How is the purchase price or monies paid for a business allocated? When a business owner sells their business for a lump sum amount, the sale is considered a sale of each individual business asset as opposed to one single asset. Of course, this would not necessarily apply if the exchange or transfer was considered a nontaxable exchange. The article below has been prepared by a Denver tax attorney at The McGuire Law Firm to provide additional information regarding the allocation of consideration that is paid for a business. Please remember to discuss your specific facts and circumstances with your tax attorney and/or business attorney. You can contact The McGuire Law Firm to speak with tax attorney in Denver.
As stated above, the sale of a business for a lump sum will be treated as the sale of each individual asset. The residual method must be used by both the buyer and the seller in allocating the consideration paid. The residual method will determine the gain or loss from the transfer of each asset, as well as how much of the consideration paid is allocated to goodwill and other intangible property. The buyer’s basis in the business assets purchased will also be determined through this method, and the buyer’s consideration is the cost of the assets that are acquired through the transaction. The seller’s consideration will be the amount realized from the sale of the assets. The amount realized would be the cash (money) received and the fair market value of any property received.
Thus, what is the residual method that will be used to determine the above issues? The residual method is the method used whenever a group of assets is transferred whereby the group of assets constitutes a trade or business, and the buyer’s basis is determined solely by the amount that was paid for the assets. The method applies to both direct and indirect asset transfers such as the sale of a business, or the sale of a partnership interest where the buyer’s basis of such interest is adjusted for amounts paid under Internal Revenue Code Section 743(b). 743(b) would apply if the partnership has made a Section 754 election. The residual method provides that consideration must first reduce (or be applied to) Class 1 assets. Thereafter, consideration is applied to Class II though VII assets. These classes of assets have been discussed in previous articles. Class I is cash and general deposit accounts and Class VII is goodwill and going concern. A group of assets will constitute a trade or business if going concern or goodwill could attach to them or, the use of the applicable assets would constitute an active trade or business under Internal Revenue Code Section 355. Thus, once a group of assets is determined to constitute a trade or business, the residual method can be viewed as a hierarchy of the application of the consideration paid for the purchase of a business into separate classes, such classes being Class I through Class VII.
If you have questions regarding how the sale of your business or the purchase of a business will be taxed, speak with a Denver tax attorney at The McGuire Law Firm. The purchase or sale of a business involves many tax related issues that should be discussed with a tax attorney or a business attorney. Schedule a free consultation with a tax attorney in Denver by calling 720-833-7705.