AAsset sales typically dominate the small business acquisition space due to the key benefits they provide to buyers. First, buyers take a higher basis in the assets purchased, which is beneficial to the buyer due to their ability to depreciate certain assets and lower taxable income. Additionally, in asset sales, buyers can pick and choose what assets to purchase. This provides a liability shield for the buyer as the buyer only takes on the identified assets and does not assume the liabilities of the seller, unless it chooses to. One often overlooked process in an asset acquisition is the purchase price allocation. Purchase price allocation is the process of assigning the consideration paid by the buyer of a business to the assets sold in the transaction. In certain business acquisitions, Section 1060 of the Internal Revenue Code requires both buyers and sellers to report a purchase price allocation on Form 8594 and attach it to their income tax returns for the year in which the acquisition occurred. Most tax advisors agree that the allocations submitted by the buyer and seller should match, as inconsistent allocations can increase the risk of an IRS challenge or audit and impose its own allocation. To ensure the buyer and seller submit matching purchase price allocations, many purchase agreements contain language requiring agreement on the purchase price allocation. The Internal Revenue Code and associated regulations outline the rules for making a purchase price allocation, known as the residual method. Under the residual method, the purchase price is allocated among seven classes of assets in a specific sequence, starting with Class I assets and ending with Class VII assets: Class I includes cash and general deposit accounts. Class II includes actively traded personal property, CDs, and foreign currency. Class III includes accounts receivables. Class IV includes inventory. Class V includes real estate and other fixed assets. Class VI includes all IRC Section 197 intangibles, such as non-compete covenants, except goodwill and going concern value. Class VII includes goodwill and going concern value. Under the residual method, the purchase price is first allocated to Class I assets, then if any purchase price is remaining, to Class II assets and so on, with any residual amount allocated to Class VII assets. If an asset could qualify for multiple asset classes, it should be allocated to the lower numbered class. To be compliant with these allocation rules, buyers and sellers must allocate PURCHASE PRICE ALLOCATION BY HANNAH FISCHER FREY, PARTNER, AND DANE HANSEN, SUMMER ASSOCIATE, BAIRD HOLM LLP 18 Nebraska CPA
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