Understanding Price Allocation Can Earn You More $$ On A Business Sale

Matteo Valles

by Matteo Valles · Updated Mar. 4, 2021

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When a business is sold, the IRS requires the buyer and seller to agree on how that money is allocated among the business’s assets.

For example, a recently closed deal sold for $770,000 and the price allocation was:

  • Equipment - $25,000

  • Inventory - $10,000

  • Goodwill - $735,000

This article will explain how those numbers are decided and their potential tax implications.

Let’s dive in.

There are 2 kinds of business sales: Stock sales & Asset sales.

Stock Sales

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A stock sale occurs when the business owner sells their shares in the company to the buyer.

The legal entity of the business and all its assets remain the same, just the shares of the business exchange hands. The larger a business is, the more likely this method of sale is to occur.

There are several pros and cons to this type of sale, which will be discussed in a future post, but in terms of price allocation, this method is the most advantageous for the seller.

In a stock sale, the IRS treats your proceeds as capital gains, just like it would when you sell a share of Apple (assuming you have owned the shares for over 1 year).

This makes price allocation a non-existent issue and gives the seller the best possible tax treatment.

Price allocation is only a factor in asset sales.

Asset Sales

Asset Sale.png

Asset Sales are the most common method of selling a small business.

This occurs when the buyer creates their own legal entity. That legal entity then pays the seller’s legal entity for all its assets (equipment, inventory, etc).

Under this situation, the IRS requires the buyer and seller to report how the total price is broken down between the assets. This breakdown is detailed in the final purchase agreement.

The various assets will almost always include equipment, inventory & goodwill, but it may also include a non-compete, accounts receivable, customer lists, patents, and more.

Let’s look at how this price breakdown is often decided.

Items like inventory and accounts receivable are straightforward. Inventory is usually sold at cost or a slight discount and accounts receivable are sold at face value minus any bad debt expectations.

Equipment value can either be negotiated between the buyer and seller or the equipment can be professionally appraised if the parties cannot come to an agreement.

Finally, all other items like non-competes, patents, etc. do not have a standard approach and can be negotiated throughout the sales process.

What is more important though is the tax implications of each category.

Tax Implications


As the seller, you usually want the maximum amount allocated to goodwill.

Why goodwill?

Goodwill is taxed solely at the capital gains rate, making it the most attractive category for you.

Other items like inventory, non-competes, and customer lists are usually taxed at the ordinary income rate.

Equipment falls in the middle, however. You will pay ordinary income on all depreciation recapture, but capital gains thereafter.

This tax treatment is important to remember during a sale because a buyer will want the exact opposite.

A buyer wants a higher value assigned to inventory because they can quickly write it off as a COGS expense when sold.

They also want larger value given to items equipment and non-competes because they can depreciate those over time.

During a business sale, work with your CPA to determine the tax implications of certain price allocations. Your specific situation and cost basis can have a large impact on your net proceeds.

Just remember, goodwill is usually what you are trying to maximize.


Author: Matteo Valles

East Tennessee | M&A Advisor/Business Broker

(865) 236-0588

Still have questions? Email me at


I’m happy to help anytime.

Thank you to Icon Scout for several of the illustrations: 1