Form 8594 Asset Classes: All Seven and the Residual Method

The asset classes on Form 8594 are seven ordered buckets — Class I through Class VII — that the buyer and seller of a business use to split the total purchase price. The classes run from the most liquid (cash) to the residual (goodwill), and the IRS requires you to fund them in that exact sequence using the residual method. Where each dollar lands controls how fast the buyer recovers basis and whether the seller’s gain is ordinary or capital.

Class I: Cash and Deposit Accounts

Class I is cash, checking accounts, savings accounts, and anything else convertible to cash at face value. Certificates of deposit are specifically excluded. Allocation here is mechanical: Class I assets get their face amount, no appraisal involved.¹

Class II: Actively Traded Personal Property

Class II covers assets you can price off a market: U.S. government securities, publicly traded stock, certificates of deposit, and foreign currency. The common thread is a readily determinable fair market value from trading on an established market.¹ The amount allocated to any Class II asset can’t exceed its fair market value on the sale date.

Class III: Debt Instruments and Mark-to-Market Assets

Class III holds accounts receivable, notes receivable, and any asset the taxpayer marks to market at least annually for tax purposes. Receivables live here, not with inventory — a common point of confusion. Certain related-party debt instruments and contingent debt instruments are excluded.¹ For the buyer, the basis assigned to receivables determines the ordinary income recognized as those receivables are collected.

Class IV: Inventory and Property Held for Sale

Class IV is stock in trade, inventory, and any property the seller holds primarily for sale to customers in the ordinary course of business.¹ Gain on these assets is ordinary income to the seller. For the buyer, the allocated basis becomes cost of goods sold when the inventory sells through.

Class V: All Other Tangible and Non-197 Intangible Assets

Class V is the catch-all. It sweeps in everything not covered by the other six classes: furniture, fixtures, buildings, land, vehicles, equipment, and intangibles that fall outside Section 197. That last piece surprises people. Separately acquired patents, certain computer software, and copyrights that sit outside the Section 197 definition land in Class V rather than Class VI.²

Class V is usually the largest bucket in a business sale and the main source of depreciation for the buyer. Land is the one wrinkle: it lives in Class V but can’t be depreciated, so its basis sits until the buyer eventually sells it.

Class VI: Section 197 Intangibles (Excluding Goodwill)

Class VI captures all Section 197 intangibles except goodwill and going concern value. Covenants not to compete, customer lists, trade names, and similar business intangibles acquired in the deal belong here.¹ The buyer amortizes these ratably over 15 years, starting in the month of acquisition, regardless of the asset’s actual useful life.³

Class VII: Goodwill and Going Concern Value

Class VII exists only for goodwill and going concern value, and it works differently from the others. You don’t independently appraise goodwill for allocation purposes. It receives whatever purchase price is left after Classes I through VI have been fully funded — a plug figure, the residual.¹ Like Class VI, the buyer amortizes this amount over 15 years starting in the month of acquisition.³

How the Residual Method Sequences the Allocation

You don’t spread the purchase price however you want. The residual method forces a strict order: allocate to Class I first, then Class II, then Class III, and so on through Class VII.² If an asset could reasonably fit in more than one class, it goes in the lower-numbered one.

The key constraint: the amount allocated to any asset in Classes I through VI cannot exceed that asset’s fair market value on the sale date.¹ Each class gets funded in turn up to its collective fair market value cap. Only after Classes I through VI are fully funded does the remainder flow into Class VII as goodwill. If the total purchase price is less than the combined fair market value of the assets in Classes I through VI, nothing reaches Class VII, and within each class the available price is split proportionally by each asset’s fair market value.

The sequential approach with a fair market value ceiling on each class is the guardrail. It prevents both parties from stuffing value into whichever class produces the best tax result for their side.

Why Buyer and Seller Fight Over the Split

The buyer and seller want opposite things across the classes, and this is where most negotiation happens.

The buyer generally wants more of the price in assets that can be depreciated or amortized quickly. Class V equipment might qualify for bonus depreciation or accelerated cost recovery. Dollars pushed into Classes VI and VII still produce deductions, but they’re locked into a 15-year amortization schedule. Anything sitting in Class I cash or Class II securities produces no deduction at all.

The seller wants the opposite. Gain on Class IV inventory is ordinary income. Gain on Class V depreciable assets can trigger depreciation recapture, also at ordinary rates. Gain allocated to Class VII goodwill is typically long-term capital gain, taxed at a lower rate. So the seller pushes value toward goodwill while the buyer pulls it forward into faster-depreciating classes.

This built-in conflict is why the IRS requires both parties to file matching allocations. Without that constraint, the buyer would file one version, the seller another, and the government would collect less tax from both.

The Written Allocation Binds Both Sides

Under Section 1060, if the buyer and seller agree in writing on how to allocate the purchase price, or on the fair market value of specific assets, that agreement binds both sides for tax purposes.⁴ The only escape valve is an IRS determination that the allocation is inappropriate, which in practice means it doesn’t reflect fair market value.

That makes the allocation clause in the purchase agreement one of the most consequential provisions in the deal. Once signed, neither party can take a different position on their return without inviting scrutiny. Negotiate the allocation with tax counsel before closing, not after.

When Form 8594 Is Required

You file Form 8594 whenever someone transfers a group of assets that make up a trade or business and the buyer’s basis in those assets is determined by the amount paid. The IRS reads this broadly: if goodwill or going concern value attaches, or even could attach, to the transferred assets, the form is required.¹ Both the buyer and the seller file their own copy with their income tax return for the year the sale closed, and the numbers must match across all seven classes.

Some situations trip people up. Buying a partnership interest is normally not an asset acquisition and doesn’t trigger Form 8594. But if the purchase is treated for tax purposes as a purchase of the partnership’s underlying assets, the buyer must file. A stock purchase doesn’t ordinarily trigger the form either, but a Section 338(h)(10) election converts the stock sale into a deemed asset sale that does. There’s one clean exception: if the entire group of assets qualifies for like-kind exchange treatment under Section 1031, no Form 8594 is needed. If only part qualifies, you still file for the non-qualifying portion.¹

Post-Closing Price Adjustments

Earnouts, holdbacks, and other post-closing adjustments change the total purchase price after the initial filing year. When that happens, the affected party files a new Form 8594 (Parts I and III) with the return for the year the adjustment is taken into account, and must reference the tax year and form number of the original filing.²

Increases and decreases hit the classes from opposite ends:

An increase in consideration is allocated starting with Class I and moving sequentially through the classes, the same order as the original allocation. No asset can be pushed above its fair market value on the original purchase date.
A decrease comes off Class VII first, then Class VI, then Class V, working backward down the hierarchy. Within each class, the decrease is spread proportionally by fair market value. An asset’s basis can’t go below zero, and any excess must be accounted for under general tax principles for cost recovery reversals.

A new supplemental Form 8594 is required for every year in which an increase or decrease occurs, not just the first adjustment year.² Form 8594 is treated as an information return, so failure to file, late filing, or incorrect information can draw penalties under the standard information return regime.⁵

1
Internal Revenue Service. Instructions for Form 8594
2
Internal Revenue Service. Instructions for Form 8594 (Rev. November 2021)
3
Office of the Law Revision Counsel. 26 USC 197 – Amortization of Goodwill and Certain Other Intangibles
4
Office of the Law Revision Counsel. 26 USC 1060 – Special Allocation Rules for Certain Asset Acquisitions
5
Office of the Law Revision Counsel. 26 USC 6721 – Failure to File Correct Information Returns