How Purchase Price Allocation Works in Real Estate

A purchase price allocation in commercial real estate splits the total price you pay for a property into separate asset buckets — land, building, land improvements, personal property, and intangibles — so each piece gets its own tax treatment. The split controls how fast you can depreciate what you bought, and because land never depreciates while some components can be written off immediately, the numbers you assign to each category directly change what you owe the IRS for years afterward. Buyer and seller must report the same allocation, and that shared filing is where most of the pressure comes from.

When You Actually Have to Do One

The formal allocation requirement comes from Internal Revenue Code Section 1060 and applies when a transaction qualifies as an “applicable asset acquisition.” Two conditions have to be true at once: the assets transferred make up a trade or business, and the buyer’s basis in those assets is determined entirely by the amount paid.¹

Most commercial deals meet that test. If the building comes with tenants, leases, and operating systems, the IRS applies a broad standard: if goodwill or going concern value could attach to what changes hands, the transfer counts as a trade or business.²

Buying vacant land or an empty building with no tenants, no leases, and no operating history usually falls outside Section 1060. You still need to split the price between land and improvements for depreciation, but the seven-class residual method and Form 8594 filing described below do not apply.

The Asset Buckets and How Fast Each One Depreciates

The reason to break the price apart is that recovery periods differ dramatically. A dollar in the wrong bucket can take four decades to deduct instead of one year.

Land

Land does not depreciate. The IRS treats it as having an indefinite useful life, so whatever you allocate here stays on your books until you sell. Every dollar assigned to land is a dollar you will not deduct.

Building and Structural Components

The structure itself — roof, walls, foundation, plumbing, electrical, standard HVAC — is real property. Nonresidential real property depreciates straight-line over 39 years. Residential rental property runs 27.5 years.³ This is the slowest depreciating bucket, which is why so much effort goes into pulling components out of it.

Land Improvements

Parking lots, sidewalks, fencing, landscaping, drainage, and exterior lighting sit in their own category and depreciate over 15 years under MACRS.³ That is well under half the building’s recovery period.

Personal Property

Items not permanently attached to the building — specialized equipment, removable furniture, certain fixtures, decorative finishes — carry recovery periods of five or seven years. This is the most tax-efficient bucket. It qualifies for accelerated depreciation, and often for immediate expensing under Section 179 or bonus depreciation.

Intangibles and Goodwill

Favorable leases, customer relationships, workforce in place, and non-compete agreements are Section 197 intangibles. They amortize ratably over 15 years from the month of acquisition.⁴ In real estate, below-market leases assumed by the buyer are often the biggest intangible on the schedule. Goodwill and going concern value — the premium above the combined fair market value of everything else identifiable — also amortize over 15 years.⁵

Why Buyer and Seller Push Opposite Directions

The allocation is a negotiation because the two sides want opposite outcomes.

The buyer wants weight on the short-lived assets. Shifting a dollar from a 39-year building bucket to a five-year personal-property bucket produces deductions roughly eight times faster. The buyer’s ideal allocation also minimizes land, since land is the one bucket that produces nothing.

The seller wants weight on the building and land, because depreciation recapture on sale is harsher for the short-lived stuff. Gain on personal property (Section 1245 property) is recaptured as ordinary income up to the total depreciation the seller previously took, which can be taxed at the seller’s full marginal rate.⁶ Gain attributable to building depreciation (Section 1250 property) gets better treatment: unrecaptured Section 1250 gain is capped at 25%, and remaining gain qualifies for long-term capital gains rates.⁷

That opposing pressure is exactly why the IRS wants a written agreement and a prescribed method.

The Seven-Class Residual Method

Section 1060 requires you to allocate the consideration across seven ordered classes, filling each up to the fair market value of the assets in that class before moving to the next. Anything left at the end lands in the final class as goodwill.¹

Classes I through IV cover cash, actively traded securities and CDs, debt instruments and receivables, and inventory. In a real estate deal these are usually small or zero. The real work happens in Class V, which holds all other tangible assets: land, building, land improvements, personal property, furniture, fixtures, vehicles, and equipment. Class VI holds Section 197 intangibles other than goodwill, and Class VII holds goodwill and going concern value.²

Splitting Class V is where the deductions are won or lost. You need to divide the amount that lands there among land, building, land improvements, and personal property based on their relative fair market values. Getting that split defensible is why the outside valuation work matters.

Writing the Allocation Into the Deal

Section 1060 says that when the buyer and seller agree in writing on the allocation of any consideration, or on the fair market value of any asset, the agreement binds both parties for tax purposes unless the IRS determines it is inappropriate.¹ The allocation is typically an exhibit to the purchase and sale agreement, or handled through a side letter before closing.

A written agreement does two things. It stops the other side from filing a conflicting allocation, which would flag both returns. And it gives you a defensible position if the IRS ever questions the numbers, especially when the allocation is backed by a professional appraisal.

If the parties cannot agree, each files their own version, and the mismatch should be expected to draw scrutiny. The IRS will fall back to fair market value: what a willing buyer and willing seller would agree to with no pressure on either side.

Backing the Numbers With Appraisal and Cost Segregation

You cannot credibly split a purchase price without professional valuation. Two engagements do the work.

A commercial appraisal from a licensed appraiser establishes the fair market value of land versus improvements. County assessor ratios are sometimes used as a shortcut and are unreliable — assessors use mass-appraisal techniques that ignore the specific characteristics of your property. A qualified appraisal is far more defensible and typically costs a few thousand dollars for straightforward properties.

A cost segregation study is a detailed engineering analysis that reclassifies building components into shorter-lived categories, identifying what qualifies as five-year, seven-year, or 15-year property rather than sitting in the default 39-year bucket. The IRS Cost Segregation Audit Techniques Guide sets the standard for a quality study, and the guide specifically notes that studies by construction engineers are more reliable than those prepared by people without an engineering background.⁸ The best time to run one is right after acquisition, when the property is placed in service, but the IRS also allows look-back studies that capture missed depreciation from prior years through a change in accounting method.

The Immediate Deductions a Good Allocation Unlocks

The payoff of a careful allocation is that certain buckets qualify for accelerated write-offs that would otherwise be trickled out over decades.

Bonus Depreciation

Bonus depreciation under Section 168(k) allows a large first-year deduction on top of normal MACRS. The One Big Beautiful Bill Act, signed into law in 2025, permanently restored 100% bonus depreciation for qualifying property acquired and placed in service after January 19, 2025. For 2026, eligible personal property, land improvements, and qualified improvement property can be fully deducted in year one. The phase-down schedule that had been reducing the percentage by 20 points a year is eliminated.

The effect on a real estate allocation is significant. On a $10 million acquisition where a cost segregation study reclassifies $2 million out of the building bucket into bonus-eligible categories, that $2 million becomes a first-year deduction instead of a 39-year drip.

Section 179 Expensing

Section 179 lets you expense qualifying property in the year it is placed in service. For 2025 the maximum deduction is $2,500,000, phasing out when total qualifying property placed in service exceeds $4,000,000.⁹ The limits adjust for inflation, so 2026 figures are expected to be slightly higher. Section 179 covers tangible personal property and certain qualifying real property improvements.

One limit to keep in mind: Section 179 deductions cannot exceed your taxable income from active trades or businesses for the year, with any excess carrying forward. Bonus depreciation has no such income cap, which is why it does most of the heavy lifting on large acquisitions.

Reporting on Form 8594

Both buyer and seller file IRS Form 8594, Asset Acquisition Statement Under Section 1060, when the transaction involves assets making up a trade or business and goodwill or going concern value could attach.¹⁰

The form attaches to your income tax return for the year the sale closed — Form 1040 for individuals, Form 1065 for partnerships, Form 1120 or 1120-S for corporations.² If the total consideration changes later because of an earnout, contingent payment, or purchase price adjustment, a supplemental Form 8594 is filed for the year the change is taken into account.¹⁰

Part I asks for identifying information — the other party’s name, address, and taxpayer ID, plus the sale date and total consideration. Part II reports the allocation across the seven asset classes, showing fair market value and allocated amount for each.

The IRS cross-references the two filings. When the buyer’s and seller’s numbers do not match, both returns get flagged. This is the most common trigger for an allocation audit, and executing a written agreement at or before closing avoids it entirely.

Form 8594 is an information return. Failing to file, or filing with incorrect information, carries a penalty of $250 per return, capped at $3,000,000 per calendar year across all information returns.¹¹ The bigger risk is not the dollar amount. A missing or inconsistent 8594 is one of the clearest signals to the IRS that the entire allocation deserves a closer look.

1
Office of the Law Revision Counsel. 26 U.S. Code 1060 – Special Allocation Rules for Certain Asset Acquisitions
2
Internal Revenue Service. Instructions for Form 8594 – Asset Acquisition Statement Under Section 1060
3
Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System
4
Office of the Law Revision Counsel. 26 U.S. Code 197 – Amortization of Goodwill and Certain Other Intangibles
5
Internal Revenue Service. Intangibles
6
Office of the Law Revision Counsel. 26 U.S. Code 1245 – Gain From Dispositions of Certain Depreciable Property
7
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
8
Internal Revenue Service. Cost Segregation Audit Technique Guide (Publication 5653)
9
Internal Revenue Service. Publication 946 – How To Depreciate Property
10
Internal Revenue Service. Instructions for Form 8594
11
eCFR. 26 CFR 301.6721-1 – Failure to File Correct Information Returns