IRC §1060 — Allocation Rules for Asset Acquisitions

Where this comes from

When two parties buy and sell an ongoing business, the purchase price has to be divided among all the assets transferred. Without a standard rule, buyers and sellers could report inconsistent allocations that each favor their own tax position. Congress added Section 1060 to require both parties to use the same method and to report consistent numbers.

The section applies when a buyer and seller transfer a group of assets that together constitute a trade or business. The IRS calls this an applicable asset acquisition. Real estate sold along with operating leases, management contracts, customer relationships, and a going-concern value fits this description.

What it says

The residual method fills seven classes of assets in order. Class I is cash and cash equivalents. Class II is certificates of deposit and marketable securities. Class III is accounts receivable. Class IV is inventory. Class V is all other tangible property, which is where real property and personal property live. Class VI is certain customer lists, licenses, and other intangibles. Class VII is goodwill and going-concern value.

The purchase price fills class I first, then class II, and so on down the list. Whatever is left after all the tangible and identifiable assets are covered flows into goodwill at the bottom. The allocation to each tangible asset sets its depreciable basis for the buyer.

If the buyer and seller agree in the purchase agreement on specific values for specific assets, the IRS generally treats those agreed values as binding. The binding allocation rule applies regardless of what an appraisal or a study might suggest after the fact.

How it shows up in a study

A cost segregation study on a going-concern acquisition starts from the Class V allocation. The study cannot create basis that was not allocated to real and personal property in the first place. If the purchase agreement put most of the value into goodwill and intangibles, the study has a smaller pool to work with.

This is why the allocation decision is a planning step at closing, not an afterthought. A buyer who will do a cost segregation study should think about the Section 1060 allocation before signing the purchase agreement. Negotiating and documenting reasonable values for specific tangible assets protects the basis the study will later rely on.

The court case Peco Foods illustrates what happens when a binding contract allocation limits the buyer's depreciation basis below what the study would otherwise support. We cover that case separately in the authority library.

What it does not mean

Section 1060 does not apply to a straightforward real estate purchase where the only thing changing hands is the property and nothing more. Buying a commercial building with no associated business does not trigger this section. The rule is for transactions where a going concern, with customer relationships, operational systems, or goodwill, transfers along with the real estate.

It also does not set the allocation itself. The parties negotiate the values, subject to the residual method rule. The IRS can challenge an allocation it believes misrepresents fair market value, but the parties generally have flexibility to set reasonable values that reflect the facts of the transaction.