When I acquired a business that included tangible and intangible assets, I quickly realized how important it is to understand the mechanics behind how the IRS treats asset acquisitions. Section 1060 of the Internal Revenue Code (IRC) sets the foundation for these transactions, especially in determining how the purchase price gets allocated among different classes of assets. In this article, I’m going to explore the topic from my perspective as someone actively involved in finance and investment, diving deep into the law, providing clear examples, breaking down formulas, and keeping everything digestible for readers.
What is Section 1060?
IRC Section 1060 governs the tax treatment of “applicable asset acquisitions,” or AAAs. These are transactions in which a group of assets constitutes a trade or business, and at least one party uses the transaction for income tax purposes. The section outlines how to allocate the total consideration among assets transferred when such a business is bought or sold.
The goal is to assign values to individual assets based on their fair market value (FMV), not their book value. This allocation impacts depreciation, amortization, and ultimately, taxable income.
When Does Section 1060 Apply?
I’ve learned that Section 1060 applies when:
- A group of assets is transferred,
- Those assets make up a trade or business,
- The buyer’s basis in the assets is determined wholly by the amount paid (not inherited or gifted), and
- At least one party considers the transaction a sale for tax purposes.
An example: I acquired a restaurant for $850,000. That included furniture, equipment, inventory, goodwill, and a customer list. Because this was a going concern, and not just a bundle of parts, Section 1060 came into play.
Classes of Assets and the Residual Method
The IRS defines seven asset classes to which the purchase price must be allocated. The residual method, outlined in Treasury Regulation 1.1060-1, allocates the purchase price in a stepwise fashion:
Asset Classes Table
| Class | Asset Type | Examples |
|---|---|---|
| I | Cash and cash equivalents | U.S. dollars, checking accounts |
| II | Marketable securities | Stocks, bonds traded on exchanges |
| III | Accounts receivable | Uncollected customer payments |
| IV | Inventory | Food ingredients, packaged goods |
| V | Tangible property | Buildings, machines, vehicles |
| VI | Section 197 intangibles | Licenses, customer lists, patents |
| VII | Goodwill and going concern | Brand reputation, assembled workforce |
You start from Class I and move through to Class VII. Any remaining value after assigning FMV to Classes I–VI is classified as goodwill (Class VII).
How the Allocation Works: A Real-World Example
Let’s say I bought a manufacturing business for $2,000,000. The assets and their FMVs were as follows:
| Asset | FMV |
|---|---|
| Cash | $100,000 |
| Accounts receivable | $300,000 |
| Inventory | $200,000 |
| Equipment | $500,000 |
| Patent | $400,000 |
| Customer list | $150,000 |
| Remaining amount | ? |
Step 1: Allocate to Classes I-VI
100000 + 300000 + 200000 + 500000 + 400000 + 150000 = 1650000Step 2: Allocate Remaining to Class VII (Goodwill)
2000000 - 1650000 = 350000So, $350,000 is allocated to goodwill. This becomes important for amortization.
Form 8594: Asset Acquisition Statement
As a buyer, I had to file Form 8594 with my federal income tax return. This form provides the IRS with the allocation I made under Section 1060. Both buyer and seller must file this form and ensure that the numbers match. Any mismatch can lead to audits or penalties.
Tax Implications for Buyers and Sellers
- For Buyers: The allocation determines depreciation schedules. Equipment (Class V) is usually depreciated over 5 or 7 years. Goodwill (Class VII) is amortized over 15 years.
- For Sellers: Each class may trigger different tax rates. For example, selling inventory might generate ordinary income, while selling goodwill may generate capital gains.
| Asset Class | Buyer Deduction Type | Seller Income Type |
|---|---|---|
| V (Equipment) | Depreciation | Ordinary or Capital gain |
| VI (Customer List) | Amortization | Capital gain |
| VII (Goodwill) | Amortization | Capital gain |
Strategic Planning for Section 1060
I found it valuable to negotiate asset allocations during the sale agreement phase. Allocating more to goodwill benefits the seller due to favorable capital gains rates. Conversely, buyers prefer more allocation to depreciable assets for immediate tax write-offs.
A balanced negotiation might look like this:
| Scenario | Seller Preference | Buyer Preference |
|---|---|---|
| Allocation to Equipment | Less favorable (ordinary income) | Favorable (depreciation) |
| Allocation to Goodwill | Favorable (capital gains) | Less favorable (15-year amortization) |
Mathematical Considerations
The total consideration C is allocated as follows:
C = \sum_{i=1}^{6} FMV_i + GWhere FMV_i is the fair market value of Class I through VI assets, and G is the goodwill.
Rewriting:
G = C - \sum_{i=1}^{6} FMV_iThe depreciation schedule D_t for tangible assets can be calculated using the Modified Accelerated Cost Recovery System (MACRS). For a 7-year asset:
D_t = B \times r_tWhere B is the basis, and r_t is the IRS recovery rate for year t.
Legal and Compliance Aspects
The IRS scrutinizes mismatched Form 8594 filings. I had to ensure that I and the seller agreed on the FMV of each class. This usually meant engaging a certified appraiser. Also, under Section 6662, significant penalties can apply for valuation misstatements.
Conclusion
Section 1060 is more than a reporting requirement. It shapes the tax future of both buyer and seller. I’ve used it to plan acquisitions intelligently, lowering my tax burden and ensuring compliance. Every asset acquisition demands that we look beyond the headline price and into how that price splits across the business’s components. That’s where the value—and the tax implications—lie.
Anyone purchasing a business should consider this early. Get valuations, negotiate intelligently, and document everything. Understanding Section 1060 is not optional. It’s essential.
