Purchase Price Allocation When Selling a Business with Real Estate
When a business and commercial real estate are sold together in a single transaction, the IRS requires both buyer and seller to agree on how the total purchase price is allocated across asset classes. This allocation is not a formality. It has direct, significant, and often opposing tax consequences for each party. Getting it right requires understanding what is at stake before you are at the closing table negotiating it under pressure.
How Allocation Works
The IRS uses a residual method for business purchase price allocation, defined in IRC Section 1060. Assets are divided into seven classes, from Class I (cash and cash equivalents) through Class VII (goodwill and going-concern value). Real property is typically allocated as Class V. Both buyer and seller must file IRS Form 8594 (Asset Acquisition Statement) reporting the agreed allocation. If the parties report different allocations, expect an audit. The agreement on allocation is typically documented in the purchase agreement itself.
Why Buyer and Seller Interests Conflict
Sellers generally prefer higher allocations to capital assets like real estate and equipment because those gains are typically taxed at long-term capital gains rates. Buyers generally prefer higher allocations to depreciable assets like equipment and shorter-life intangibles because they can write those off faster.
Goodwill allocation is where the conflict is sharpest. Sellers prefer goodwill because it generates long-term capital gain. Buyers dislike goodwill because it is a 15-year amortizable intangible with slow recovery and no accelerated depreciation. Real property sits in the middle: for sellers it generates capital gain with Section 1250 depreciation recapture at 25%; for buyers it recovers over 39 years for commercial property.
The Negotiation
Allocation is a negotiation, and leverage determines the outcome. A seller with multiple competing buyers has no reason to make concessions on allocation. A seller who has accepted a letter of intent and entered exclusivity has already given away negotiating leverage. The time to establish allocation principles is during LOI negotiation, not during due diligence or final purchase agreement drafting.
One practical approach: appraise the real estate independently before going to market. A certified appraisal establishes a defensible fair market value that provides a credible basis for the allocation discussion and removes subjectivity from the negotiation.
Tennessee-Specific Note
Tennessee imposes a deed transfer tax of $0.37 per $100 of consideration on real property transfers. When a business and real estate are sold together, the allocation to real property determines the basis for this transfer tax calculation. A higher allocation to real estate increases the transfer tax. This is a modest cost relative to purchase price but worth noting in total closing cost calculations.
Related Reading
- Selling a Business That Owns Its Building: Your Three Options
- Nashville Commercial Real Estate and Business Sales: What Owners Need to Know
- Icon Commercial: Commercial Real Estate Advisory for Business Owners
Work Through the Tax Implications Before You Go to Market
Allocation decisions made at the closing table under time pressure are rarely optimal for sellers. Icon works through purchase price allocation as part of pre-market preparation, so you know your tax position before the first offer arrives.
