Once you and your buyer agree on a purchase price and sign a letter of intent, most sellers assume the financial negotiation is over. It’s not. The conversation about how that purchase price gets allocated across different asset categories — known as Purchase Price Allocation, or PPA — is one that will significantly impact both your tax bill and your buyer’s tax position. Understanding it before you close can be worth tens of thousands of dollars.
What Is Purchase Price Allocation?
In an asset purchase (how most preschool sales are structured), the total purchase price must be divided across different categories of assets. The IRS requires this allocation to be reported using Form 8594, and both buyer and seller must use the same figures.
The main asset categories in a typical preschool APA allocation:
- FF&E (Furniture, Fixtures, Equipment): Tables, chairs, playground equipment, commercial kitchen items, computers
- Inventory: Supplies, curriculum materials of value
- Section 197 Intangibles: Non-compete agreements, customer lists, licenses
- Goodwill and Going Concern Value: The reputation, brand, relationships, and operational value of the business as a whole
Why Buyers and Sellers Have Opposite Tax Interests
Buyers prefer allocation to depreciable assets (equipment, non-compete). Equipment can be depreciated over 5–7 years and Section 197 intangibles (including non-competes and customer lists) amortize over 15 years. Higher allocation to these categories means faster tax deductions for the buyer.
Sellers prefer allocation to goodwill. Goodwill is taxed as a long-term capital gain — typically 0%, 15%, or 20% depending on your income bracket. By contrast, amounts allocated to equipment you’ve already depreciated get “recaptured” and taxed as ordinary income (22–37%). On $100,000 in allocation, the tax difference between goodwill treatment and depreciation recapture can easily be $15,000–$20,000.
A Concrete Example
A preschool selling for $650,000. Buyer’s preferred allocation: $80,000 to FF&E, $50,000 to non-compete, $20,000 to supplies, $500,000 to goodwill. Seller’s preferred allocation: $30,000 to FF&E, $10,000 to non-compete, $10,000 to supplies, $600,000 to goodwill. Total: same. But the difference in FF&E allocation ($80,000 vs. $30,000) can change the seller’s tax bill by $15,000–$25,000 — even though the sale price is identical.
How the Negotiation Works
PPA is negotiated as part of the overall deal, typically after the purchase price is agreed upon. Your attorney and CPA work with the buyer’s representatives to reach an allocation both parties can accept and report consistently to the IRS. Key points:
- You and the buyer must report the same allocation. Different reports trigger IRS scrutiny for both parties.
- The allocation must be reasonable — you can’t allocate $600,000 to goodwill if there are clearly $120,000 in tangible assets.
- Having an FF&E inventory with documented current values gives you a stronger negotiating position.
How to Prepare for the PPA Conversation
- Work with a CPA who specializes in business sales — this is deal-specific tax analysis that requires expertise beyond standard tax preparation.
- Know your depreciation schedule before negotiations. Understand which assets have been fully depreciated (subject to ordinary income recapture) and which haven’t.
- Think about total after-tax proceeds, not just price. Sometimes a slightly lower price with a more favorable PPA results in more money in your pocket than a higher price with unfavorable allocation.
What This Means for You
Most sellers don’t think about PPA until they’re at the closing table. By then, the allocation is being negotiated from a position of limited knowledge — often under time pressure. Understanding PPA before negotiations begin means you can advocate for the allocation that serves your tax situation best. This is one area where the right CPA at the right time can pay for themselves many times over.
