The allocation schedule sets your future deductions.

The allocation schedule turns one purchase price into seven buckets, and each bucket carries its own recovery period. Section 1060 forces the residual method: fair market value fills Classes I through VI in order, and whatever is left falls into goodwill and going concern value, recovered straight line over fifteen years. Both sides report it on Form 8594.

What does the Section 1060 allocation schedule actually do?

Section 1060 governs an applicable asset acquisition, meaning a transfer of assets constituting a trade or business where the buyer’s basis is determined wholly by reference to the consideration paid. The statute requires the residual method. The allocation schedule fixes your tax basis in each asset, and that basis is what later becomes depreciation and amortization.

The price on the first page of the agreement is not a tax number. The seller sits in the same document with opposite economics: what shortens your recovery period lengthens the seller’s tax bill.

If you agree the allocation in writing, that agreement binds both of you unless the IRS determines it is not appropriate. It does not stop the IRS attacking your numbers, and it does stop you: walking away from your own signed allocation takes something close to fraud, duress or mutual mistake.

Law: 26 U.S.C. 1060(a); 26 C.F.R. 1.1060-1.

How are the seven asset classes allocated, and in what order?

The seven classes are filled in sequence. Consideration goes to Class I, then II, III, IV, V and VI, in each case capped at the fair market value of the assets in that class and spread within the class in proportion to value. Whatever remains lands in Class VII, a residual rather than a negotiated figure.

Most of the price in an operating company is Class V, VI and VII. The fair market value ceiling on Classes I through VI is a legal limit, not a negotiating convenience. Overstate the equipment and the excess does not stay there. It belongs in the residual, and the return that says otherwise is wrong.

Peco Foods agreed, in its purchase agreements, to allocations naming the acquired assets item by item, then commissioned a cost segregation study and tried to reallocate to shorter-lived property. The Tax Court held it to what it had signed and the Eleventh Circuit affirmed. What bound Peco was the specificity of its own schedule; a class-level schedule leaves room an asset-by-asset schedule does not. You choose at signing.

Law: 26 C.F.R. 1.338-6(b), (c), applied by 26 C.F.R. 1.1060-1(c)(2); 26 U.S.C. 168(c); Peco Foods, Inc. v. Commissioner, T.C. Memo. 2012-18, aff’d, No. 12-12169, 522 F. App’x 840 (11th Cir. July 2, 2013).

What is a dollar moved from goodwill to equipment actually worth?

Moving consideration from Class VII to Class V does not create a deduction. It accelerates one. A dollar in goodwill is deducted at roughly 6.7 cents a year for fifteen years under Section 197, while a dollar in qualifying equipment can be deducted in year one. Same deduction, different timing.

Run $100,000 moved from goodwill to machinery at a 32 percent marginal rate, discounting at 8 percent, each saving valued at year end:

• As goodwill: $6,667 of amortization a year, worth about $2,133 in tax, for fifteen years. Present value roughly $18,300.
• As equipment expensed in year one: $100,000 of deduction, worth $32,000 in tax. Present value on the same convention, roughly $29,600.
• As five-year MACRS property with no first-year expensing: present value roughly $26,000.

That is about 11 cents per dollar shifted in the expensing case and about 7.7 cents in the MACRS case. Change the assumptions and the figures move; the ranking does not. On $400,000 of equipment value that is real money, bounded by what the assets are worth.

First-year expensing on used equipment is not automatic: bonus depreciation reaches used property only if you never used it and did not buy it from a related party, and Section 179 is capped and cannot exceed your active trade or business income.

I build the schedule from the fixed asset register and the physical inventory count before I look at the price, so the residual is an output rather than a target.

A deduction shelters taxable income, and in a year with no taxable income it shelters nothing. Expensing in year one, while the business absorbs transition costs and your compensation, can produce a loss you cannot use yet: noncorporate taxpayers face the excess business loss limitation, and through an S corporation your losses are capped by your basis, which guaranteeing the company’s bank loan does not give you.

Law: 26 U.S.C. 197(a); 168(k)(2)(E)(ii); 179(b), (d); 461(l); 26 C.F.R. 1.1366-2(a)(2)(ii). Bonus depreciation and Section 179 limits were changed by 2025 legislation and eligibility is asset-specific. Stated as of September 2026; confirm current figures with your accountant.

The allocation does not create deductions. It decides when you get them, and whether you have the income to use them.

Does allocating to a covenant not to compete still help the buyer?

A covenant not to compete entered into in connection with the acquisition of an interest in a trade or business, or a substantial portion of one, is a Section 197 intangible amortized straight line over fifteen years. It sits in Class VI and recovers on the same schedule as goodwill in Class VII.

The old timing advantage of a short covenant is gone. The Tax Court applied the fifteen-year rule to a one-year covenant given on the buyout of a twenty-three percent interest, and the First Circuit affirmed; the Ninth Circuit reached the same result on a company’s redemption of its own stock. Section 197 sets the recovery period, not the term, and the clock runs from the month of acquisition.

When a seller resists allocating money to the covenant, the argument is about the seller’s income character, not your deductions: covenant payments are generally ordinary income to the seller, who prices that in. Take the covenant to stop the seller reopening across the street, not for a faster write-off.

Law: 26 U.S.C. 197(a), (d); Recovery Group, Inc. v. Commissioner, T.C. Memo. 2010-76, aff’d, 652 F.3d 122 (1st Cir. 2011); Frontier Chevrolet Co. v. Commissioner, 329 F.3d 1131 (9th Cir. 2003).

Why does the seller fight your Class V number?

Section 1245 recaptures the seller’s prior depreciation as ordinary income, to the extent of gain. A seller whose equipment is fully depreciated pays ordinary rates on every dollar you allocate to Class V, while goodwill is usually capital gain. That gap, not obstinacy, is what sits behind the seller’s resistance to your Class V number.

Usually is not always: a seller who bought this business and has been amortizing Section 197 goodwill faces ordinary recapture on that amortization too. Ask which position the seller is in, and price it in early.

Law: 26 U.S.C. 1245(a); 197(f)(7).

A seller who will not move on Class V is usually not being difficult. That seller is reading an old depreciation schedule and doing the same arithmetic you are.

What belongs in the allocation clause of the asset purchase agreement?

An allocation clause that works has five moving parts: a schedule with a delivery deadline, a consistent reporting covenant, an objection window, a deadlock mechanism with a named neutral, and a hook that pulls later price changes back through the schedule. Miss one and the tax position becomes a dispute.

• The schedule itself. Attached at signing, or delivered a stated number of days after closing. Name it: “Schedule 2.7 (Allocation)” exists, “as agreed between the parties” does not.
• Consistent reporting. Both parties covenant to file all returns, including Form 8594, consistently with the final schedule. A schedule both sides negotiate and neither files is worse than none.
• Objection window. A fixed number of days, running from delivery of the schedule, to object in writing with reasons. Silence counts as acceptance only if the clause says so.
• Deadlock. An independent accountant, named now, deciding only the disputed line items within a stated number of days, final absent manifest error. At this size that is a local or regional firm both sides accept, not the national-firm neutral mid-market agreements assume. Say who pays.
• The adjustment hook. Any post-closing change in consideration, including seller note adjustments, indemnity payments and a true-up if you have one, runs through the schedule, with supplemental statements filed as required.

I ask for the seller’s depreciation schedule before I argue about Class V, because that document tells me what the fight costs the other side.

How do later price changes and indemnity payments affect the allocation?

A change in total consideration runs back through the residual method. Where an increase or decrease is taken into account after the close of the first taxable year that includes the sale date, the regulations require the buyer and the seller each to file a supplemental asset acquisition statement on Form 8594.

A working capital true-up is one way that happens, and it is not the norm at this size: most owner-operator deals leave the receivables with the seller and price the inventory at closing. If your deal has one, the change runs through the same class order and the same fair market value ceilings, tested at the acquisition date. More receivables or inventory actually delivered lands in Class III and Class IV; if only the price moved, the Class VII residual absorbs it.

The agreement should also treat indemnity payments as purchase price adjustments for tax purposes to the extent permitted by law. No statute makes that treatment automatic and your agreement does not bind the IRS; it buys one agreed reporting position instead of two.

Law: 26 C.F.R. 1.1060-1(e); allocation of the change under 26 C.F.R. 1.338-7, applied by 26 C.F.R. 1.1060-1(c)(2).

Where does the SBA fit, and as of when?

SBA rules do not set your tax allocation, but SBA underwriting produces a document that sits next to it. Stated as of September 2026: SOP 50 10 8 governs 7(a) lending, and SOP 50 10 8.1 applies to applications issued an SBA loan number on or after October 1, 2026. Confirm the version your lender is applying.

The version in force when your loan number issues governs your file. Under the version effective October 1, 2026, a change of ownership calls for an independent business valuation from a qualified source, ordered by and prepared for the lender. Under the earlier version a lender could use its own internal valuation where the financed business value, net of real estate and equipment, was $250,000 or less. Neither position is permanent, and nothing in the SOP guarantees an outcome.

That appraisal is prepared for the lender’s credit decision, not for your return, and it does not bind the IRS. It is still a third-party view of what you bought, so reconcile it to your schedule while you can still talk to the seller.

Authority: SBA SOP 50 10 8, effective June 1, 2025; SOP 50 10 8.1, issued August 14, 2026 by SBA Notice 5000-880695, effective for applications receiving an SBA loan number on or after October 1, 2026. Stated as of September 2026; confirm the current SOP with your lender.

What should you do first?

Build a first-pass allocation before the asset purchase agreement is drafted, not after it is signed. The inputs are ordinary diligence documents you should already be requesting from the seller. Do it in this order, and take the result to your accountant before the lawyers paper the clause.

• Request the fixed asset register with acquisition dates and book values, the depreciation schedule from the last filed return and the aged receivables listing, and fix the method and date for the inventory count.
• Value the equipment at what it is worth today, not at book value and not at the number that helps you. If a machine matters, get support.
• Add the classes up, subtract from consideration, and look at the residual. That is your Class VII goodwill. It cannot go below zero; if your arithmetic says it is negative, your Class V values are too high or the price is below what the hard assets are worth.
• Then instruct on the clause: attached schedule, reporting covenant, objection window, named neutral with the cost allocated, and the adjustment hook.

Fight for Class V where the assets support it. Accept Class VII for what it is, the residual the statute assigns you. The mechanism is the part you still control after closing.