What is Allocation of Purchase Price?
The Short Answer
Allocation of Purchase Price explained simply
When you buy a business, you pay a single price. But for tax and accounting, that price needs to be broken down. This is called the "Allocation of Purchase Price." You assign parts of the total price to specific assets like equipment, inventory, and real estate. You also assign parts to liabilities. Any leftover amount is usually assigned to "goodwill," which is the value of the business beyond its tangible assets. This allocation is crucial for both the buyer and seller because it impacts their tax obligations.
Real-World Example
The Coffee Shop Acquisition
Imagine you buy a coffee shop for $200,000. The assets include:
- Equipment: $50,000
- Inventory: $10,000
- Leasehold Improvements: $20,000
- Customer List: $15,000
Total identifiable assets are $95,000. The remaining $105,000 ($200,000 - $95,000) is allocated to goodwill. This allocation determines how much the buyer can depreciate over time and how the seller reports their gain or loss.
Why this matters
This matters because it directly affects your taxes. As a buyer, proper allocation allows you to depreciate assets, which reduces your taxable income. As a seller, it impacts how your gain from the sale is taxed. Getting this right can save you a lot of money and prevent issues with the IRS.
Always have a tax professional review your purchase price allocation. It’s a complex area with significant tax implications for both sides of the deal.
Always have a tax professional review your purchase price allocation. It’s a complex area with significant tax implications for both sides of the deal.
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