How is the purchase price allocated in an asset sale?

You and the buyer decide it by negotiation, and it is written into a schedule attached to the asset purchase agreement. Neither side can set it alone. The buyer wants value placed where it can be written off fastest. You want value placed where it is taxed least. The schedule is where those two goals meet.

The mechanics follow a set order. Cash is carved out first. Receivables, inventory, and equipment are then assigned fair market value. Real estate, if it is part of the sale, gets its own value. Whatever price is left over after the tangible assets and identified intangibles goes to goodwill. That residual method is why goodwill is usually the largest line in a service business and the line both sides argue about least openly.

Both parties then report the allocation to the IRS on a form filed with their tax returns for the year of the sale. The agreement should obligate each side to file consistently with the schedule. If your return and the buyer's return tell different stories, the mismatch can draw an inquiry to both of you. Your CPA files your side, so the schedule has to be final before closing, not reconstructed in the spring.

Take a business with $1,000,000 in revenue and $250,000 in SDE. The truck, tools, and inventory are valued at what they would fetch in the market. The earnings power the buyer is paying for sits in goodwill. For how that line is taxed, read how goodwill is taxed when you sell, and ask your CPA to run the schedule before you sign the LOI.

Each asset class is taxed differently, so the same total price can leave you with different after-tax proceeds depending on the split. Goodwill generally receives capital gain treatment. Inventory and receivables generally produce ordinary income. Equipment you have depreciated can trigger recapture, which is taxed as ordinary income up to the depreciation you claimed. The mechanics are in depreciation recapture in a business sale.

The buyer's incentives run the other way. Value placed on equipment can be recovered through depreciation faster than value placed on goodwill, which is written off over a long fixed schedule. A buyer's CPA will push for a heavier equipment allocation. That push costs you if the equipment is already depreciated below its market value, because the gap between market value and your tax basis is recapture income.

The non-compete is a separate line. Money allocated to a covenant not to compete is generally ordinary income to you, so a buyer who proposes a large non-compete allocation is shifting price from a lower-taxed bucket into a higher-taxed one. Terms that hold up are covered in non-compete agreements in a business sale.

Your CPA will model the after-tax result for each proposed split and tell you the dollar cost of every point you concede. Ask for that model before the buyer sends a first draft of the schedule.

Put the allocation principles in the LOI and attach the full schedule to the purchase agreement, because your leverage is highest before exclusivity begins. After you sign an LOI and stop talking to other buyers, a buyer who raises the allocation late faces little pressure to compromise.

1. Get an equipment value from an outside source. A third-party appraisal of fixed assets gives you a number to defend that is not your opinion against the buyer's.
2. Fix the non-compete number in writing. State the amount, or state that it is a nominal portion of the price, so it does not appear as a surprise in the final schedule.
3. Decide how adjustments flow. Working capital true-ups and earnout payments change the total price after closing. The agreement should say which line absorbs them, and goodwill is the usual landing place for added price. See working capital pegs and the earnouts guide.
4. Check it against the lender's view. If the buyer is using an SBA loan and the price is above $350,000, the lender must order an independent valuation of the business. A schedule that sharply contradicts that valuation invites questions in underwriting, which can delay closing.

The same logic applies to the choice of deal structure itself. If you are still weighing it, read asset sale vs stock sale for a seller. Then take the draft schedule to your CPA and your attorney, who will confirm the tax treatment of each line against the current code for your entity type and state.