When a company purchases another company`s assets, it is crucial to properly allocate the purchase price in the Asset Purchase Agreement (APA). The allocation of purchase price determines how much the buyer will pay for each asset, which affects the tax consequences for both the buyer and seller. In this article, we will discuss the importance of allocating the purchase price and the factors that influence the allocation.

What is the Allocation of Purchase Price?

The allocation of purchase price is the process of assigning a value to each asset being sold in an APA. The total purchase price is divided among the various assets, such as tangible assets like equipment and inventory or intangible assets like patents, trademarks, and goodwill.

Why is Allocation of Purchase Price Important?

The allocation of purchase price is important because it affects the tax implications for both the buyer and seller. The IRS requires both parties to report the sale price on their tax returns, but they also require a detailed breakdown of how that price was allocated among the assets.

The seller will want to allocate as much of the purchase price as possible to assets with a low tax basis. This reduces the amount of gain taxed as ordinary income. On the other hand, the buyer will want to allocate as much of the purchase price as possible to assets with a high tax basis because this increases their depreciation deductions.

Factors that Influence the Allocation

Several factors influence the allocation of purchase price, including the type of assets being sold, the parties` negotiations, and the IRS regulations. Let`s take a closer look at each factor.

Type of Assets Being Sold

The type of assets being sold is a critical factor in the allocation process. For example, tangible assets like real estate and machinery have a definite value, while intangible assets like brand reputation and customer relationships are more challenging to value. Each asset`s value should be determined based on its fair market value at the time of sale.

Negotiations

The allocation of the purchase price is a negotiation between the buyer and seller. Suppose the seller is more concerned with minimizing taxes. In that case, they will want to allocate more of the purchase price to assets with lower tax basis, while the buyer will want to allocate more to assets with higher depreciation schedules.

IRS Regulations

The IRS has strict regulations concerning the allocation of purchase price. The allocation must be based on the fair market value of the assets, and it must be reasonable. The IRS takes a dim view of allocations that are not based on fair market value or are not reasonable.

Conclusion

The allocation of purchase price is an essential aspect of any Asset Purchase Agreement. It has a significant impact on the tax implications for both the buyer and seller. As a result, it is essential to ensure that the allocation is based on the fair market value of the assets being sold and is reasonable. When drafting an APA, it is essential to work with an experienced attorney who understands the intricacies of purchase price allocation and its tax implications.