When you buy a business, you probably don’t want the former owners competing with you—at least not for a while. To prevent the competition, you will likely enter into a non-compete agreement with the former owners. The agreement has tax implications that you need to consider.
As the buyer, you or your business entity must amortize amounts allocated to non-compete agreements over 15 years, even though the term of the agreement may be much shorter (often three to five years or even less). Fifteen-year amortization is not terrible, but it’s not as fast as what is allowed for some other assets. This fact has the following tax planning implications.
When you buy a business by purchasing its assets, you probably prefer to allocate more of the purchase price to the value of assets that you can write off quickly, such as receivables and inventory, and to the value of assets with short depreciable lives, such as furniture and fixtures, computer gear, and software.
You likely prefer to allocate less of the price to assets that you must depreciate over long periods, such as commercial buildings (39 years). You cannot depreciate land costs at all.
You must amortize purchase price amounts allocated to most intangible assets—such as customer lists, franchise rights, trademarks, and goodwill—over 15 years. Ditto for amounts allocated to non-compete agreements.
In the documents for your purchase/sale transaction, be sure to specify the amounts that you allocated to non-compete payments. Otherwise, the IRS can always call into question your 15-year amortization deductions.
Note that both you and the seller must report the business purchase/sale transaction and its allocations to the IRS on Form 8594 (Asset Acquisition Statement Under Section 1060). To help avoid IRS scrutiny, you want both the buyer and the seller reporting the same dollar amounts to the IRS.