Selling Your Freelance Business (2026): Asset Allocation, Form 8594 & Why Goodwill Is Your Best-Taxed Dollar

Published: August 4, 2026 · Reading time: 13 min

TL;DR: A sole proprietorship has no entity to sell, so the sale is an asset sale — each asset taxed on its own terms. §1060 allocates the price across seven classes using the residual method, both sides file Form 8594, and a written allocation is binding on both parties under §1060(a). Where the money lands decides the rate: goodwill is long-term capital gain outside self-employment tax; equipment is §1245 ordinary recapture; a covenant not to compete is ordinary income; and a consulting agreement is ordinary income plus 15.3% self-employment tax — a $16,000 line item that costs $1,989 more as consulting than as a covenant. In the worked example below, two allocations of the same $100,000 price differ by $2,250 in tax. And §453(i) denies installment treatment to the recapture, so seller financing can leave you taxed on money you have not received.

Most freelancers who sell a business sell it once. The buyer's accountant has usually done it before, which is why the allocation schedule that arrives with the purchase agreement tends to favour the buyer — and why a seller who signs it without pricing it out is making the most expensive uninformed decision of the transaction.

This guide is about selling a going concern. If you are simply shutting down, see the Schedule C final return; if you are disposing of a single asset without selling the business, retiring and abandoning business assets covers that.

There is nothing to sell but the assets

A sole proprietorship is not a separate legal or tax entity. Neither is a single-member LLC, which the IRS disregards. So when you "sell the business", what actually transfers is a bundle: the van, the camera bodies, the finished inventory, the client list, the domain, the name, and the intangible willingness of customers to keep coming.

Federal tax treats that bundle as what it is — a sale of each asset, each with its own basis, holding period, and character. The purchase price has to be allocated across them, and that allocation is what determines your tax rate.

The rule is IRC §1060, which applies to an "applicable asset acquisition": a transfer of assets constituting a trade or business where the buyer's basis is determined by the consideration paid. Essentially every freelance business sale qualifies.

The seven classes

§1060 uses the residual method. Consideration is allocated to each class in order, up to fair market value, and whatever is left over drops into the final class.

Goodwill is the residual by construction. It absorbs whatever the identified assets do not — which is precisely why buyers push to identify more, and value it higher.

The rate is set by the class

This is the part worth internalising before you look at a schedule:

Two of those deserve a second look.

Equipment is where the ordinary income hides. If you expensed a $46,000 vehicle and equipment package with Section 179 or bonus depreciation, your adjusted basis is near zero — so almost every dollar allocated to Class V comes back as ordinary income, not capital gain. That is not a penalty; it is the mirror image of the deduction you already took. The mechanics are in depreciation recapture for freelancers.

Self-employment tax mostly stays away. §1402(a)(3) excludes from net earnings from self-employment any gain or loss from the sale of a capital asset, and from the disposition of property that is neither inventory nor held primarily for sale to customers. Equipment and goodwill both fall outside self-employment tax on that basis — the equipment gain is ordinary but not self-employment income. Inventory is expressly outside the exclusion, so a bulk inventory sale can carry self-employment tax.

The worked example: same price, $2,250 apart

Marcus is selling his freelance photography business for $100,000. His equipment package originally cost $46,000, he has taken $39,500 of depreciation, and his adjusted basis is $6,500. Inventory transfers at its $4,000 cost, so it produces no gain. His goodwill is entirely self-created, so its basis is zero. Assume a 24% ordinary rate and 15% long-term capital gain rate.

Allocation A — the schedule the buyer proposed

• Equipment gain: $40,000 − $6,500 = $33,500, entirely §1245 ordinary (it is below the $39,500 of depreciation taken)
• Ordinary income: $33,500 + $16,000 = $49,500 → tax $11,880
• Capital gain: $40,000 → tax $6,000
• Total tax: $17,880

Allocation B — the schedule Marcus negotiated

• Equipment gain: $26,000 − $6,500 = $19,500, all §1245 ordinary
• Ordinary income: $19,500 + $5,000 = $24,500 → tax $5,880
• Capital gain: $65,000 → tax $9,750
• Total tax: $15,630

Same $100,000. A $2,250 difference, entirely in a schedule attached to the contract.

Why the buyer wanted Allocation A

Because the buyer's deduction timing is the mirror image of the seller's rate:

Under §197, the buyer amortises both goodwill and the covenant ratably over 15 years from the month of acquisition — while Class V equipment can often be expensed in year one. So every dollar the buyer moves from Class VII to Class V is a dollar deducted now instead of over fifteen years, and every one of those dollars costs the seller the spread between ordinary and capital rates. The tension is structural, and it is the whole negotiation.

The written allocation binds you

§1060(a) is unambiguous: where the transferee and transferor agree in writing on the allocation of consideration or on the fair market value of any asset, that agreement "shall be binding on both the transferee and transferor unless the Secretary determines that such allocation (or fair market value) is not appropriate."

Three consequences:

1. The allocation schedule in the purchase agreement is a tax return in advance. Negotiate it with the same care as the price.
2. You cannot improve it at filing time. A seller who signs Allocation A and files Allocation B is filing inconsistently with a binding agreement.
3. The IRS can still challenge an allocation that does not reflect economic reality. Agreement between the parties does not license an obviously artificial schedule — $95,000 of goodwill on a business whose only real asset is a $60,000 truck will not hold.

Both parties then file Form 8594, each attached to their own return for the year the sale date falls in. If consideration later changes — an earnout settles, a holdback releases, a price adjustment is agreed — each party files a supplemental Form 8594 for the year of the change, with the reason for the reallocation.

The covenant-versus-consulting trap

Buyers frequently want the seller to stay for a transition period. How that is papered is worth real money.

A covenant not to compete is a Class VI intangible: ordinary income to you, and — as above — a §197 write-off for the buyer whose period is fixed at fifteen years no matter what term the covenant itself states. A three-year non-compete is still a fifteen-year deduction for them, which is exactly why they may prefer to call it something else.

A consulting or transition services agreement is payment for work. That makes it ordinary income and self-employment income, and it lands on your Schedule C rather than in the sale computation at all.

On the same $16,000:

$1,989 more for the identical cash, purely from the label. If you genuinely will perform services, the consulting agreement is the honest characterisation and you should price it accordingly. If you will not, do not let the paperwork say you will.

Seller financing and the §453(i) surprise

Spreading the gain with an installment sale on Form 6252 is a natural instinct — until you read §453(i), which says that "any recapture income shall be recognized in the year of the disposition, and any gain in excess of the recapture income shall be taken into account under the installment method." Recapture income is the §1245 or §1250 ordinary amount, computed as if all payments were received in the year of sale.

Applied to Allocation B: Marcus's $19,500 of equipment recapture is taxed in full in year one, whatever the payment schedule says. Only the goodwill gain spreads.

If the deal is $20,000 down with the balance over four years, run the year-one tax against the year-one cash before you sign. Sellers who skip this discover in April that they owe tax on money arriving in 2029.

What else the sale year brings

• A final Schedule C. Report the year's operating income and expenses as normal; the asset dispositions go on Form 4797, not on Schedule C. See closing a business.
• Net investment income tax. Gain from disposing of property held in an active trade or business in which you materially participate is generally excluded from net investment income, so the 3.8% NIIT usually does not reach a working freelancer's business sale. It is worth confirming rather than assuming, because the rules are less forgiving for passive owners.
• A large, lumpy estimated tax problem. A sale can multiply your annual income. The safe harbour based on last year's tax is the simplest protection against an underpayment penalty; without it, you need a payment in the quarter the sale closes.
• State tax and bulk sale rules. Several states require notification of a bulk transfer of business assets, and some impose sales tax on the transfer of tangible equipment. Check before closing, not after.
• QBI in the sale year. Operating profit through the sale date is still qualified business income; the gain on the sale generally is not. See the QBI deduction.

Common mistakes

• Signing the buyer's allocation without pricing it. It is binding, and it is where the buyer's accountant has already optimised.
• Assuming the whole sale is capital gain. Equipment recapture is ordinary, and it is usually the largest ordinary piece.
• Letting a covenant be re-labelled a consulting agreement. That relabelling adds self-employment tax.
• Filing an installment sale and expecting the recapture to spread. §453(i) says it does not.
• Skipping Form 8594. Both parties file. A missing form on one side highlights the transaction on both.
• Forgetting the supplemental filing after an earnout. A later change in consideration requires a new Form 8594.
• Not knowing your equipment's basis. You cannot compute recapture — or negotiate an allocation — without the original cost and accumulated depreciation for every asset. If those records are incomplete, fix them long before you have a buyer; anything bought secondhand from an individual is the hardest case, and proving basis on private-party equipment is where to start.

Frequently Asked Questions

How is the sale of a sole proprietorship taxed?

Not as a single transaction. There is no entity to sell, so the sale of a sole proprietorship is treated as a sale of each individual asset, and every asset carries its own tax character. Equipment you depreciated produces ordinary income to the extent of the depreciation you took, under the section 1245 recapture rules. Inventory produces ordinary income. A covenant not to compete produces ordinary income. Self-created goodwill produces long-term capital gain, taxed at capital rates. That is why the allocation of the purchase price across the assets matters more than the price itself in many deals — the same headline number can produce materially different tax depending on where it lands.

What is Form 8594 and who has to file it?

Form 8594, the Asset Acquisition Statement, reports how the purchase price of a business was allocated across the seven asset classes under the section 1060 residual method. Both the purchaser and the seller must file it, each attaching a copy to their own income tax return for the year the sale date falls in. If the consideration later increases or decreases — an earnout settles, a holdback is released, a price adjustment is agreed — each party files a supplemental Form 8594 for the year the change occurs, explaining the reallocation.

Can the buyer and seller allocate the price differently?

Not if they agreed in writing. Section 1060(a) provides that where the transferee and transferor agree in writing on the allocation of consideration or the fair market value of any asset, that agreement is binding on both of them unless the IRS determines the allocation is not appropriate. In practice this means the allocation schedule in the purchase agreement is a tax document, not a formality, and the time to negotiate it is before signing rather than at filing. Two parties who file inconsistent Forms 8594 have handed the IRS a matched pair of returns that disagree, which is an efficient way to invite examination of both.

Do I pay self-employment tax when I sell my freelance business?

On most of it, no. Section 1402(a)(3) excludes from net earnings from self-employment any gain or loss from the sale of a capital asset, and from the disposition of property that is neither inventory nor held primarily for sale to customers. Goodwill and equipment both fall outside self-employment tax on that basis, even though the equipment gain is taxed at ordinary rates as recapture. Two things do not get the exclusion: inventory, which is expressly carved out of it, and any amount paid for post-sale services — a consulting or transition agreement is compensation for work, and it carries the full self-employment tax.

Can I use an installment sale when I sell my business?

Yes for most of it, but not for the recapture. Section 453(i) requires that recapture income — the amount that would be ordinary under section 1245 or 1250 — is recognised in full in the year of disposition, with only the gain in excess of recapture spread under the installment method. The practical consequence catches sellers hard: if you sell for $20,000 down and the rest over four years, you may still owe tax on the entire equipment recapture in year one, from a fraction of the cash. Model the first-year tax against the first-year cash before agreeing to seller financing.

Authoritative References

• IRS — Instructions for Form 8594, Asset Acquisition Statement
• IRC §1060 — Special Allocation Rules for Certain Asset Acquisitions
• IRC §197 — Amortization of Goodwill and Certain Other Intangibles
• IRC §453 — Installment Method
• IRC §1402 — Definitions (Net Earnings From Self-Employment)
• IRS — About Form 4797, Sales of Business Property
• IRS — Sale of a Business

You Cannot Negotiate an Allocation You Cannot Substantiate

Every number in this guide runs off one input: the original cost and accumulated depreciation of each asset the buyer is acquiring. Without that, you cannot compute recapture, you cannot price the buyer's schedule, and you cannot argue for a dollar more in Class VII. Sellers routinely discover this in the middle of a deal, years after the receipts went missing.

CentSense keeps every equipment purchase scanned, dated, and searchable from the day you buy it, so the asset history exists long before anyone asks for it. Start free with 10 AI scans a month, no credit card; the Solo plan ($5/month) adds unlimited scanning and mileage tracking.

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This article is educational and not tax or legal advice. Business sales are fact-specific, and allocation, recapture, and installment treatment can turn on details not covered here. Confirm current rules at irs.gov and engage a qualified tax professional before signing a purchase agreement.