triggered by a partner's exit, the formula in a [buy-sell agreement](https://www.409.ai/articles/buy-sell-agreement-valuation-connelly-life-insurance) may already fix the price while the allocation is still open.
One more distinction avoids confusion. This allocation is a tax exercise. A company that records the purchase in its financial statements follows a separate set of rules, covered in [our guide to ASC 805 purchase price allocation](https://www.409.ai/articles/asc-805-purchase-price-allocation-startup-acquisition). The two can produce different numbers for the same deal, and neither replaces the other.
An independent [fair market value report](https://www.409.ai/products/smb-valuation) for the business and its main assets gives both sides a document to point to when the allocation is written down. It does not decide the tax result. That stays with the buyer's and seller's advisors.
What to do before the purchase agreement is signed
Put the allocation in the agreement as a schedule, not as a promise to agree later. Section 1060 gives a written agreement its binding force, and a blank schedule leaves each side to file its own number.
Then check the schedule against the seven classes. Is every number in Classes III to VI supportable? Does the residual in Class VII look like what the buyer is really paying for? Do the buyer's and seller's advisors agree on the same table, down to the dollar?
If they do, both Form 8594s will say the same thing. That is the whole goal.