Purchase Price Allocations: Tax and Contractual Aspects

• Pages: 317-360
• Date: 01 April 2025
• Published date: 01 April 2025
• Author: Jay A. Soled,Leonard Goodman,Alan Kornstein,Daniela C. Gallagher
• Subject Matter: Administrative & Public Law

Tax Lawyer, Vol. 78, No. 3 317

Purchase Price Allocations: Tax and

Contractual Aspects

JAY A. SOLED, LEONARD GOODMAN, ALAN KORNSTEIN, AND

DANIELA C. GALLAGHER*

Abstract

It is commonly understood among tax practitioners that, even though not

required by the Code, an agreement for the purchase and sale of business

assets ideally should allocate the purchase price to the different categories of

assets being conveyed or, alternatively, provide a methodology that achieves

the same objective. This practice has been driven by the well-settled principle

that a trade or business is comprised of multiple assets or categories of assets,

each of which gives rise to separate tax determinations, and not a single,

unified business as a whole. Notwithstanding this common practice,

contractual purchase price allocations are not binding on the Service, albeit

they generally are binding on the parties themselves—even if those allocations

do not comply with applicable provisions of the tax law.

To make matters more complicated, buyers and sellers do not always agree

on the substantive approach to the allocations or the corresponding

contractual provisions by which those allocations would be determined. To

the contrary, the parties frequently have adverse tax interests that make it

difficult to reach an accord, occasionally causing the parties to leave the

contract silent. Consider the fact, too, that contractual provisions originally

motivated by a desire to minimize the risk of a Service challenge could have

ancillary consequences beyond the scope of the Code, increasing the burden

on counsel to avoid any unanticipated legal traps.

Although practitioners commonly associate purchase price allocations with

Code section 1060, their implications are far broader. By way of example,

they are potentially relevant to “hybrid” deal structures in which the income

tax treatment of a taxpayer’s purchase or sale of an equity interest in a flow-

through entity—including partnership interests, membership interests in an

LLC treated as a disregarded entity, or S corporation stock subject to a sectio n

338(h)(10) election—will depend on the manner in which the deal

* Jay A. Soled is a Distinguished Professor of Taxation at Rutgers Business School; Leonard

Goodman was a Professor at Rutgers Business School who untimely passed away; and Alan

Kornstein is a partner and Daniela C. Gallagher is an associate at the law firm of McCarter &

English, LLP.

318 SECTION OF TAXATION

Tax Lawyer, Vol. 78, No. 3

consideration is allocable among the entity’s assets. Furthermore, whether or

not Code section 1060 applies to a particular purchase and sale transaction,

the Code contains a plethora of reporting requirements relating to the

foregoing transactions that reinforce the need to proceed cautiously.

In sum, this Article explores the broad tax and non-tax technical and

practical aspects of purchase price allocations. Its readers will grasp that, when

it comes to contractual negotiations and tax burden determinations, such

allocations are of critical importance.

Table of C ontents

I. Introduction ...................................................................................... 319

II. Overview of Asset Deals ................................................................... 320

A. Historical Background ........................................................... 322

B. Congressional Reform ............................................................ 323

III. Purchase Price Allocations Generally ............................................... 324

IV. General Rules of Section 1060 ........................................................ 327

A. Residual Method ................................................................... 330

B. Contractual Allocations Generally Binding on Taxpayer ........ 332

C. Contractual Allocations Not Binding on the Service .............. 334

D. Taxpayer Exception to Binding Effect Rule ........................... 335

E. Section 1060 Reporting Requirements ................................... 335

V. Drafting Considerations—At a High Level ....................................... 337

A. Post-Closing (or Post-Signing) Determinations...................... 338

B. Allocation Principles Set Forth in Contract ............................ 338

C. Opt-Out Approach ................................................................ 339

D. Term Sheet or Letter of Intent (LOI) .................................... 339

VI. Drafting Considerations—Getting into the Weeds ......................... 339

A. Location of Contractual Allocation Provisions ....................... 340

B. Coordination of Allocations with Other Provisions ................ 340

C. Defined Terms ...................................................................... 340

D. Procedures for Reaching Agreement ...................................... 341

E. How to Address Each Party’s Form 8594 ............................... 341

F. Installment Method Considerations ....................................... 341

G. Nonrecognition Transactions with Boot ................................ 342

VII. Implications of a Challenge by the Service ..................................... 342

PURCHASE PRICE ALLOCATIONS 319

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VIII. Ancillary Consequences of Purchase Price Allocations .................. 344

A. Breach of Covenant of Consistent Reporting ......................... 345

B. Impact on Right of First Refusal (ROFR) .............................. 346

C. Real Property Transfer Tax Implications ............................... 347

D. Real Property Assessment Considerations .............................. 348

E. Sales and Use Tax Implications .............................................. 350

F. Enforceability of Purchase Agreement .................................... 350

G. Damages for Loss of Goodwill ............................................... 351

H. Financial Statement Implications .......................................... 352

I. Indemnification Payments ...................................................... 352

J. Earn-Outs ................................................................................ 353

K. Cash Grants ........................................................................... 354

IX. Sales of Partnership Interests ........................................................... 354

A. Impact of Look-Through Rules on Selling Partner ................. 355

B. Impact of Section 754 Election on Purchasing Partner ........... 356

C. Section 1060 Reporting Requirements for Partnership

Transactions......................................................................... 357

D. Non-Section 1060 Reporting Requirements for Partnership

Transactions......................................................................... 357

X. Conclusion ....................................................................................... 358

I. Introduction

This Article provides an explanation of how purchase price allocations

affect the negotiation and drafting of agreements for asset acquisitions and

other deal structures in which the allocation of consideration among assets

may be relevant for federal and state income tax purposes and contractual

purposes as well.1 We have divided this Article into several parts, proceeding

from the basics to the more sophisticated. A complete overview of this Article

and its salient attributes are set forth below:

1 Over the years, there has been a plethora of academic and practitioner tax literature written

which discuss purchase price allocations. See, e.g., Robert A. Rizzi, Purchasing Assets in a

Depreciating Economy: Allocations and Anomalies, 36 J. CORP. TAX’N 22 (2009); Mark J. Silverman

& Andrew J. Weinstein, Purchase Price Allocation Rules: Sections 1060, 338, and 197, ALI-ABA

COURSE OF STUDY (SG024 ALI-ABA 3515 (2001)); Joseph P. Jaconetta, Purchase Price Allocations

to Covenants Not to Compete Under the Internal Revenue Code of 1986, 44 TAX LAW. 217 (1990);

Michael Schler, Sale of Assets After the Tax Reform: Section 1060, Section 338(h)(10), and More, 43

TAX L. REV. 605 (1988).