How to Determine and Allocate Aggregate Purchase Price

When a group of assets is purchased together, such as in a business acquisition, the total cost must be established. This total is known as the aggregate purchase price, representing the overall consideration transferred from the buyer to the seller. This figure is the first step in assigning a tax basis to each individual asset acquired.

The aggregate purchase price is not merely the cash exchanged; it is a comprehensive calculation of the total value given up by the buyer. This figure serves as the starting point for tax and accounting, directly influencing future calculations for depreciation and the gain or loss upon the eventual sale of any of the assets.

Determining the Components of the Purchase Price

The total purchase price begins with the actual cash transferred. Beyond cash, the fair market value (FMV) of any other property or assets the buyer transfers to the seller must be included. If the buyer gives the seller company stock, real estate, or equipment as part of the deal, the current market value of these assets is added to the total price.

Liabilities the buyer assumes from the seller also increase the purchase price. When a buyer takes on the seller’s outstanding business debts, such as accounts payable, bank loans, or accrued expenses, the value of these assumed liabilities is treated as an additional amount paid for the assets.

Certain costs incurred by the buyer to facilitate the acquisition are added to the total price. These acquisition costs can include legal fees for drafting the purchase agreement, accounting fees for due diligence, and other professional service fees directly related to the purchase.

Allocating the Purchase Price to Acquired Assets

Once the aggregate purchase price is determined, it must be allocated among the various assets acquired. This process is governed by Internal Revenue Code Section 1060, which mandates the “residual method.” This method assigns a specific cost basis to each asset based on its fair market value, which is used for future depreciation deductions and to calculate gain or loss when an asset is sold.

The residual method divides assets into seven classes, and the purchase price is allocated to them in sequential order. Class I is the first category, consisting of cash and general deposit accounts like checking and savings accounts.

The allocation then moves to Class II assets, which include actively traded personal property like publicly traded stocks and securities. Class III covers assets that are marked to market for tax purposes, certain debt instruments, and accounts receivable. The remaining purchase price is allocated to Class II and III assets up to their fair market value.

Class IV is composed of the business’s inventory or property held for sale to customers. After allocating to the prior classes, the remaining purchase price is assigned to inventory up to its FMV. Class V is a category for all assets not in other classes, which includes machinery, equipment, buildings, and land.

Next, the allocation proceeds to intangible assets. Class VI includes Section 197 intangibles, excluding goodwill and going concern value. Examples of these assets are covenants not to compete, customer lists, patents, and trademarks.

Any purchase price that remains after allocating to the first six classes is assigned to Class VII, which consists solely of goodwill and going concern value. This “residual” amount represents the premium paid over the fair market value of the identifiable tangible and intangible assets.

Filing and Reporting the Transaction

After the purchase price has been calculated and allocated, both the buyer and the seller must report the transaction to the IRS. This is done by filing Form 8594, Asset Acquisition Statement Under Section 1060, which ensures both parties report the allocation consistently.

Both the purchaser and the seller must file Form 8594. Each party attaches the form to their federal income tax return for the year in which the sale occurred.

The form requires the disclosure of the total aggregate purchase price and the final allocation of that price to each of the seven asset classes. It has specific lines for showing the fair market value of the assets transferred within each class.

If the amount of consideration is increased or decreased after the tax year of the sale, such as due to a contingency payment, both parties may need to file a supplemental Form 8594. This amended form is filed with the tax return for the year in which the adjustment was made.