Updated July 29, 2026. Quick answer: Treas. Reg. §1.338-6(b)(2)(iii) defines Class III as mark-to-market assets and debt instruments “(including accounts receivable)”. That parenthetical decides a great deal: receivables absorb purchase price at full fair market value three classes before anything reaches Class VII goodwill. For a cash-basis service business, that is the difference between a capital-gain sale and an ordinary-income one.
Why the parenthetical is the whole thing
Every summary of the seven classes writes Class III as “debt instruments” and moves on. Read the text and receivables are named inside it. Because the waterfall fills each class at fair market value in order, a large receivables balance is not a rounding item — it is consideration removed from the pool before Class V, VI and VII see any of it.
The cash-basis seller is the case that bites. A professional practice or service business that never took the receivables into income now sells them. The allocation pushes a substantial slice of the price into Class III, and that slice does not behave like the goodwill the seller was picturing when the headline number was agreed. The time to notice is while the allocation is being drafted, not on the return.
What Class III does not include
The regulation carves out three categories by name: debt instruments issued by persons related to the target under §267(b) or §707; contingent debt instruments subject to the cited regulations, unless they meet the stated exceptions; and debt instruments “convertible into the stock of the issuer or other property.” Anything ejected from Class III falls to Class V, which is defined purely by exclusion.
Neighbouring classes are also wider than their labels. Class IV is not just shelf inventory — it reaches “property held by the taxpayer primarily for sale to customers in the ordinary course of its trade or business.” And Class II pulls in certificates of deposit and foreign currency “even if they are not actively traded personal property” while pushing out stock of target affiliates. Each of those movements changes what is left for goodwill.
The mechanism behind all of it is the ordering rule — the classes are filled in sequence and goodwill is the residual. And what the allocation produces in ordinary income feeds straight into what gets taxed in year one.
Sources
IRC §1060; Treas. Reg. §1.338-6(b)(1), (b)(2)(i) through (b)(2)(vii) and (b)(3); IRC §197; IRC §1092(d)(1); IRC §1221(a)(1). All read July 2026.
This states what the cited authority says. It is not tax or legal advice. A business sale turns on the entity type, the deal documents and the allocation actually agreed, none of which a page can see, and the numbers here are structural rather than yours.