Form 8594 allocation

[Joe dentist]

I recently retired and sold my dental practice. At the closing the broker allocated the Purchase Price as follows:

Equipment, Furniture/Fixtures, Supplies, Personal Goodwill, Non-Compete/Non-Solicitation Covenants, Accounts Receivables, Consulting Agreement

For each item, I need to determine both whether it is ordinary income (<1 year) or long term capital gain. I also need to decide which "Asset Class" they fall under.

My best guesses are: 

Equipment, Furniture/Fixtures = Income, Class V

Supplies = Income, Class V

Personal goodwill = LTCG, Class VII

Non-compete/Non-Solicitation Covenants = Income, Class VI

Accounts Receivables = Income, Class III

Consulting Agreement = LTCG, Class VII

Can anyone verify this or tell me what is correct? I have looked at the instructions every day for more than a week, called the broker, asked a CPA, and tried to contact the IRS, but cannot get a clear, consistent answer.

[M-MTax]

You may not get a clear answer but there's one thing for sure and that's that your 8594 and the buyer's 8594 must match exactly. So, you need to make sure you're on the same page there in the first place. Most business sales stipulate in the sales and purchase agreements how much of the purchase price is allocated to each asset, inventory, and to goodwill.

[Joe dentist]

Hi Martin,

   Yes, thank you for your answer. I spoke with the buyer yesterday and he told me the name of his CPA. I will go to his CPA as well for advice - that way it will match. The sales contract does list the amounts, I just am not sure about whether the items should be ordinary income or LTCG and I am not sure about the Asset Class. I have seen conflicting things in articles on the web as well.

Thank you again,

Joe

[Rick19744]

Some thoughts on your question:

• This is not a difficult area, and a CPA that couldn't help you is one you should avoid anyhow.  Unless they just told you that this was not a strong point of their practice.
• Keep in mind, that discussing this with the buyer's CPA is like using the same attorney in a divorce.  They can really only represent one person.  Buyer's and seller's have conflicting goals in these situations.
• Your purchase agreement should have spelled out exactly how the purchase price was to be allocated and by each class listed in the form 8594.  The agreement should have mirrored what will be reported on the form 8594.
• Once you have the purchase price allocated to the correct class, you then determine your gain or loss by subtracting your basis in the items in that respective class.  This will drive your ordinary or capital gain.
• Question 5 on the form 8594 specifically asks if there is a written and signed allocation
• Question 6 on the form 8594 specifically asks about the covenant not to compete and the consulting agreement.  Once again, requires specifics.
• You need to be careful on the allocated amount of personal goodwill.  Technically, this should have been a separate agreement.  This is a hot button for the IRS.
• You will have ordinary income in the areas of depreciation recapture, supplies (depending on how you accounted for them), and your consulting agreement at a minimum.  So these are the areas that the buyer wants to allocate more as these items will be depreciable over shorter lives for the fixed assets.
• The other item not discussed is whether you received the full purchase price; other than maybe the consulting component.  This can be critical as if you have an installment sale, all depreciation recapture is recognized in the year of sale.  This catches some sellers off guard as their initial proceeds may not cover the tax due on the depreciation recapture.
• If you get a comfortable feeling from the buyer's CPA, I might recommend that you just have him prepare your tax return.
• Your class breakdown looks reasonable, other that I don't believe any personal goodwill should be a part of the business purchase.  As "personal" is being used, this should be a separate agreement with a separately determined amount.

[Joe dentist]

Hi Rick,

  Thank you for your thoughts. There were dollar amounts allocated to each area in the contract. I just didn't want to put them because it is kind of personal information. Also, the amounts do not affect whether the area is ordinary income or LTCG, and they don't affect the section. 

   Supplies is whatever you have on hand. There were supplies that had been sitting around for years. I have no idea how any one on earth could put a single date acquired for all the supplies in a dental office, or determine a cost basis for that matter. Likewise, for the rest - how on earth is a person to determine an acquisition date for furniture purchased over the past 35 years or a cost basis? This is true for all the non-tangibles as well. How can any one determine an acquisition date or cost basis for: goodwill, accounts receivable, non-compete, or consulting?

   I will just hand it over to the CPA.

Thank you,

Joe 

[Rick19744]

Follow-up:

• I understand not wanting to provide actual $$.
• You will have to provide input to the CPA as to how you accounted for the supplies; example if you just expensed them, then obviously there is no basis in that item so all will be gain - ordinary.
• Most businesses maintain a fixed asset detail of items as purchased which would include the cost, depreciation taken, etc.  Once again, if all furniture has been fully depreciated, then you will have gain to the extent of prior depreciation.  It is doubtful that you are now receiving an amount that exceeds original purchase price for these items.  As a result, all will be gain - all ordinary depreciation recapture.
• The goodwill will automatically be LTCG based on how long you have been in business
• The non-compete will / should have been specified in the purchase contract; ie: a certain period of time
• Same for the consulting - ordinary as received.
• The above is just to give you a heads up that the CPA will ask you for details related to the items discussed above.
• Enjoy retirement

[Joe dentist]

Thank you! I appreciate the time you put into this. I did keep records of equipment and furniture for City Property Tax - but like you said, it all is fully depreciated. The non-compete period is 10 years, I don't know if this changes it from Ordinary Income to LTCG. I thought the consulting would be LTCG like Goodwill but, I gather, it should be ordinary income. I will contact the CPA in the morning.

Thank you again!

Joe